Re John Walter Mcardle v the Commissioner of Taxation of the Commonwealth of Australia [1988] FCA 59 (11 March 1988)

FEDERAL COURT OF AUSTRALIA

Re: JOHN WALTER McARDLE
And: THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
No. G2087 of 1987
Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA
SOUTH AUSTRALIA DISTRICT REGISTRY
GENERAL DIVISION
Fisher J.(1)

CATCHWORDS

Income Tax - assessable income - stock options in employer company granted to certain employees - surrender by taxpayer of his rights for lump sum payment - whether the lump sum was an allowance given or granted in relation to employment within the meaning of s.26(e) - whether lump sum formed part of taxpayers gross income from all sources within the meaning of sub.s.25(1).

Income Tax Assessment Act 1936 - sub.s.25(1), s.26(e), s.26AAC.

HEARING

ADELAIDE
11:3:1988

Counsel for the Appellant: Mr. A.H. Goldberg Q.C. with Mr. S.T. O'Loughlin

Solicitors: O'Loughlin Robertson

Counsel for the Respondent: Mr. M.L. Robertson Q.C. with Dr. I.J. Hardingham

Solicitors: Australian Government Solicitor Mr. G. Gretsas

ORDER

The appeal be allowed and the appellant's objection upheld.

The Commissioner do pay to the appellant his costs of the appeal.

The assessment be remitted to the Commissioner for amendment in accordance with the terms of this judgment.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

DECISION

This is an appeal which comes before this Court consequent upon its transfer from the Supreme Court of South Australia pursuant to sub.s 4(3) of the Jurisdiction of Courts (Miscellaneous Amendments) Act 1987. John William McArdle ("the taxpayer") was dissatisfied with the disallowance by the Commissioner of Taxation for the Commonwealth of Australia ("the Commissioner") of his objection to an assessment of income tax for the year of income ended 30 June 1982. He requested the Commissioner to treat his objection as an appeal and, in accordance with s.187 of the Income Tax Assessment Act 1936 as it then provided, to forward the same to the Supreme Court of South Australia. This was done and the objection was transmitted on 15 July 1987. Subsequent to 1 September 1987 the appeal was transferred to this Court pursuant to sub.s 4(3) as abovementioned, the hearing thereof not having begun before the Supreme Court.

2. The taxpayer had duly lodged his return of income for the year ended 30 June 1982 and in a schedule thereto made reference as follows to a sum of $1,100,000 received by him during that year:

"ITEM 6F

During the period December 1975 to March 1980 I was
granted Options to acquire stock in Delhi International
Oil Corporation, a United States corporation which
employed me directly or through a subsidiary company
from 1967 to January 1982. On 11 November 1981 I
entered into an agreement with Delhi International Oil
Corporation whereby I surrendered all of my rights under
the Stock Option Agreement and in consideration was paid
$1,100,000. I believe this payment is in the nature of
a capital receipt and is not assessable."

On 2 July 1984 the Commissioner issued his notice of assessment and included the sum of $1,100,000 in the assessable income of the taxpayer. In the adjustment sheet annexed to the said notice he stated that the said sum was a "Benefit derived under stock appreciation rights assessable when rights exercised" and he added that amount to the taxable income of the taxpayer as returned.

3. There was little dispute on the relevant facts of the matter, but they are complex and need to be set out in some detail. Suffice to say at this stage that the sum of $1,100,000 was received by the taxpayer on 11 November 1981 from Delhi International Oil Corporation, ("Delhi International") which company or one of its subsidiaries ("Delhi Australia") had employed the taxpayer for a number of years. It is pertinent to note that in the taxpayer's extensive affidavit filed in support of his appeal these two companies are respectively called "D.I.O.C." and "Delhi". The said sum was the subject of a "Surrender of Stock Options Agreement" and was stated therein to be the consideration for the surrender by the taxpayer of all his rights under certain "Stock Option Agreements and Limited Stock Appreciation Rights Agreements". When the appeal came on for trial the Commissioner contended that the said sum formed part of the assessable income of the taxpayer by virtue of s.26(e) or sub.s 25(1) of the Act. He expressly disclaimed any reliance upon s.26AAC of the Act and the appeal was conducted upon that basis. Section 26(e) was at the relevant time in the following form -

"26 The assessable income of a taxpayer shall include

(a) ...

(b) ...

(d) ...

(e) the value to the taxpayer of all allowances,
gratuities, compensations, benefits, bonuses and
premiums allowed, given or granted to him in
respect of, or for or in relation directly or
indirectly to, any employment of or services
rendered by him, whether so allowed, given or
granted in money, goods, land, meals, sustenance,
the use of premises or quarters or otherwise:

Provided that this paragraph shall not apply to
any allowance, gratuity or compensation which is
included in paragraph (d), which is an amount to
which section 26AC or 26AD applies or which
under any provision of this Act is deemed to be
a dividend paid to the recipient;"

Sub-section 25(1) includes in the assessable income of a resident taxpayer the gross income derived directly or indirectly from all sources whether in or out of Australia which is not exempt income.

4. Counsel for the taxpayer contended that the said sum did not form part of his client's assessable income under s.26(e) because the amount was paid by Delhi International by reference to the taxpayer's existing contractual rights. As such it was said that the taxpayer did not receive the payment in his capacity of employee and any connection which the receipt had with his employment was insufficient being only historical or temporal. The true transaction was one entered into by the taxpayer as the holder of options to acquire shares in Delhi International.

5. The taxpayer commenced employment with Delhi Australia Petroleum Ltd, which became in 1970 Delhi International, as a clerk in 1967. He gained a Diploma in Accountancy, became an Associate of the Australian Society of Accountants and was promoted to the position of accountant in 1969.

6. In 1972 the taxpayer became Senior Accountant and in 1973 he was appointed Procedures Advisor. As such he still controlled the accounting section, but also became more involved in the company's commercial activities. In 1974 he was appointed Commercial Manager.

7. As a result of a transfer of assets in 1978 by Delhi International to Delhi Australia the taxpayer was thereafter employed by Delhi Australia from the start of 1979. Subsequently he was promoted to the position of Deputy Managing Director and later Managing Director of Delhi Australia.

8. Although he virtually had complete control of Australian operations (which comprised ninety percentum of Delhi Australia's assets and almost its entire profit) the taxpayer was not at any time a member of the Board of Directors of Delhi International.

