London Australia Investment Co Ltd v Federal Commissioner of Taxation

[1977] HCA 50

HIGH COURT OF AUSTRALIA

Barwick C.J., Gibbs and Jacobs JJ.

LONDON AUSTRALIA INVESTMENT CO. LTD. v. FEDERAL COMMISSIONER OF TAXATION

(1977) 138 CLR 106

20 September 1977

Income Tax (Cth)

Income Tax (Cth)—Assessable income—Profit arising from sale of property acquired for purpose of profit-making by sale—Profit arising from carrying on or carrying out profit-making undertaking or scheme—Gross income—Investment company—Profits from sales of shares—Shares not acquired for purpose of sale at profit—Shares sold to maintain consistent yield on capital and increase liquidity—Whether profits assessable—Bonus shares—Sale—Profit—Calculation—Income Tax Assessment Act 1936 (Cth), ss. 25 (1)*, 26 (a) **. * Section 25 (1) of the Income Tax Assessment Act 1936 (Cth) provides, so far as is material: "The assessable income of a taxpayer shall include—(a) where the taxpayer is a resident—the gross income derived directly or indirectly from all sources..." ** Section 26 (a) provides: "The assessable income of a taxpayer shall include—(a) 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".

Decisions

1977, September 20.
The following written judgments were delivered: -
BARWICK C.J. The appellant is an investment company incorporated in New South Wales with a shareholding predominantly held by residents of the United Kingdom. It did not carry on any business in Australia other than investment in Australian companies with a view to the production of an income from dividends. A full description of its manner of operating its investment policy is to be found in the carefully expressed judgment of Helsham J. from which these appeals are brought. It suffices for my present purpose to say that the appellant, with the advice and recommendation of an Australian management company which managed its affairs in Australia, pursued a policy of endeavouring to maintain a consistent yield on its capital invested in shareholding in Australian companies. It did not purchase or otherwise acquire shares in order to make a profit by their resale. But, in order to maintain the desired yield, it was advisable if not indeed necessary from time to time to realize shares which, by reason of changes in market value or dividend paid, ceased to provide that yield. A share of which the market value substantially increased would have a diminished yield unless in the unlikely event its dividend rate commensurately increased. Upon realization of such a share in order to maintain a consistent yield, an excess over the cost of the share could result. But, as the learned primary judge found, this was not a result sought by the appellant or its advisers for its own sake. Indeed, the appellant's articles of association precluded the use of any such excess for the payment of dividends to shareholders. Sums so obtained must be held in an equalization account designed to protect the invested capital. From this account amounts could be carried in the discretion of the board to a capital reserve. An excess in recovery or a deficiency in recovery were similarly treated. Dividends were payable only out of the income derived from dividends received on shares held by the appellant. (at p110)

2. Also in pursuance of its investment policy, occasions arose for the appellant to increase its liquidity. For this purpose, realizations of shareholdings were effected. The difference between recovery on disposal and cost on such operations was placed in the equalization fund to provide for diminution in value of capital assets. (at p110)

3. In consequence of the pursuit of its investment policy, the appellant bought and sold shares on a considerable scale from the time of its commencement in 1957. But in the tax years 1967, 1968 and 1969, there was a large surplus in recovery because of very substantial realizations, principally because of dramatic increases in market values in those years of shares in which the appellant had invested. The consequential fall in yield had caused the appellant to sell, a course which resulted, in the years in question, in an excess in recovery in each of the years as follows: 1967, $816,651; 1968, $140,166; and 1969, $413,263. The respondent Commissioner included these sums as assessable income in making his assessment for each of those years. The appellant's objections to the assessments were disallowed and the subsequent appeals to the Supreme Court of New South Wales rejected (1974) 23 FLR 89; 4 ALR 44; 4 ATR 638; 74 ATC 4213 . (at p111)

4. The Supreme Court (Helsham J.), having heard oral evidence, expressly found that the appellant had not acquired any of the shares realized in those years for the purpose of profit-making by sale. He also found that none of the sums I have mentioned constituted a profit from the carrying on or carrying out of a profit-making undertaking or scheme. He thereupon held that the several sums did not constitute assessable income by dint of s. 26 (a) of the Income Tax Assessment Act 1936, as amended ("the Act"). This conclusion, well reasoned and expressed, is, in my opinion, acceptable and beyond challenge. (at p111)

5. But the Court found that, none the less, the several sums were properly included in the appellant's assessable income by virtue of s. 25 of the Act; that they formed part of the income of a business carried on by the appellant. He held that, in the years in question, it was "an integral part of the appellant's business to deal in shares, in the sense that switching of investments was desirable to produce the best dividend returns, indeed was necessary if the appellant's policy of investing in shares with growth potential was to be adhered to". I might here interpolate that his Honour had accepted as fact that the appellant's interest in growth potential was an interest in increase in dividend and not in an increase in market value. His Honour approximated the business of the appellant to that of a bank or insurance company in relevant respects. (at p111)

6. I begin my consideration of these appeals on the footing that none of the individual transactions which produced the sums in question fell within either branch of s. 26 (a). It was part of the reasoning which resulted in that finding that the sales were effected in pursuance of an investment policy wedded to securing a particular yield by dividend. Indeed, the Supreme Court was given the detailed reasons for the realization of the particular shares and the relationship of those reasons to the settled investment policy of the appellant and, as I read his Honour's reasons, those reasons were accepted by him. (at p111)

7. It must appear, certainly at first sight, extremely odd that an accretion to capital derived from the sale of an asset, not forming part of circulating capital and not purchased or held as a trading asset, should be accounted income. But the question is whether, none the less, the decisions and settled doctrine in the law of income tax required such a conclusion. Discussion of the subject usually begins with a citation of the remarks of the Lord Justice Clerk in California Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 Tax Cas 159, at p 166 . The oft citation of the truism there expressed has given it a delphic significance. But, in truth, what was there said furnishes no criterion for determining such a question as is now before this Court in this case. Of course, what is produced by a business will in general be income. But whether it is or not must depend on the nature of the business, precisely defined, and the relationship of the source of the profit or gain to that business. Everything received by a taxpayer who conducts a business will not necessary be income. As I have said, it must depend on the essential nature of his business and the relationship of the gain to that business and its conduct. (at p112)