9. In late 1981 CSR Limited acquired the shares held by Delhi International in Delhi Australia. CSR Ltd. had prior thereto made a tender offer for these shares which offer expired on 27 October 1981. Under the terms of a number of Limited Stock Appreciation Rights Agreements hereinafter more specifically identified the taxpayer was entitled to exercise certain rights during a period which commenced on 28 October 1981 and expired thirty days thereafter. These rights crystallized consequent upon the abovementioned tender offer of CSR Ltd.

10. Early in 1982 the taxpayer ceased employment with the Delhi group of companies and took up a position with Santos Limited as Commercial Director.

11. By letter dated 19 December 1975 the taxpayer was advised that Delhi International had established a "Non Qualified Stock Option Plan" ("the Stock Option Plan") whereunder the taxpayer was granted an option to acquire shares in that company. This letter was in the following terms:

" December 19, 1975
Mr. John W. McArdle
Delhi International Oil Corporation
Adelaide, South Australia

Dear John:

As a result of action taken by the Board of Directors
at a meeting on December 15, 1975, a Non-Qualified
Stock Option Plan was adopted. In recognition of your
past performance as an employee and manager of Delhi
International Oil Corporation, it is my pleasure to
advise you that you have been designated as an Optionee
under this Plan.

You will note that there is enclosed:
(a) One copy of the Stock Option Plan adopted by the
Board. This is for your records.
(b) Two copies (executed on behalf of the Company) of
the Stock Option Agreement. Please execute both
copies, retain one for your records, and return
one to the Company.

It is presently intended that any shares purchased from
the Company by the exercise of this option will be
delivered out of presently authorized and unissued
shares. It is also the present intent of the Company
to cause the shares optioned to you to be registered
under a Ford S-8 registration with the Securities and
Exchange Commission. There is no assurance that such
registration will become effective; therefore, I
strongly suggest that you contact Bruce Lintner prior
to exercise of this option and prior to any sale of
shares thus acquired so that you will be fully aware of
the then situation with regard to your ability to sell
any shares acquired.

On behalf of the Board, I want to express our
appreciation to you for your efforts, enthusiasm, and
loyalty towards the Company and trust that the stock
option grant will provide further incentives to you for
continued dedication to your job with the Company.

Yours very truly,
Norman C. Miller President "

Accompanying the letter was a copy of the Stock Option Plan the relevant clauses or portions of clauses of which are set out hereunder:

"1. Purpose of Plan. This Stock Option Plan ("Plan") is
intended to provide selected officers and key employees
("Optionees") of Delhi International Oil Corporation
("Company") and its present and future subsidiary
corporations, as such terms are defined in Paragraph 4
below, with the opportunity to acquire or increase
ownership of shares of the Company and to give them
additional incentive to promote the success of the
Company.

2. Shares Subject to Plan. There will be reserved for
issue upon the exercise of options ("Options") to be
granted from time to time under the Plan an aggregate
of 262, 833 shares of $.10 par Common Stock ("Common
Stock") of the Company, which shares may be in whole or
in part, as the Board of Directors of Company ("Board
of Directors") shall from time to time determine,
authorized unissued Common Stock or issued Common Stock
which shall have been reacquired by the Company.

3. Administration of Plan ...

4. Optionees to Whom Options Shall be Granted. An
option may be granted, as determined by the Board of
Directors, to such officers and key employees of the
Company or its present and future subsidiary
corporations, if any, existing from time to time. Any
Optionee may hold more than one Option, but only on the
terms and subject to the restrictions hereinafter set
forth.

5. Factors Considered in Granting Options. In making
any determination as to Optionees to whom Options shall
be granted and as to the number of shares to be covered
by such Options, the Board of Directors shall take into
account the duties of the respective Optionees, their
present and potential contributions to the success of
the Company, and such other factors as the Board of
Directors shall deem relevant in connection with
accomplishing the purpose of the Plan.

6. Option Prices. The purchase price per share of the
Common Stock which shall be covered by each Option
shall be the greater, at the time of granting the
option, of (a) one hundred percent (100%) of the per
share fair market value of the Common Stock at the time
of granting the Option; (b) fair value; or (c) Book
Value Per Share....

7. Terms of Options. No Option shall be exercisable
after the expiration of ten (10) years from the date it
is granted, but each Option shall be subject to earlier
termination as hereinafter provided.

8. Exercise of Options. Each Option shall be
exercisable in whole or in part as to not more than the
cumulative percentage after the periods of continuous
service for the Company indicated in the following
table.

Years of Continuous Percentage of Option
Service Exercisable
1 10%
2 25%
3 45%
4 70%
5 100%

Upon granting of an Option, that Option shall be
immediately exercisable to the extent of the Optionee's
entitlements as determined by the foregoing table;
i.e., an Optionee with three years of continuous
service at the time an Option is granted would be
entitled to immediate exercise of 45% of his Option.
If an installment covers a fractional share, the
installment will be rounded off to the next highest
share. The Option may be exercised only with respect
to full shares, and no fractional shares of Common
Stock shall be issued....

9. Non-Transferability. An Option shall not be
transferable otherwise than by last will and testament
of the Optionee or the laws of descent and
distribution. An Option may be exercised, during the
lifetime of the Optionee, only by him.

10. Termination of Service Other Than by Death. In the
event that an Optionee to whom an Option shall have
been granted shall cease to be in the service of the
Company or its present or future subsidiaries, if any,
for any reason other than by his death and shall no
longer be in the service of any of them, such Optionee
may exercise such Option (to the extent that the
Optionee shall have been entitled to do so at the date
of such termination of service) at any time within
ninety (90) days after such termination of service...

11. Death of an Optionee. If an Optionee to whom an
Option shall have been granted shall die while he shall
be in the service of the Company or its present or
future subsidiaries, if any, or within a period of
minety (90) days after termination of service, such
Option may be exercised (to the extent that the
Optionee shall have been entitled to do so at the date
of his death) by a legatee or legatees of the Optionee
under his last will and testament, or by his personal
representative or distributees, subject to the other
terms of this Plan, at any time within one (1) year
after his death.

12. Adjustments Upon Changes in Capitalization. ...

13. Effectiveness of Plan. The Plan shall become
effective upon its adoption by the Board of Directors.

14. Time of Granting Options. The date of granting of
the options shall be the date the granting takes place
or as otherwise designated by the Board of Directors.

15. Time Limitation on Sale of Shares. Each Option
under the Plan which is granted prior to January 2,
1977 shall be granted on the condition that Common
Stock purchased thereunder may not be sold or exchanged
by the Optionee until January 2, 1977; provided
however, that, subject to all of the other provisions
of this Plan, this restriction on sale or exchange will
not apply in the following circumstances:

(a) Stock purchased by an Optionee pursuant to an
Option granted under this Plan may be sold prior to
January 2, 1977 in the event of the Optionee's death.

(b) In the event of a merger, consolidation or
other corporate reorganization involving the Company,
which is either approved or recommended by the Board of
Directors, pursuant to which the shareholders of the
Company must or may sell or exchange their shares as a
constituent part or such reorganization, any shares
purchased under Options granted pursuant to this Plan
may be sold or exchanged pursuant to the plan or
reorganization regardless of whether such sale or
exchange occurs prior to January 2, 1977.

16. Investment Purpose ...

17. Indemnification of Board of Directors ...

18. Termination and Amendment of Plan. The Plan shall
not terminate until expressly terminated by resolution
of the Board and an Option shall not be granted under
the Plan after such termination. The Plan (including
the form of Option Agreement which is attached hereto
marked Exhibit "A") may at any time or from time to
time be terminated, modified, or amended by the
Directors of the Company; provided, however, that the
termination or any modifications or amendment of the
plan shall not, without the consent of an Optionee,
affect his rights under an Option theretofore granted
to him.

19. Applicable Law. This Plan is intended to be
performed in the State of Texas and shall be construed
and enforced in accordance with and governed by the
laws of such State."

A Stock Option Agreement in respect of the options at that time granted to the taxpayer also accompanied the letter and was, except in so far as it repeated clauses in the Stock Option Plan, as follows:

"THIS STOCK OPTION AGREEMENT ("Agreement") made this
15th day of December, 1975, between Delhi International
Oil Corporation ("Company"), a Delaware corporation,
and John W. Ardle ("Optionee"), a person in service of
the Company or one or more of its subsidiaries.

WHEREAS, the Company desires, by affording the Optionee
an opportunity to purchase shares of its $.10 par
Common Stock ("Common Stock"), as hereinafter provided,
to carry out the purpose of the Stock Option Plan
("Plan") of Company, which has been approved by its
Board of Directors.

NOW, THEREFORE, in consideration of the mutual
covenants hereinafter set forth and for other good and
valuable consideration, the parties hereto agree as
follows:

1. Grant of Option. The Company hereby grants to the
Optionee the Option to purchase on the terms and
conditions hereinafter set forth 3,144 shares on the
Common Stock of Company.

2. Purchase Price. The purchase price of the Common
Stock covered by the Option shall be $3.73 per share,
which is the greater of (a) $3.19 per share, the fair
market value of the Common Stock on the day of the
grant as determined by the Board of Directors, (b) $.10
per share, of (c) $3.73 per share, the Book Value Per
Share (as defined in the Plan) at the time of the
grant.

3. Time to Exercise. This Option shall be exercisable
in the following manner:

Date Percentage of Option
Exercisable Exercisable
15 December 1975 100%
...

4. Subject to Plan. This Option and the exercise hereof
is subject to the terms and conditions of the Plan,
which is incorporated herein by reference and made a
part hereof, but the terms of the Plan shall not be
considered an enlargement of any benefits under this
Agreement. In addition, this Option is pursuant to the
Plan, now or thereafter in effect.

5. Term. Except in the case of death, this Option
shall terminate at (a) 5:00 P.M. on the 15th day of
December 1985, or (b) the date ninety (90) days after
termination of the Optionee's service, whichever is the
first to occur.

6. Who May Exercise. ...

7. Restrictions on Exercise...

8. Manner of Exercise...

9. Non-Assignability. This Option is not assignable or
transferable by Optionee except by last will and
testament or by the laws of descent and distribution.

10. Rights as Stockholder. The Optionee shall have no
rights as a shareholder with respect to any shares
covered by the Option evidenced by this Agreement until
the issuance of one or more certificates to him for
such shares upon due exercise of the Option. A
reasonable time shall be allowed after the exercise of
an Option for the issuance of stock certificates on the
shares thereby purchased. Except as provided in
Section 11, no adjustment shall be made for dividends
or other rights for which the record date is prior to
the issuance of certificates.

11. Capital Adjustments. ...

12. Time Limitation on Sale of Shares. ...

13. Investment Purpose...

14. Law Governing. This Agreement is intended to be
performed in the State of Texas and shall be construed
and enforced in accordance with and governed by the
laws of such State."

12. The abovementioned Stock Option Plan was amended on 4 May 1976, and the taxpayer was advised by letter dated 7 June 1976 of the amendments. These amendments involved adding section 15 to his original agreement which section provided that if the option holder died or Delhi International was involved in a merger, consolidation or reconstruction the taxpayer was entitled to exercise his options prior to 1 January 1977.

13. On or about 21 July 1977, 19 July 1979, 29 February 1980 and 13 March 1980 the taxpayer was issued with additional options by further Stock Option Agreements substantially in the same terms as the agreement set out above. In each instance the agreements were presented to the taxpayer without prior consultation with or request by him. He said he understood that similar options were issued to other employees on each occasion except on 13 March 1980. On that occasion the options were issued to him alone in recognition of his appointment as managing director of Delhi Australia.

14. By letter dated 28 February 1980 Delhi International advised the taxpayer of three significant amendments to the Stock Option Agreements. Two of these amendments extended the period after the termination of the employment or death of the option holder within which the options could be exercised. I have emphasised the relevant passages. The letter was as follows:

" February 28, 1980
To: John W. McArdle

On October 25, 1979, the Board of Directors of Delhi
International Oil Corporation ("Delhi") approved a
Stock Option, Stock Appreciation Rights and Limited
Stock Appreciation Rights Plan ("Plan"), which amends
and restates the Delhi Stock Option Plan ("Stock Option
Plan") dated December 15, 1975. The Board also
approved at the same time an amended Stock Option
Agreement, a Stock Appreciation Rights ("SARs")
Agreement and a Limited Stock Appreciation Rights
("Limited SARs") Agreement which are to be entered into
between the Company and each participant when stock
options, SARs and Limited SARs are granted under the
Plan. At the same time, the Company granted Limited
SARs with regard to all unexercised options.

While the provisions of the Plan and the agreement
covering stock options are substantially the same as
the ones amended, there are three significant changes
which are called to your specific attention, all of
which apply to stock options already granted and to be
granted.