8. In holding that gains upon the realization of securities by banking and insurance companies constitute income by the banking or insurance business, the Court relied upon the particular nature of those businesses and the relationship which investment realization bore to that nature: see Commissioner of Taxation v. Commercial Banking Co. of Sydney (1927) 27 SR (NSW) 231 , Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946) 73 CLR 604 : see the group of cases referred to by Menzies J. in Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation (1959) 100 CLR 502 . In high contrast, the Court in Charles v. Federal Commissioner of Taxation (1954) 90 CLR 598 held that such realization did not form part of the income of the unit trust business conducted by the taxpayer. The Court accepted that the switching or realization of investments was not part of the particular investment business conducted by the unit trust company. No doubt the switching or realization was incidental to that business and occurred because of the exigencies of that business. But as trafficking in shares did not form part of that business, the gains or losses were not income gains or losses. Having regard to the findings of the primary judge in this case, it is worth noting that a decisive factor in arriving at the Court's conclusion was the fact that the realized shares were not bought for profit-making by resale (1954) 90 CLR, esp at p 610 . (at p112)

9. That the appellant carried on investment in Australian shares as a business or business activity cannot be doubted. The essence of that business was the receipt of dividends in order to service the dividend to be paid by the appellant to its United Kingdom shareholders. Quite clearly, it was no part of that business to traffic in shares. Accordingly, no shares were acquired with the purpose of making profit by their resale. But, as the maintenance of the subscribed capital and of a consistent yield upon it was also of the essence of the company's business, realization of shares from time to time became necessary or advisable. Market conditions and the fortunes of companies in which shares were held determined whether or not realization should occur. Those realizations could be said, in my opinion, to be a result of the nature of the company's business but no part of that nature. It would indeed be surprising, in my opinion, if the company could successfully claim as deductions from its dividend income losses incurred by it on realization of unwanted investments. The facts in Commissioner of Taxation v. Commercial Banking Co. of Sydney (1927) 27 SR (NSW) 231 are in contrast to those in this case. The Court in that case could properly say that "the money used was part of the" bank's "stock in trade, it was used in an operation of business, and it was used in carrying out the" bank's "scheme of profit making as a banker". Here, quite clearly, the realized shares did not form part of the appellant's stock in trade or of any circulating capital. The money invested in them formed part of the capital of the appellant, capital derived from the subscription of shareholders except to the extent that possibly some part of the equalization account had at some stage been carried to capital reserve. But, in that event, the augmentation was contingent and problematical. Subsequent losses on realization may reduce that accretion: indeed may fully absorb it. (at p113)

10. In my opinion, nothing in the banking and insurance cases included in the references I have made requires the conclusion that the gains or losses on realization of shares by this company formed part of, or in the case of a loss, a reduction of, its assessable income. I have included in the references I have made the decision in Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation (1959) 100 CLR 502 . For present purposes I am prepared to treat that decision as explicable on the footing that the investment in the real estate by the taxpayer was part of the nature of its particular business of insurance. There may be good reasons, in my opinion, for doubting that conclusion but it is unnecessary for me in the decision of this case to pursue that matter. On the other hand, the reasoning of the Court in Charles v. Federal Commissioner of Taxation (1954) 90 CLR 598 supports the view that such a conclusion should not be drawn in this case. If analogy is of any assistance to decision in this kind of case, the investment policy outlined in the reasons for judgment in Charles v. Federal Commissioner of Taxation bears a striking similarity to the investment policy evidenced and accepted in this case. (at p114)

11. In my opinion, the gains or losses in realization of shares by the company accumulated by pursuit of its investment policy cannot properly be brought to account in determining the assessable income of the company. The appeals should be allowed. (at p114)

GIBBS J. The principal question for decision in these three appeals is whether the Commissioner was right in including in the taxpayer's assessable income for the years 1967, 1968 and 1969 the respective amounts of $816,651, $140,166 and $413,263 which represent the difference between the net proceeds of the sale of shares sold by the taxpayer in each of those years and the average cost to the taxpayer of the shares. If the Commissioner was entitled to include in the assessable income the surplus resulting from the sales of the shares, the taxpayer does not challenge the manner in which the amount of the surplus has been determined. The question was whether the surplus was correctly treated as income. (at p114)

2. The facts of the case have been fully stated in the judgment of Helsham J. in the Supreme Court (1974) 23 FLR 89; 4 ALR 44; 4 ATR 638; 74 ATC 4213 and it will be sufficient if I state them shortly. The taxpayer is an investment company whose shareholders were mostly residents of the United Kingdom. Its principal object was to invest mainly or wholly in Australian securities, for the purpose of producing dividend income which it could distribute to its shareholders. The taxpayer in fact held a large portfolio of Australian shares. During the years in question the directors of the taxpayer met each month to decide whether shares should be bought or sold, and during that period, as Helsham J. found, the taxpayer engaged in a continuous large scale activity in the buying and selling of shares. In deciding what shares should be bought, sold or retained the taxpayer was guided by a number of principles, but one important consideration in buying shares was that the shareholding should immediately or within a reasonable time produce a dividend yield of four per cent or better. The dividend yield is the return on the shares calculated as a percentage of their market value. In buying shares the taxpayer was influenced by their "growth potential", that is, the expectation that they would produce a greater dividend yield. Although a share which is likely to produce an increased dividend is for that very reason likely to increase in value, the taxpayer never bought shares for the purpose of profit-making by sale, or with the intention of selling them, or simply because their market value was likely to increase. It bought shares to hold as an investment to yield dividends, but it foresaw that it was likely that the shares would increase in market value, and of course hoped that this would occur. If the shares did increase in value, but the dividend rate did not correspondingly increase, the dividend yield would fall, and the taxpayer would then be likely to sell the shares. In the years in question there was a steady rise in share prices and in consequence the dividend yield of many shares held by the taxpayer fell and many shares were sold. The shares sold in each of the years in question exceeded a million dollars in value and amounted to at least one-tenth of the total value of the shares held in that year. The moneys realized on the sale of the shares were not under the articles of the taxpayer available for dividend but could be used to buy further shares or to make up a future capital loss. (at p115)

3. Helsham J. found that the main or dominant purpose actuating the acquisition of the shares was not profit-making by sale. He further said that he did not believe "that the profits obtained from a continuity of the business activity of the appellant over three years fall within the concept of profit arising from the carrying on or carrying out of any profit-making undertaking or scheme". He added that "the cases relating to the circumstances in which this basis of assessment is to be applied are reviewed by Stephen J. in his reasons for judgment" in Williams v. Federal Commissioner of Taxation (1972) 128 CLR 645 . He accordingly held that the surpluses did not fall within s. 26 (a) of the Income Tax Assessment Act 1936, as amended. But he held that they were properly treated as income within s. 25 of the Act. (at p115)

4. When a taxpayer sells one of its investments, the question whether the profit on the sale should be treated as capital or income is to be answered by applying the tests stated in Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 Tax Cas 159, at pp 165-166 , in a passage which has constantly been cited, or repeated, with approval; see, e.g., Commissioner of Taxes (Vict.) v. Melbourne Trust Ltd. (1914) 18 CLR 413, at pp 420-421 ; Ruhamah Property Co. Ltd. v. Federal Commissioner of Taxation (1928) 41 CLR 148, at pp 152, 165 ; Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation (1959) 100 CLR 502, at p 506 and White v. Federal Commissioner of Taxation (1968) 120 CLR 191, at p 222 . The principle was stated as follows in Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946) 73 CLR 604, at p 614 :

"Prima facie the depreciation in or accretion to the capital value of a security between the date of purchase and that of realization is a loss of or accretion to capital and is therefore a capital loss or gain and does not form part of the assessable income ... But in the words of the Lord Justice Clerk in Californian Copper Syndicate v. Harris (1904) 5 Tax Cas, at p 166 which have been so often quoted, 'it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business'."

Their Honours went on to point out that not all of the proceeds of a business carried on by a taxpayer are income for the purposes of the Act; they will be so only if they are income "in accordance with the ordinary usages and concepts of mankind, except in so far as the Act states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income" (1946) 73 CLR, at p 615 . However it is in my opinion established by this and the many other cases in which Californian Copper Syndicate v. Harris has been applied that if the sale in question is a business operation, carried out in the course of the business of profit-making, the profit arising on the sale will be of an income character. To apply this criterion it is necessary "to make both a wide survey and an exact scrutiny of the taxpayer's activities": Western Gold Mines N.L. v. Commissioner of Taxation (W.A.) (1938) 59 CLR 729, at p 740 . Different considerations may apply depending on whether the taxpayer is an individual or a company. In the latter case it is necessary to have regard to the nature of the company, the character of the assets realized, the nature of the business carried on by the company and the particular realization which produced the profit: Hobart Bridge Co. Ltd. v. Federal Commissioner of Taxation (1951) 82 CLR 372, at p 383 citing Ruhamah Property Co. Ltd. v. Federal Commissioner of Taxation (1928) 41 CLR, at p 154 . (at p116)

5. In the present case the taxpayer naturally placed considerable reliance on the finding that the shares were not bought for the purpose of selling them at a profit. That is indeed an important circumstance. It was then submitted that the shares were acquired on the capital account of the company, for the purpose of adding to its profit-making structure, as the means of producing dividend income, rather than as part of the profit-earning activities within that structure, and amongst other cases National Bank of Australasia Ltd. v. Federal Commissioner of Taxation (1969) 118 CLR 529, at p 538 was cited in support of that view. If that submission were correct, the fact that the shares were realized in a methodical and enterprising way, so as to secure the best results for the taxpayer, would not convert the proceeds of realization into income. But the question whether the shares were acquired on the capital account of the taxpayer can only be answered by applying the tests indicated by Californian Copper Syndicate v. Harris (1904) 5 Tax Cas 159 . Helsham J. found that during the three years in question it was an integral part of the taxpayer's business to deal in shares, in the sense that switching of investments was desirable to produce the best dividend returns and was indeed necessary if the taxpayer's policy of investing in shares with growth potential was to be adhered to. In my opinion it is impossible to controvert that finding; it was clearly right. Although the company's business was to invest in shares with the primary purpose of obtaining income by way of dividends, the conduct of the investment business required that the share portfolio should be given regular consideration, and that shares should frequently be sold when the dividend yield dropped, which for practical purposes usually meant when the shares went up in value. The taxpayer systematically sold its shares at a profit for the purpose of increasing the dividend yield of its investments. The sale of the shares was a normal operation in the course of carrying on the business of investing for profit. It was not a mere realization or change of investment. (at p117)

6. The present case is in my opinion indistinguishable from the decision in Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation. The material facts of that case appear in the judgment of Starke J. at first instance. His Honour said (1946) 73 CLR, at p 606 :

"The general manager of the Society said, in his evidence, that the general policy of the Society was to hold its securities as investments and not to traffic in or to make a profit from realizing them and that the governing consideration in purchasing stocks or debentures or varying or 'switching', as it is called, its investments in such securities was to increase its effective interest yield. I see no reason to doubt the accuracy of this statement."