Paragraph 10 of the Plan and the new agreements provide
that after termination of employment other than because
of death an employee may exercise outstanding options,
SARs or Limited SARs, to the extent that they could
have been exercised on the date of employment
termination, for a period of seven (7) months following
the date of termination. Under the prior Stock Option
Plan and related agreements the period of time for such
contingency was only ninety (90) days.

Paragraph 11 of the Plan and the new agreements provide
that should an employee die while employed by Delhi or
a subsidiary or within seven (7) months after
termination of employment, the outstanding options,
SARs or Limited SARs may be exercised, to the extent
that they could have been exercised on the date of
death, by the estate of the employee at any time within
one year after death. In your prior stock option
agreements the period of time for such contingency was
limited to the termination date specified in the
agreement (ten years from date of grant of the option)
or the date one year from date of death, whichever
first occurred.

The Plan also contains an Acceleration of Option
provision to the effect that if an offer (as "offer" is
defined in the Plan) is made for shares of the Company,
each outstanding option that would not otherwise be
exercisable becomes exercisable on the day after shares
are required under the offer. This provision was not
in the prior Stock Option Plan.

When the Board of Directors declared the
"three-for-two" stock split on January 24, 1980, it
also declared that the number of shares and the
purchase price of all shares for which unexercised
options were outstanding and the total number of shares
reserved for issuance under the Plan shall be adjusted
proportionately to the stock split. As your Limited
SARs and their exercise price are based upon related
stock options, and are determined by and are equal to
the same number of your stock options and their
purchase prices, your Limited SARs and their exercise
prices are automatically adjusted with the adjustments
in the related stock options. The Limited SARs and
their related stock options are identified by the
original date of grant of the stock options.

Attached to and made a part of this letter is a
Schedule showing the adjusted number of shares and the
adjusted purchase price for all of your outstanding and
unexercised stock options an Limited SARs as a result
of the stock split. In lieu of executing new
agreements to cover the three changes referred to above
an to adjust the number of shares and purchase prices
caused by the stock split, this letter is intended and
shall constitute an amendment to the agreements to
cover said matters.

Please acknowledge your acceptance of the amendments
referred to above, and the adjustments set forth on the
attached Schedule, by signing a copy of the Schedule
and returning a signed copy to the Corporate Secretary.

Very truly yours,
(Signed)
Norman C. Miller
President and Chief
Executive Officer."

15. On or about 25 October 1979 the taxpayer received, as well as on 29 February 1980 and 13 March 1980, an agreement called a Limited Stock Appreciation Rights Agreement ("LSAR agreement") from Delhi International. The agreement of 25 October 1979, to the extent relevant to these proceedings, was in the following terms:

"1. Limited stock Appreciation Rights Subject to Plan.
This limited Agreement, the Limited Stock Appreciation
Rights granted herein and the exercise thereof are
subject to the terms and provisions of the Plan which
are incorporated herein by reference, and all words
used herein which are defined in the Plan shall have
the same meaning as ascribed to them in the Plan. The
terms and conditions of the Plan shall not increase or
decrease any of the benefits granted to the Limited
Holder under this Limited Agreement.

2. Grant of Limited Stock Appreciation Rights
("Limited SARs"). The Company hereby grants Limited
SARs to the Limited Holder entitling the Limited Holder
to obtain on the terms and conditions hereof a cash
payment equal to the excess of the price contained in
an Offer for the Stock over the Exercise Price of the
Limited SARs as hereinafter provided on the number of
Shares of Stock covered by and relating to the Stock
Options ("Related Options") granted to the Limited
Holder as follows:

Date Related Purchase Price Number of
Option Granted Per Share Shares
12-15-75 $ 3.73 3,144
7-21-77 9.56 622
7-19-79 12.6875 1,512

3. Term of Limited SARs. ...

4. Exercise Price Per Share. The Exercise Price per
Share at which each Limited SAR may be exercised shall
be the Purchase Price per Share at which each Related
Option was granted, as indicated in Paragraph 2.

5. Who May Exercise the Limited SARs. During the
lifetime of the Limited Holder, the Limited SARs may be
exercised only by the Limited Holder. If the Limited
Holder dies prior to the termination dates set forth in
Paragraph 3(a) or (b) hereof without having exercised
the Limited SARs as to all Shares covered thereby, the
remaining Limited SARs may be exercised, to the extent
the Limited Holder was entitled to exercise the Limited
SARs at the date of death, by the Executor or
Administrator of the Limited Holder's Estate or by the
person or persons acquiring the Limited SARs upon the
death of the Limited Holder, at any time within one (1)
year from date of the Limited Holder's death.

6. Time of Exercise. The Limited SARs shall be
exercisable:

(a) six months after the date of the grant of the
Limited SARs, except in the event of the death of the
Limited Holder.

(b) only during the period beginning on the first
day after the date of expiration of any Offer and
ending on the thirtieth (30th) day following such date.

7. Manner of Exercise.

(a) Subject to such administrative regulations as
the Board of Directors may from time to time adopt, to
exercise the Limited SARs, the Limited Holder shall
give written notice to the Company, addressed to its
home office to the Secretary of the Company, specifying
the number of Shares being exercised and the Exercise
Price per Share...

8. Restrictions on Exercise. Notwithstanding the
provisions of any other section of this Limited
Agreement, the Limited SARs may be exercised:

(a) only with respect to full Shares;

(b) only during the term of the Limited SARs set
forth in Paragraph 3, or in the event of the death of
the Limited Holder, then in accordance with the
provisions of Paragraph 5;

(c) only for cash payment; and

(d) only after six (6) months from the date of its
grant, except in the event of death of the Limited
Holder.

9. Calculation of Cash Payment Upon Exercise.

(a) For purposes of this Limited Agreement "Offer
Price Per Share" shall mean the highest price per Share
paid or exchanged in any Offer in effect at any time
during the period beginning on the sixtieth (60th) day
prior to the date on which such Limited SARs are
exercised and ending on the date on which the Limited
SARs are exercised. Any securities or properties which
are a part or all of the consideration paid or
exchanged for the Shares in the Offer shall be valued
in determining the Offer Price Per Share at the higher
of (1) the valuation placed on such securities or
property by the corporation, person or other entity
making such an Offer, or (2) the valuation placed on
such securities or property by the Board of Directors.

(b) Upon the exercise of Limited SARs, a Limited
Holder shall be entitled to the "Spread," which is the
amount equal to the product computed by multiplying the
excess of the Offer Price Per Share over the Exercise
Price per Share of the Limited SARs by the number of
Shares with respect to which the Limited SARs are being
exercised.

(c) In the event the Limited Holder elects to
exercise Limited SARs based upon more than one Exercise
price, the Spread shall be calculated separately as to
each Exercise Price and then aggregated.

(d) Upon payment of the Spread the Company shall
collect from the Limited Holder an amount required by
the appropriate taxing authorities to be collected for
withholding taxes on the Spread.

10. Termination of Related Options and Related SARs.
Upon the exercise of the Limited SARs, any Related
Options and Related SARs shall cease to be exercisable
to the extent of the number of Shares with respect to
which such Limited SARs are exercised.

11. Non-Assignability. These Limited Holder shall have
no rights as a Stockholder with respect to Shares
granted in a Related Option.

13. Capital Adjustments...

14. Law Governing. This Limited Agreement is intended
to be performed in the State of Texas and shall be
construed and enforced in accordance with and governed
by the laws of such State.

16. The taxpayer said that he was not in any way involved in the formulation of these agreements. However he understood that these new arrangements were made because of difficulties which arose under the Securities Exchange Act of the United States which required officers of companies to "disgorge" profits made at or about the time of a takeover.

17. These difficulties were explained in advice tendered to Delhi International by its solicitors in a letter dated 15 October 1981. To the extent relevant the letter was as follows:

" October 15, 1981
Mr. Norman C. Miller, President
Delhi International Oil Corporation
3500 First International Building
Dallas, Texas 75270

Re: Tender of Delhi Shares and Exercise
of Delhi LSARs by Delhi Officers

Dear Norman:

This letter outlines the considerations applicable to
transactions by Delhi officers in connection with the
Delhi/CSR tender offer and merger necessary to avoid
liability under Section 16(b) of the Securities
Exchange Act of 1934. The transactions by which Delhi
officers will convert their presently owned Delhi
shares, stock options and limited stock appreciation
rights ("LSARs") into cash must be structured to avoid
any potential liability under Section 16(b). This has
been done to date but the transactions hereafter
followed by Delhi officers must be in the manner set
forth below to insure the avoidance of any liability.
Each Delhi officer should review his own situation to
make sure that no potential Section 16(b) problems
exist.

APPLICATION OF SECTION 16(b)

Section 16(b) provides that any profits realized by a
director, officer, or more than 10% shareholder from
the purchase and sale, or sale and purchase, of a
security of the Company within a six month period are
recoverable by the Company or by a shareholder acting
on behalf of the Company. Strict liability is imposed
under the Statute in the event of any violation, no
matter how unintentional or inadvertent. Certain
transactions have been exempted from the operation of
16(b) and it will be necessary to rely upon such an
exemption with respect to the handling of the exercise
of the LSARs (and resulting cancellation of the stock
options).

TENDER OF PRESENTLY OWNED DELHI SHARES

The tender of presently owned Delhi shares pursuant to
the tender offer will constitute a sale for the
purposes of Section 16(b). No exemption under Section
16(b) is applicable to that transaction. If any
non-exempt purchase occurred within six months before
the tender of such shares or occurs within six months
after the tender of such shares, there will be Section
16(b) liability.

The first concern is whether any officer has purchased
Delhi stock within the six month period preceding the
tender. The acquisition of any stock pursuant to the
exercise of a stock option does constitute a purchase,
whether before or after the tender of the shares. No
exemption would apply to the acquisition of stock
pursuant to the exercise of the stock option.

It is assumed that no Delhi officer has purchased any
stock within the preceding six month period. However,
if such situation does exist, the transactions of that
individual officer must be reviewed to see if Section
16(b) liability can be avoided although such might not
be possible. Such an officer should not tender his
shares until that review has been made.

The second concern with respect to tendering presently
held Delhi shares is that no purchase occurs after the
tender. The cancellation of stock options by the
exercise of the LSARs is to be handled so that
transaction does come within an exemption under Section
16(b). So long as that transaction is handled
properly, no purchase will occur for the purposes of
Section 16(b) and there will be no exposure with
respect to the prior tender of the presently held Delhi
shares. If for any reason, the exercise of the LSARs
cannot be handled in the manner set forth below, then
further consideration would be necessary as to whether
Delhi officers should tender their shares or, instead,
surrender their shares for cancellation pursuant to the
merger transaction.

EXERCISE OF LSARs/CANCELLATION OF STOCK OPTIONS

The concern with respect to the exercise of the LSARs
which results in a cancellation of the tandem stock
options is that this transaction could be treated as a
simultaneous purchase and sale or a purchase or sale
which could be matched with a prior sale or purchase,
producing Section 16(b) liability. Although there is
conflicting authority on whether a purchase or sale
does occur, the exercise of the LSARs should be handled
to come within an express exemption under Section 16(b)
to provide the greatest possible protection.

Rule 16b-3(e) provides an exemption for the cash
settlement of stock appreciation rights. The Rule
contains a number of requirements which pertain to the
plan under which the stock options and stock
appreciation rights must be issued. The Delhi plan was
prepared in compliance with those requirements. There
are additional requirements, however, pertaining to the
manner of the actual exercise of the LSARs granted
under the plan.

The LSARs must be exercised during a "window" period
beginning on the third business day following the date
of release for publication of certain financial data of
the Company and ending on the twelfth business day
following the date of such release. The financial data
consists of quarterly or annual summary statements of
sales and earnings. Such information would be the type
of information that would be released in connection
with the filing of the third quarter Form 10-Q of the
Company.

Rule 16b-6(c) is not entirely clear as to which
transactions come within the Rule...

However, Rule 16b-6(c) has been interpreted by the SEC
staff to extend to non-option shares in addition to
stock option shares or the stock options themselves
cancelled pursuant to the Agreement of Merger...

Due to the uncertainties in the scope of the Rule
16b-6(c) exemption and because of the timing
requirements under the Agreement of Merger, it is
preferrable not to structure any disposition of Delhi
shares, stock option or LSARs in reliance upon the Rule
16b06(c) exemption.

SUMMARY AND RECOMMENDATIONS

Based on the assumption that the exercise of the LSARs
will be handled to come within the Rule 16b-3
exemption, Delhi officers may proceed to tender their
presently owned Delhi shares at this time. If for any
reason, the exercise of the LSARs cannot be structured
in the manner described herein, further review is
necessary and the tender of presently owned Delhi
shares should be delayed to permit such review.
Additionally, if any officer has acquired any Delhi
shares within the six months prior to the date of the
tender, he personally should delay the tender of his
presently owned Delhi shares until we can review his
particular situation.