Nevertheless it was held that the profits were taxable. On behalf of the taxpayer it was submitted that the decision in Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation, and in other cases such as Punjab Co-operative Bank Ltd., Amritsar v. Income Tax Commissioner, Lahore (1940) AC 1055 ; Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation (1959) 100 CLR 502 and Commissioner of Taxation v. Commercial Banking Co. of Sydney (1927) 27 SR (NSW) 231 depended on the special nature of the business of banking or insurance which the taxpayer carried on. With all respect I cannot agree. In all those decisions the test suggested in Californian Copper Syndicate v. Harris (1904) 5 Tax Cas 159 was applied. That test is applicable to any business, and if the sale of the shares is an act done in what is truly the carrying on of an investment business the profits will be taxable just as they would have been if the business had been that of banking or insurance. (at p118)

7. The position of an investment company is materially different from that of an individual managing his own portfolio of shares. It is different also from that of a trustee managing a portfolio of shares in a trust fund. In Charles v. Federal Commissioner of Taxation (1954) 90 CLR 598 the moneys said to be taxable were received by the beneficiaries of a unit trust and derived from the realization of investments held by the trustees. Evidence was given that at no time were securities acquired for the express purpose of resale at a profit, and that sales were normally made when the managers anticipated a fall in the value of shares (1954) 90 CLR, at p 610 . The Court held that the case was distinguishable from such cases as Punjab Co-operative Bank Ltd., Amritsar v. Income Tax Commissioner, Lahore (1940) AC 1055 and Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946) 73 CLR 604 . Their Honours referred to the evidence already mentioned and said (1954) 90 CLR, at p 612 :

"According to that evidence, the moneys in question arose, not (as in the cases cited) from transactions forming incidents in the conduct of a business or a profit-making scheme, but from transactions effected in the course of performing a fiduciary duty to preserve for beneficiaries as far as practicable the assets comprising the trust fund and any increments in the value of those assets which might appear from time to time to be in jeopardy. The case therefore differs fundamentally from the cases relied upon by counsel for the commissioner."

That passage reveals the distinction between that case and the present. (at p119)

8. The finding of Helsham J. that the profits did not fall within the second branch of s. 26 (a) at first sight appeared to create a logical difficulty for the Commissioner because in situations such as the present it is sometimes suggested that s. 25 and the second branch of s. 26 (a) provide alternative methods by which profits may be brought to tax. However in the case which Helsham J. cited, Williams v. Federal Commissioner of Taxation, Stephen J. (1972) 128 CLR, at pp 653-654 , cast doubt on this view, and referred to a number of cases in which it has been said that s. 26 (a) has quite a distinct field of operation from that covered by the conventional method of assessment, and that the latter method applies where the profit is made in the course of the ordinary business of the taxpayer. Although Helsham J. did not elaborate on his finding, it seems to me that he intended to hold that the profits did not fall within the second branch of s. 26 (a) because they were made in the course of the taxpayer's business as a whole, rather than in the course of some special or isolated transaction. It is unnecessary to examine that question further, for it is clear that Helsham J. did not intend to hold that the profits were not made in the course of a business. It was common ground that the taxpayer was carrying on the business of investing, for the purpose of producing income, and the question was whether the buying and selling of the shares was done as part of that business; Helsham J. expressly found that it was. The resulting profits were therefore profits of the business and income within ordinary usages and concepts, and fell within s. 25. (at p119)

9. For the reasons I have given, in my opinion Helsham J. was correct in holding the profits made on the sale of the shares to be assessable income and the main argument advanced on behalf of the taxpayer should fail. (at p119)

10. The second question raised by the appeal was whether in calculating the amount of the surplus, Helsham J. was wrong in failing to take into account anything in respect of the cost of shares acquired as the result of a bonus issue and later sold. It was conceded on behalf of the Commissioner that in this respect the judgment was not consistent with the decision of this Court in Curran v. Federal Commissioner of Taxation (1974) 131 CLR 409 (which had not been given at the time Helsham J. delivered judgment) and to that extent the appeals must be allowed. (at p119)

11. I would allow the appeals and would order that the assessments be remitted to the Commissioner for amendment. I would allow the appellant one-half of its costs of the appeals to Helsham J. but would order the appellant to pay the costs of the appeals to this Court. (at p120)

JACOBS J. The appellant company was incorporated in New South Wales in 1957. Capital in the company was in the year of its incorporation subscribed to the extent of one million pounds divided into 1,000,000 shares of one pound each. At all times material to the question presently before the Court, the subscribed capital was $7,500,000 divided into ordinary stock units of $1 each. The primary object of the company was stated in cl. 3 (1) of the memorandum of association as follows:

"(1) To carry on the business of an investment trust company and to acquire and hold shares, stocks, debentures, debenture stocks, bonds, obligations, securities and evidences of indebtedness or of the right to participate in profits or assets or other similar documents issued or guaranteed by any company wheresoever constituted or incorporated, or by any government, sovereign ruler, commissioners, public body or authority, supreme, municipal, local or otherwise, whether at home or in any other part of the world and any options or rights in respect thereof and to buy and sell foreign exchange." (at p120)

2. The company was not listed on any stock exchange in Australia but at some time after July 1960 it was listed on the London Stock Exchange. The shareholders in the company were mostly residents of the United Kingdom. The company did not at any relevant time have a place of business in Australia and it had no employees in Australia. Its affairs were managed by a management company in this country, at first by Anglo-Australian Corporation Pty. Ltd. and later by Australian United Corporation Ltd. (at p120)

3. The subscribed capital of the company was for the most part invested in the ordinary shares of Australian companies, mostly those whose shares were quoted on Australian stock exchanges. The management company provided advice and recommendations to the appellant company on its investments and generally provided management services including accounting and secretarial services. (at p120)

4. A company such as the appellant was of particular interest to shareholders resident in the United Kingdom because there were particular tax benefits which could be obtained by such residents in respect of income received from dividends declared by such a company to the extent that those dividends were derived from the distribution to the company of dividends from Australian companies whose source of income was outside the United Kingdom. The same advantage did not exist in so far as dividends of such a company were declared out of profits other than the dividends of such Australian companies. (at p121)

5. There was provision in the articles of association of the appellant company which precluded the distribution of profits by way of dividend to the extent to which the profit represented money realized on the sale or payment off of any capital asset of the company in excess of the price at which the asset should stand in the books of the company. Such moneys were required to be carried to the credit of an account called "Provision for diminution in value of capital assets" and thereafter at the discretion of the directors to a reserve called the "Capital Reserve". (at p121)