No Delhi officer should exercise any stock option.
Instead, each Delhi officer should exercise the tandem
LSARs for cash, resulting in a cancellation of the
stock options. The exercise of each LSAR must occur
within the ten business day "window" period under Rule
16b-3. This will require proper timing by the Company
of the release of its third quarter financial
information so that the "window" period will occur
within the thirty day exercise period of the LSARs
under the Delhi plan and prior to the effective date of
the merger or shareholders' meeting as required under
the Agreement of Merger.

The Company must release its third quarter financial
information and the financial information required by
Rule 16b-3 no earlier than two business days prior to
the expiration of the tender offer and no later than
three business days prior to the expiration of thirty
days after the expiration date of the tender offer. No
later than fourteen to eighteen days after the
expiration of the tender offer is preferable since that
will permit the full ten business day "window" period.
The effective date of the merger (or the shareholders'
meeting to approve the merger) must occur no sooner
than four business days, and preferrably twelve
business days or more, after the release of the
financial information. This will permit the "window"
period under Rule 16b-3 to occur at a time which will
satisfy the requirements of both the Delhi plan and the
Agreement of Merger.

All Delhi officers must be made aware of when the
"window" period will occur and that they must exercise
their LSARs within that "window" period.

Very truly yours,
(signed)"
I have added the emphasis.

18. By agreement dated 11 November 1981 executed by the taxpayer and Delhi International the taxpayer surrendered, and Delhi International cancelled, his rights under the agreements set out in the schedule thereto. In consideration of such surrender the taxpayer received $A1,100,000. The Agreement and Schedule were as follows:

"SURRENDER OF STOCK OPTIONS AGREEMENT

THIS AGREEMENT made this 11th day of November 1981,
between DELHI INTERNATIONAL OIL CORPORATION ("Company")
a Delaware Corporation, and John W. McArdle, a person
employed by the Company or one of its subsidiaries.

WHEREAS the Company has entered into with John W.
McArdle certain STOCK OPTION AGREEMENTS and LIMITED
STOCK APPRECIATION RIGHTS AGREEMENTS as set out in the
Schedule "Exhibit A" attached hereto and the Company
now desires to obtain from John W. McArdle the
surrender of all of his rights under the said
agreements.

NOW, THEREFORE, John W. McArdle does hereby surrender
all of his rights under the said agreements and the
Company does hereby contemporaneously cancel all rights
under the said agreements. In consideration hereof the
Company shall pay to John W. McArdle into a bank
account nominated in Australia, the sum of 1,100,000
Australian dollars within 30 days of the date hereof.

IN WITNESS WHEREOF, the Company has caused this
Agreement to be signed by its duly authorized officer
and John W. McArdle has duly signed this Agreement on
the day and year first above written.

(Signed)
John W. McArdle

DELHI INTERNATIONAL OIL CORPORATION

"'EXHIBIT A'
SCHEDULE
A. 1. Stock Option Agreement dated 15 December, 1975 as
amended by Amendment letter dated 7 June, 1976

2. Stock Option Agreement dated 21 July, 1977

3. Stock Option Agreement dated 19 July 1979 as
amended by Amendment letter dated 2 October, 1979

4. Limited Stock Appreciation Rights Agreement dated
25 October, 1979 all as amended by Amendment
letter dated 28 February, 1980

B. 1. Stock Option Agreement dated 29 February, 1980

2. Limited Stock Appreciation Rights Agreement dated
29 February, 1980

3. Stock Option Agreement dated 13 March, 1980

4. Limited Stock Appreciation Rights Agreement dated
13 March, 1980.

(Signed)
John W. McArdle

DELHI INTERNATIONAL OIL CORPORARTION "

19. Should the fact be of any significance, the taxpayer's evidence, which was subjected to cross-examination, was that he was motivated to enter into these arrangements because of the doubts which surrounded the application of s.16(b) of the Securities Exchange Act 1934 and the fact that a lump sum cash payment would probably not form part of his assessable income.

20. The Commissioner's contentions in support of his assessment were based, as previously mentioned, on s.26(e) and sub.s 25(1) of the Act. He says that, because of the circumstances and the relationship of the parties at the time of the receipt of $1,100,000 by the taxpayer, that sum falls for assessment because it, for the purposes of s.26(e), was granted to the taxpayer in the terms of that section. Alternatively that it was an amount received on revenue account and thus formed part of the taxpayer's gross income from all sources (sub.s.25(1)).

21. The Commissioner conceded that the taxpayer did not derive assessable income at the various times he was granted options by Delhi International. Furthermore he did not attach any significance, for income tax purposes, to the taxpayer's entry into the LSAR agreements with that company. Prima facie the rights acquired by the taxpayer on each occasion when he was granted options were benefits allowed given or granted to him by his employer and assessable under s.26(e). (See per Bowen J. as he then was in Donaldson v Federal Commissioner of Taxation 74 ATC 4192). However in consquence of that decision the Act was amended by the insertion of s.26AAC by s.8 of Act No.126 of 1974. That section applies to options or other rights, including shares, acquired after 17 September 1974. It is, in my opinion, a significant aspect of the context in which s.26(e) has application to employee share schemes. Sub-section 10 of s.26AAC is the relevant provision and it provides that -

"(10) For the purposes of paragraph (e) of section 26,
the acquisition by a taxpayer of a share in a company,
or of a right to acquire a share in a company, under a
scheme for the acquisition of shares by employees shall
be deemed not to be an allowance, gratuity,
compensation, benefit, bonus or premium allowed given
or granted to him".

22. The consequence of the use by the legislature of the "deeming" technique in the drafting of this amendment is to acknowledge that but for the amending provision the shares or rights would be that which they are thereafter deemed not to be (See per Cave J. in R. v Norfolk County Court (1891) 60 L.J.Q.B.379 at p.380) i.e. income assessable, if the circumstances are otherwise appropriate, under s.26(e).

23. Section 26AAC postpones the time at which a taxpayer derives assessable income to the time when either the shares are acquired or the rights are disposed of by the taxpayer. The taxpayer in this present matter held at all relevant times only rights to acquire shares and thus sub.s (8) might arguably have had application to his dealing on 11 November 1981 with those rights. This sub-section provides to the extent relevant that:

"Where a taxpayer -

(a) has acquired a right (whether that right was
unconditional or was subject to conditions) to
acquire a share in a company under a scheme for the
acquisition of shares by employees (including...);
and

(b) has disposed of that right to a person not being an
associate of the taxpayer

the assessable income of the taxpayer of the year of
income during which the taxpayer disposed of the right
as mentioned in paragraph (b) includes the amount, if
any, received by the taxpayer as consideration for the
right less the amount, if any, paid or payable by the
taxpayer as consideration for the right."