6. Over the years the company bought and sold shares in Australian companies. It commenced so to do in 1957. The years with which the present three appeals are concerned are the calendar years 1967, 1968, and 1969, the appellant's accounting and tax years being the calendar years. In each of these years there was a surplus of gains over losses arising from the sale of shares, and the respondent Commissioner included this surplus in the assessable income of the appellant in each year. The method of calculation of gains and losses was not based on the difference between actual purchase price and actual sale price of any particular parcel of shares but was based on the difference between the latter and the average purchase price of the particular class of shares in the particular company. No question arises on these appeals on the correctness or otherwise of this method of calculation. The surplus of gains over losses in respect of the 1967 year was $816,651, of the 1968 year $140,166 and the 1969 year $413,263. (at p121)

7. The appellant objected to the inclusion of these surpluses in its assessable income; its objections were disallowed, and it appealed to the Supreme Court of New South Wales. Helsham J. upheld the assessments (1974) 23 FLR 89; 4 ALR 44; 4 ATR 638; 74 ATC 4213 and it is from his decision that these appeals are brought. (at p121)

8. The hearing before Helsham J. occupied some days and in his reasons for judgment upholding the assessments the learned judge reviewed the evidence at length and expressed his conclusions thereon with analysis of the legal questions arising. His detailed expression of his conclusions on questions of fact and his analysis of the legal conclusions flowing therefrom is of great assistance and considerably simplifies the task of this Court. The questions which the learned judge decided were, broadly speaking, as follows. Had the shares which were sold at a profit in each of the subject years been acquired by the appellant company for the purpose of resale at a profit or as part of a profit-making undertaking or scheme? If not, were the purchase and sale of the shares part of a business of purchasing and selling shares whereby profits from that activity were income of the appellant company within s. 25 of the Income Tax Assessment Act? An alternative framing of the latter question is whether the incomings and outgoings on sale and purchase of shares were incomings and outgoings under s. 25 and s. 51 of the Act respectively. (at p122)

9. It was necessary for Helsham J. to determine the purpose or purposes of the appellant company at the time of acquisition of the various shares and whether that determination disclosed that the shares which were sold at a profit had been acquired by the company for resale at a profit within the meaning of those words in s. 26 (a) of the Income Tax Assessment Act. In addition to much documentary evidence, he had the oral evidence of Mr. Harper who as an employee of the first management company, Anglo-Australian Corporation Pty. Ltd., and as general manager of the second management company, Australian United Corporation Ltd, and as director of the appellant company since 1962, was accepted by the learned judge as being in a strong position to give evidence on the course of business of the appellant and on the policies and purposes guiding the directors of the appellant. He also had the evidence of Mr. MacKinnon who during the years 1967 to 1969 was the portfolio manager of the second management company. He had previously been on the staff of the first management company. Much depended upon whether or not these witnesses, particularly Mr. Harper, were believed on the question whether the shares which were sold during the relevant years had been acquired by the appellant company for the purpose of resale at a profit within the meaning of those words in s. 26 (a). Helsham J. accepted the evidence of Mr. Harper that they had not been so acquired. This finding of fact must be accepted and it makes it unnecessary to review all the reasons given by his Honour in the course of reaching this conclusion. It is sufficient to go to his conclusions upon this question. It is convenient to use the language of Helsham J. in his conclusions with the omission of his discussion of the evidence which led to those conclusions. (at p122)

10. The company was an investment company, the primary object of its investment activities being to produce dividend income which it could distribute to shareholders. In order to produce this income, the appellant invested in a number of shares in listed public companies in Australia from which it hoped or expected it could immediately or within a reasonable time obtain a dividend yield of four per cent or better. Dividend yield here means return on shares calculated as a percentage of their market value. The total of the company's investment holdings was known as its share portfolio. Certain considerations governed the makeup of the appellant's share portfolio. One was the holding of an adequate number of shares in any company in which an investment was made so that adequate supervision of the assets of the appellant could be ensured. Another consideration governing the makeup of the company's share portfolio was a requirement that shares held should be readily marketable so that they could be disposed of in the event that a change of investment became necessary or desirable. It was an aspect of marketability that investments should be made in companies, the market value of whose shares were not likely to decline. Another consideration was that a proportion should be kept in the holding between various companies and the appellant aimed at not permitting any one holding to exceed about five per cent of its total investment. Another consideration was the earning yield of the companies in whom investment was made. It was desirable that companies in which shares were held should have current earning yields of one and one and a half to two times dividend yield so that dividends were adequately covered. A result of this investment emphasis and policy was that the appellant was always interested in growth potential of shares and Helsham J. was satisfied that the company was interested in shares with growth potential in the sense that that expression was defined by Mr. Harper as "potential for growth in income from dividends". His Honour realized that growth potential looked at in this way was very much the same thing as potential for increasing in market value. He discussed this aspect and concluded (1974) 23 FLR, at p97; 4 ALR, at p52; 4 ATR, at pp 644-645; 74 ATC, at p 4220. :

"Notwithstanding all this, I am quite satisfied that to this company in relation to decisions about shares, growth potential meant the expectation of greater dividend yield, and that one of the considerations motivating purchase of shares by it was the growth potential of those shares in this sense. Equally, I am satisfied that the prospect of an increase in capital value alone was not a factor which guided the Board of the company in the purchase of shares. Both Mr. Harper and Mr. McKinnon have sworn that shares were never bought by the company for the purpose of profit-making by sale, or for the purpose or with the intension of selling them; nor were they bought with the expectation of increase in market value as the sole reason for purchase. I accept their evidence." (at p124)

11. His Honour then further discussed the relationship between the policy adopted and what he described as the inevitable increase in market value. The word "inevitable" has been criticized but clearly his Honour meant extreme likelihood or practical certainty and so read his statement is correct when account is taken of the economic or market climate of the time. His Honour proceeded in his reasons as follows (1974) 23 FLR, at pp 97-98; 4 ALR, at pp 52-53; 4 ATR, at p 645; 74 ATC, at p 4220. :