24. If however the taxpayer had exercised his right to acquire the shares in Delhi International over which he had the options, sub.s(5) of s.26AAC would doubtless have required the net value of the shares to be included in his assessable income. That sub-section provides that -

"(5) Where a taxpayer has acquired during the year of
income a share in a company under a scheme for the
acquisition of shares by employees, the assessable
income of the taxpayer of the year of income includes
the value of that share at the time when it was
acquired by the taxpayer less the sum of -

(a) the amount, if any, paid or payable by the taxpayer
as consideration for the share; and

(b) if the taxpayer acquired the share as a result of
the exercise or operation of a right (whether that
right was unconditional or subject to conditions)
to acquire the share - the amount, if any, paid or
payable by the taxpayer as consideration for the
right."

25. These provisions, and others, in s.26AAC in my opinion appear to provide that benefits to employees arising under schemes for acquisition by them of shares in employer companies are not to be included in assessable income pursuant to s.26(e) at the time when the shares or "options" are acquired. The fact that express provision is also made by s.26AAC for the assessable income of a taxpayer to include the net value of the share when acquired or the net consideration for the disposal of the right without in either instance making reference to s.26(e) tends to indicate an exclusive code pursuant to which, and only which, the shares or rights are to be regarded as assessable income. In this case it might be argued that s.26(e) has prima facie no application to employee share schemes and that the assessability of any form of receipt or benefit to an employee arising out of such a scheme falls for consideration only in accordance with the express provisions of s.26AAC.

26. In this matter the Commissioner expressly disavowed any reliance on the provisions of s.26AAC and in particular sub.s (8) thereof. Doubtless he felt unable to support a contention that in the present circumstances there had been a "disposal" by the taxpayer of his rights "to a person". The hearing of the appeal proceeded on the basis of the Commissioner's concession.

27. The Commissioner's primary contention was that the sum of $1,100,000 being the consideration for the "surrender" formed part of the assessable income of the taxpayer, in the terminology of s.26(e), as a benefit allowed given or granted to him in respect of for or in relation directly or indirectly to his employment. He based this submission as a matter of law upon the very extensive scope of s.26(e) as disclosed, he said, by the reasons for judgment of the High Court in Smith v Federal Commissioner of Taxation (1987) 74 ALR 411. He also said that the finding of fact in this matter must be that it was the employment relationship which led to the entry by the parties into the contract of surrender. The facts established that an employer and an employee entered into an arrangement beneficial to the employee which arose out of his employment and gave him a benefit to which he was not otherwise entitled. This benefit was the rearranging of the share options and LSAR transactions so as to give the employee his reward in a different form i.e. a lump sum probably not taxable. This re-arrangement amounted to a benefit granted by the employer to an employee such as contemplated by s.26(e), in support of which conclusion the Commissioner placed great reliance upon dicta in Smith's case supra. He distinguished Constable v Federal Commissioner of Taxation [1952] HCA 64; (1952) 86 CLR 402, an authority relied upon by the taxpayer, on its facts, contrasting the benefit there received by an employee from a fund consequent upon the vesting of a pre-existing contingent interest with the facts of the present matter.

28. Before considering whether Constable's case and Federal Commissioner of Taxation v Dixon [1952] HCA 65; (1952) 86 CLR 540, two authorities relied upon by the taxpayer, identify the principles of law which should be applied in this present matter, it is in my opinion preferable to ascertain in the first instance whether the Commissioner is entitled to place such reliance, as he did, upon Smith's case. It is necessary to determine whether those members of the High Court who comprised the majority did, contrary to the Commissioner's submission in this matter, identify any limitations on the application of the section. In Smith's case a payment was made by an employer directly to an employee being an allowance paid in accordance with the employer's "encouragement to study scheme". A majority both in the High Court and Full Court of the Federal Court were of opinion that the allowance was assessable under s.26(e). However all of the judges in the High Court who comprised the majority carefully spelt out the circumstances in which that section had no application.

29. Wilson J. on page 412 specifically noted a comment of Dixon C.J. and Williams J. at p.554 of Dixon's case "that only 'a mere historical connection'" existed between the employment and the payments, this being insufficient to bring the moneys received within the terms of s.26(e). He also referred on p.413 to the comment of McTiernan J. at p.558-9 of Dixon's case that "although the taxpayer would not have received the payment but for the fact that at one time he had been in the employment, that circumstance did not necessarily make it a payment in respect of, or for or in relation directly or indirectly to, the employment". In a paragraph on page 414 Wilson J. stated that the mere existence of the relationship at the time the payment was received or any earlier time was not sufficient for the purposes of s.26(e). He said:

"The problem presented by the present case is whether
the facts establish the requisite relationship between
the benefit received by the appellant and his
employment. It is not sufficient to find that the
appellant received the benefit at a time when there was
an employment relationship existing between himself and
the bank. The mere temporal connection would not
enable the payment to be characterised as a benefit
given to him in relation directly or indirectly to his
employment. It is tempting to strive to identify
criteria which will assist in the process of
characterisation. But, however helpful such criteria
may be, it is unwise to expect any paraphrase to
provide a final or overriding test. Ultimately, it is
the words of the statute that must prevail. Toohey J.
finds it helpful to ask whether the benefit allowed,
given or granted is a consequence of the employment of
the taxpayer (see also Dixon CJ and Williams J in Dixon
at 554). So do I. I also find it helpful to ask
whether the benefit is a product or incident of the
employment, as did Fullagar J in Hayes at 57, and
Windeyer J in Scott at 525-6. Of course, in each of
those cases the asking of the question led to a
different answer from that to which I have come in this
case." I have added the emphasis.

30. Brennan J. stated at p.415 that "liability to tax under 26(e) does not arise merely because the taxpayer is an employee of or has rendered services to the person from whom the allowance is received". He also indicated that it was necessary to establish that the payment was the consequence of the employment, saying later on that page "... it is sufficient to attract 26(e) that the allowance be paid to an employee in consequence of his employment. When is an allowance paid in consequence of employment?"