"With the type of shares that the company chose to invest in, and the market climate that existed in 1967, 1968 and 1969, sales of shares did take place, the capital base of the company was enlarged, and the dividend income increased. I have already referred to the figures showing an increase in shareholders' funds in the three years; the corresponding dividend income was $478,406 for 1967, $515,314 for 1968 and $546,233 for 1969. But notwithstanding this I accept what Mr. Harper says, namely that the purpose of selling and buying shares was the improvement of the dividend return to the company from the capital employed in producing it. I think one can summarise this evidence by stating that the relevant business of the company consisted of investing money in shares for the purpose of producing income to be paid as dividends to shareholders, safety and preservation of capital being a factor that influenced investment policy, but the underlying or basic factor being the use of shareholders' funds for the acquisition and retention of satisfactory income-producing shares. The law must be applied to a business of this nature in order to determine its tax liability." (at p124)

12. Helsham J. next examined the scale of the company's purchases and sales of shares. He concluded that there was over the period in question a continuous large scale activity in the buying and selling of shares. This can hardly be disputed. There were purchases in every month and sales in every month except three. The yearly figures were as follows:
1967 Purchases $1.470,182.98

Sales 2,062,610.27

1968 Purchases 1,700,408.97 Sales 1,816,086.21

1969 Purchases 1,248,730.61 Sales 1,114,472.42

The total funds in share investments at cost in each of the three years were as follows:

1967 $9,813,896 1968 9,879,229 1969 10,530,040

Then his Honour stated (1974) 23 FLR, at p 99; 4 ALR, at p 54; 4 ATR, at p 646; 74 ATC, at p 4221. :

"But it is proper to reiterate that the investment policy considered by the Board best suited to further the interests of this investment company required this amount of buying and selling, and that sales and purchases of shares by the appellant were geared to dividend yield, and that the decisions were made with the object of ensuring the best dividend return upon the capital available pursuant to an investment policy I have tried to explain." (at p125)

13. Before Helsham J. the respondent Commissioner had pointed to certain apparent exceptions to the company's underlying policy of share investment and to the dealings in fourteen companies in particular. His Honour examined the evidence and, relying largely on the evidence of Mr. Harper, he declined to regard the apparent exceptions as falling into a special category. Next he examined the evidence relating to the rise over the relevant years in the All Ordinaries Index. He concluded (1974) 23 FLR, at pp 101-102; 4 ALR, at p 56; 4 ATR, at p 648; 74 ATC, at p 4223. :

"I think the state of the market is one factor explaining the course of business adopted by the appellant, and I have taken it into account in reaching the conclusions I have reached as to what the company was doing and why it was doing it."

Then he examined the effect if any on his conclusions of a change in activities in 1967 brought about by the suggestions of Sir Maurice Hutton, then a director of the appellant company. He concluded: "...the Hutton activities did not yield profits that come into any category of income different from that made by the company on its other disposals of shares." (at p125)

14. Helsham J. then proceeded to his ultimate conclusions from the findings of fact which he had made. He stated (1974) 23 FLR, at pp 103-104; 4 ALR, at p 58; 4 ATR, at p 650; 74 ATC, at p 4224. :

"By reason of my findings the share dealings over the three years cannot be fragmented and dealt with separately but must be looked at as a whole. And taken as a whole I have found that the shares were not property acquired by the taxpayer for the purpose of profit making by sale; this was not the main or dominant purpose actuating the acquisition of the shares (see per Gibbs J. in Jacob v. Federal Commissioner of Taxation (1971) 45 ALJR 568, at p 569). Nor do I believe that the profits obtained from a continuity of the business activity of the appellant over three years fall within the concept of profit arising from the carrying on or carrying out of any profit-making undertaking or scheme." (at p126)

15. Helsham J. here refers to "main or dominant" purpose and it is clear that he has directed his mind to the application of s. 26 (a). His earlier finding wherein he accepted the evidence of Mr. Harper and Mr. MacKinnon that shares were not bought for the purpose of profit-making by sale, or for the purpose or with the intention of selling them or "with the expectation of increase in market value as the sole reason for purchase", was likewise clearly directed to the same question, the applicability of s. 26 (a). (at p126)

16. The learned primary judge then set out the further rival contentions of the taxpayer and the Commissioner - on the one hand that the company was not trading in shares and on the other hand that buying and selling of shares was part of the regular business of the company resulting in a gain to the company and that the activities of the company were directed to a composite gain which was income. Having discussed certain of the authorities, Helsham J. came to his final conclusion which he expressed as follows (1974) 23 FLR, at p 108; 4 ALR, at p 62; 4 ATR, at pp 653-654; 74 ATC, at pp 4227-4228. :

"It was, during the three years in question, an integral part of the appellant's business to deal in shares, in the sense that switching of investments was desirable to produce the best dividend returns, indeed was necessary if the appellant's policy of investing in shares with growth potential was to be adhered to. I find it not relevant in this case to assert that the business of the appellant was an investment business with securities as its very capital, its structure, as it was put, and therefore different from a bank or assurance company, which could be said to be using its money through investment to assist its banking or assurance business - carrying on the business of investment within a banking or assurance structure; drawing a distinction between the profit yielding structure and the process of operating it may be useful as a means to solving some tax problems, but I do not believe it to be so here (cf. Sun Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337, at pp 359-360 per Dixon J., as he then was; Strick (Inspector of Taxes) v. Regent Oil Co. Ltd. (1066) AC 295). Nor is it relevant to talk of dominant purpose of investment, i.e. to provide a dividend, when considering the application of s. 25 of the Act. The fact is that the appellant as part of its business regularly and systematically bought and sold shares and used any favourable yield in its business; the evidence shows that a large part of the activities centred around the collation and assessment of materials and the making of decisions about share disposals, retentions, and purchases with a view to maintaining the optimum capital base or dividend return. In my view the taxpayer has not shown that the buying and selling of shares was no more than an incident in the business of producing dividends from investment in capital assets, something in the nature of a realization or change of investment only. Rather has it been shown that the activities of buying and selling were done as part of the business of the appellant in order to use to best advantage the shareholders' money; the profits which arise from such share movements are as much profits of the business as the income is; a layman would describe them in ordinary parlance as business profits of this investment company. So would I. The main attack upon the assessments therefore fails and the appeals are not to be upheld on this ground." (at p127)

17. The question for this Court is whether on the findings of fact made by the learned judge at first instance his conclusion was a correct one. It does not matter whether the conclusion is described as one of ultimate fact, or one of law or one of mixed fact and law. It is subject to review. However, it would be out of the question for this Court to displace any findings of primary fact, based as they were on the judge's acceptance of the credibility of witnesses before him. It is not suggested that we should do so. (at p127)

18. The starting point is that on the findings of fact made by Helsham J. the shares were not acquired for the purpose of resale at a profit within the meaning of those words in s. 26 (a) of the Income Tax Assessment Act. The first limb of s. 26 (a) is therefore not applicable. The questions still remain whether the profit arising from the acquisition and disposal of the shares is income being a profit arising from the carrying on of a profit making undertaking, the second limb of s. 26 (a), and whether there is income as a result of the application of s. 25 and s. 51. In the circumstances of the present case it is unnecessary to distinguish between these two questions. In each case the profit will only be income if it arose from the carrying on of a business undertaking. The identification and characterization of the business carried on by the taxpayer is the essential task. (at p127)

19. It may first be stated that the activity of the taxpayer must be identified as a business activity. If, otherwise than as part of a business of so doing, a man purchases a particular item of property primarily in order to enjoy it in specie or to enjoy the income from it, but at the same time expecting and intending that he will at some time in the future, if and when an opportune occasion presents itself, sell the item of property at a profit, the profit will not be taxable under the first limb of s. 26 (a). But if the dominant purpose is that of sale, then it will be. (at p128)

20. If the acquisition and disposal of property is part of a business of so doing, the position is significantly different. There must still be a purpose of resale because resale is part of the description of the relevant business, and, since business has in it the notion of profit-making rather than loss-making, there must no doubt be a purpose of resale at a profit. But the significant difference is that the purpose of resale need not be the sole purpose or the primary or dominant purpose, as is the case under the first limb of s. 26 (a). It need only be one of the purposes. And in this context the word "purpose" is hardly if at all distinguishable from intention or expectation. The dominant or primary purpose may be to obtain income from the items of property acquired but if there is a purpose or intention or expectation of selling at a profit if and when a suitable occasion arises then one condition of carrying on a business of buying and selling at a profit is satisfied. If a man makes a business of acquiring property with a dual purpose of enjoying it or its profits and of reselling it eventually at a higher price than he paid for it, then not only the income from the property but also the profit on resale will be income in the ordinary sense of the term, and within the second limb of s. 26 (a). (at p128)

21. Therefore, once profits on sale are found not to fall within the first limb of s. 26 (a), the determinant is the carrying on of a business, not any associated business in a general sense, but the specific business of acquisition with a purpose or intention or expectation of resale and subsequent resale with consequent profit. Though frequent activity of acquisition and resale does not necessarily signify a business, it is evidence from which it may be inferred that there is a business. First, the frequency of the activity may itself tend to show that it is not of a private or of a casual nature, but that rather the person is carrying on the activity as a business operation. Secondly, the frequency of the activity may enable the inference to be drawn, if the fact be in dispute, that there was a purpose or intention or expectation, at the time of acquisition, of dealing at a profit if and when a suitable occasion should arise. Nevertheless, it must be made quite clear that frequency of an activity is not synonymous with business. There may be no business despite frequency and on the other hand there may be a business where the activity is an isolated one. Every business must begin with an initial transaction. (at p129)

22. It is not possible exhaustively to enumerate the facts or circumstances which will support the inference that a course of activity is a business. I have referred to one. It would seem that a course of activity on the part of a company otherwise engaged in commercial activity may more readily be termed a business than one on the part of an individual but no great emphasis should be given to this feature. Cf. Western Gold Mines N.L. v. Commissioner of Taxation (W.A.) per Latham C.J. (1938) 59 CLR 729, at p 733 . The nature of the property acquired, e.g. trading stock, may be evidence that it is acquired as part of a business of acquisition and resale. (at p129)

23. A circumstance which appears to me to be of substantial significance is that referred to by Kitto J. in National Bank of Australasia Ltd. v. Federal Commissioner of Taxation (1969) 118 CLR 529, at p 537 :

"...what was recovered through the sale of the shares was circulating capital, and what ultimately was not recovered was a loss on revenue account just as any excess would have been an income profit: cf. Punjab Co-operative Bank Ltd., Amritsar v. Income Tax Commissioner, Lahore (1940) AC 1055 at p 1072 ; Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946) 73 CLR 604, at pp 608, 614 ; Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation (1959) 100 CLR 502 ;

Commissioner of Taxation v. Commercial Banking Co. of Sydney (1927) 27 SR (NSW) 231 ."
The cases referred to are some of what may be described as the "banking" and "insurance" cases, upon which naturally the Commissioner relies quite strongly on this appeal. But there is a significant difference between a banking or insurance business which involves investment activity and the course of investment activity in the instant case. The nature of a banking or insurance business, as part of its putting of money as circulating capital to use, involves not only occasional acquisition of property in satisfaction of advances, as in the situation to which Kitto J. was referring, but also and more commonly the purchase and sale of various kinds of property whereby moneys which are obtained as part of the business but which form no part of the original capital structure of the bank or insurance company, or of that structure enhanced by accumulated net profits, are put to use short term or long term. All profits arising from that activity are profits of the business of banking or insurance. At any time and from time to time the property acquired may need to be sold, in whole or in part, to meet the requirements of the banking or insurance business and the hope and expectation is that in the meantime not only will the property have earned income but that it will have risen in value. The scale of activity coupled with the source of the funds leads to the inference that a purpose or intention of the acquisition is eventual resale at a profit. But in so far as the original capital or that capital enhanced by accumulated profits is laid out in investments in property and not in the business activity of banking or insurance, the investments will have the character of capital and profits or losses on a sale thereof will not be profits of the business of banking or insurance. The banking and insurance cases thus do not provide an answer to the question which arises in the instant case. The source of moneys for the activities of the appellant company is not money of a kind which can be described as circulating capital. It is essentially investment and reinvestment of moneys which were originally part of, or which were added out of capital profits to, the capital structure of the appellant. (at p130)

24. Though the findings of Helsham J. certainly preclude a conclusion that shares were acquired and disposed of for a primary or dominant purpose of profit making, he did not conclude that there was no purpose at all in a relevant sense, when the shares were respectively acquired, of resale at a profit. I am not sure that he found it necessary to direct his mind to this question. Rather, he was satisfield to rely upon the scale of the activity as itself constituting the business. I do not think that a conclusion on scale by itself provides the answer; but it is very important evidence tending to show a business of acquiring and disposing of shares and it was some evidence from which a purpose of thereby making a profit might be inferred. It was for the appellant to rebut the latter inference. In my opinion it has not done so. It has in its favour the very important circumstance that the source of the funds was the subscribed capital of the company. But this is only part of the evidence. The evidence taken as a whole strongly supports a conclusion that a purpose or intention or expectation implicit in the carrying into effect of its investment policy was that shares acquired would be resold if and when an occasion arose which would make it desirable so to do and an element of desirability was that there would be greater financial benefit in disposing of the shares at an enhanced value than in retaining them. The fact that enlargement of dividend income was the dominant purpose does not gainsay the existence of a concurrent purpose of resale if and when that resale would throw up a profit which could be used to enlarge the dividend income. The massive scale of the activities in the years in question practically compels the inference that the investment policy was one which in its inception and throughout the course of carrying it into effect would in the expected state of the rising market require frequent and regular realizations of shares whenever they rose in market price before dividends from them were increased. (at p131)

25. But it is the expected increase in dividend which causes shares to rise in price. The investment policy of the company was such that on a purchase of any particular parcel of shares the company had a then present purpose, intention or expectation of not awaiting an increase in dividends if the market price rose in expectation of such an increase but of anticipating the rise in dividend by realization of the shares at an enhanced price. It is true that the purpose or intention or expectation was contingent in the sense that sale would only take place if dividends had not been raised before the share price also rose. The contingency of this purpose enabled a finding to be made that higher dividend yield was the primary purpose of the operations and that therefore s. 26 (a) was not applicable. But when with such an investment policy which envisages regular and frequent sales of the shares acquired, operations are conducted on such a very large scale, the proper conclusion is that the acquisitions and disposals of shares were part of a business of acquisition and disposal. It is no answer to say that if the share prices did not fall proportionately to a lowered dividend, so that a lowered return on market price would be currently received, the investment policy would require sale, even at a loss. The dealings took place on a market which was regarded by the company as having growth potential. A rising, not a falling, market was expected and it was on that expectation that the investment policy was based. (at p131)

26. The appellant placed considerable reliance upon Charles v. Federal Commissioner of Taxation (1954) 90 CLR 598 . However, there were differences in the facts which explain the decision. There was evidence that sales were normally made when the managers anticipated a fall in the value of shares. The purpose was to preserve for the fund any increase in value which had occurred and which it seemed likely would otherwise be lost (1954) 90 CLR, at p 610 . The Court said (1954) 90 CLR, at pp 611-612 :

"It remains to consider one argument upon which counsel
for the commissioner relied. They contended, in effect, that even if the position be accepted that the course pursued in the administration of the Trust cannot properly be described as the carrying on of a business of stock-jobbing, still it amounted to a business of making profits of various kinds for the certificate holders, and that the selling of rights, and the buying of securities and re-selling them at prices in excess of cost, were part and parcel of the sum of activities by which those profits were made. In such a situation, counsel submitted, cases such as Punjab Co-operative Bank Ltd., Amritsar v. Commissioner of Income Tax, Lahore (1940) AC 1055 and Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946) 73 CLR 604 show that the whole of the profits realized, even though some part of them would otherwise be of a capital nature, are to be regarded as income. To accept this argument, however, would be to ignore the evidence already mentioned, which is inconsistent with the notion that the activities of the managers, or of the managers and the trustees together, were different in kind from those in which trustees normally engage who hold a portfolio of shares with power to vary investments from time to time as they consider the interests of the beneficiaries require. According to that evidence, the moneys in question arose, not (as in the cases cited) from transactions forming incidents in the conduct of a business or a profit-making scheme, but from transactions effected in the course of performing a fiduciary duty to preserve for beneficiaries as far as practicable the assets comprising the trust fund and any increments in the value of those assets which might appear from time to time to be in jeopardy. The case therefore differs fundamentally from the cases relied upon by counsel for the commissioner". (at p132)

27. Thus it could be concluded that there was no business but merely an activity of investment which was explicable by reference to the specific duties of trustees and therefore did not lead to an inference adverse to the taxpayer. In my opinion the same cannot be said of the course of activity and the reasons given therefor which are present in the instant cases. (at p132)

28. I am therefore of the opinion that the principal objections were properly disallowed and that the decision of the primary judge was correct in this regard. It is however agreed that certain amounts have been included in the assessments which, in the light of the decision of this Court in Curran v. Federal Commissioner of Taxation (1974) 131 CLR 409 , ought not to have been included. It is therefore necessary to remit the matters for reassessment. To that extent the appellant succeeds. The respondent should pay to the appellant one-half of its costs of the proceedings in the Court below, but the appellant should pay the costs of the appeal. (at p133)

Orders

Appeals allowed. Order the appellant to pay the costs of the appeals to this Court.

Orders of Supreme Court set aside. In lieu thereof order that the appeals be allowed and that the assessments be remitted to the Commissioner for amendment, and further order that the respondent Commissioner pay to the appellant one half of the costs of the appeals to the Supreme Court.