31. After considering various alternative circumstances he said on page 417:

"The difficult problem which arises under s.26(e) is to
identify the nature and degree of the relationship, if
any, between the allowing, giving or granting to a
taxpayer of an allowance, etc on the one hand and the
taxpayer's employment or the services rendered by him
on the other. The difficulty is the greater when the
allowance is paid not in discharge of a legal
obligation but voluntarily. There is no doubt that
voluntary payments may fall within s.26(e): see per
McTiernan J in Dixon at 558. If an allowance is paid
under a contract between the payer and the taxpayer,
the consideration for the payment is usually decisive
of the matter 'in respect of, or for or in relation...
to' which the allowance is paid, but if the allowance
is paid voluntarily, it is necessary to inquire 'how
and why it came about that the gift was made' (to adopt
the words of Kitto J in Squatting Investment Co Ltd v
FCT at 628): see Federal Coke Co Pty Ltd v FCT (1977)
15 ALR 449 at 472-3."

It is significant that thereafter in his reasoning Brennan J. dealt exclusively with gifts or voluntary payments, and thus did not attempt to identify "the consideration for the payment". However in respect of gifts he indicated that it is necessary to ascertain the reason for the payment by reference to "evidence of external indicia tending to show the reason for (or the cause of) the payment".

32. At the bottom of page 417 he said:

"The question of law that arises on those facts is
whether such a payment was made in consequence of the
appellant's employment."

Brennan J. also took up the words of McTiernan J. in Dixon's case, namely that in that matter "although the scheme 'grew out of' the employment relationship, the scheme was' ultra that relationship'."

33. The other member of the majority, Toohey J. also adopted the test of whether the payment was a consequence of the employment. He said on p.424 -

"The sum paid to the appellant was one of the many such
sums paid by the bank to its employees under its
'encouragement to study scheme'. There was an evident
connection between the appellants employment and the
sum he received. And in a very real sense the payment
was a consequence of the existing relation of employer
and employee. It was only as an employee that the
appellant qualified for the benefits payable under the
scheme. Borrowing the language of the majority in
Savage (R v Savage (1983) 83 DTC 5409) at 5414, there
was no element of gift or personal bounty or of
consideration extraneous to the appellant's
employment."

34. The majority of the Full Court of the Federal Court approached the case in like manner. At page 461 of the report (Federal Commissioner of Taxation v Smith (1986) 67 ALR 455) they said:

"Two subsequent cases, each decided by single justices
of the High Court, emphasise that it is not sufficient
to activate s.26(e) that there be at the date of the
receipt by the taxpayer of money or other benefits, a
relationship of employee and employer or of provider
and recipient of services between the taxpayer and the
payer of the money; see Hayes v F.C.of T. [1956] HCA 21; (1956) 96 CLR
47, Scott v T.C. of T. [1966] HCA 48; (1967) ALR 561; (1966) 11 CLR
514. It is also necessary that the money be received
by the taxpayer in such a capacity and not otherwise."

35. In my opinion the passages cited indicate clearly that it is necessary to go beyond the historical or temporal connection which had existed or presently existed between an employer and an employee. It is necessary to consider whether the taxpayer received the payment in any capacity other than that of employee, whether there was any consideration other than services rendered or to be rendered, and whether it could be said that the payment was in consequence only of the employee's service or of some other consideration.

36. Both Constable's case and Dixon's case supra are in accord with and confirmatory of this approach. Constable's case has some significant factual differences, as identified by counsel for the Commissioner. The payment to the taxpayer employee was not made by the employer but by the trustees of a provident fund and was not a voluntary payment. It was made because the employee became as a matter of law entitled to call upon the fund for payment. The members of the High Court who comprised the majority did not base their decision on whether the payment arose out of the taxpayer's employment but on the question whether it was "allowed, given or granted to him".

37. They said on page 417:

"On these facts we are of opinion that, whether or not
the payment or any part of it may be described as an
allowance, gratuity, compensation, benefit, bonus or
premium in resepct of or for or in relation to the
taxpayer's employment or services rendered by him, it
cannot correctly be said that it was such an
allowance, &c. 'allowed given or granted to him' during
the year of income under assessment.

It appears to us that the taxpayer became entitled to a
payment out of the fund by reason of a contingency
(viz.: an alteration of the regulations curtailing the
rights of members) which occurred in that year enabling
him to call for the amount shown by his account. It
was a contingent right that became absolute. The
happening of the event which made it absolute did not,
and could not, amount to an allowing giving or granting
to him of any allowance, gratuity, compensation,
benefit, bonus or premium. The fund existed as one to
a share in which he had a contractual, if not a
proprietary, title. His title was future, and indeed
contingent or, at all events, conditional. All that
occurred in the year of income with respect to the sum
in question was that the future and contingent or
conditional right became a right to present payment and
payment was made accordingly. This, in our opinion,
cannot bring the amount or any part of it within
s.26(e). The amount received by the taxpayer from the
fund is a capital sum, and, unless it or some part of
it falls under s.26(e) (there being no other applicable
imposition of liability), it is not part of the
assessable income." I have added the emphasis.

38. Webb J. considered whether the monies were paid in respect of the taxpayer's employment. He said on p.423:

"In my opinion, then, the moneys paid out of the fund to
the appellant were not moneys paid for or in respect of
his employment; nor were they in the events that
happened a retiring allowance."

39. In Dixon's case an employer made up during the war the difference between the military pay of an employee who had enlisted, and what he would have received in his civilian employment. It was held by the Court that s.26(e) had no application, although the amounts were assessable as income under the provisions of s.25 of the Act. In referring to s.26(e) Dixon C.J. & Williams J. said on page 554:

"It may be conceded also that the proviso has an effect
upon the construction of par. (e) of s.26, but the
effect is only to show that the allowance may be in
consequence of a retirement from or termination of the
office, not to show that a mere historical connection,
as it may be called, is sufficient."

40. At page 564 Fullagar J. said:

"The fact of the respondent's employment explains the
selection of him as a recipient but it in no degree
characterizes the payment. The payment does not
partake in any degree of the character of a reward for
services rendered or to be rendered."

These two sentences can be aptly applied to the present matter, where the taxpayer was selected as a recipient of options because he was an employee, which fact however has no bearing on the character of the payment received by him under the surrender agreement.

41. In my opinion the test of assessability of benefits under s.26(e) as stated by the majority of the High Court in Smith's case is that the benefit must be the consequence of the employment relationship. In the present matter the crucial fact was that by the month of November 1981 the taxpayer had significant rights in contract as an option holder to acquire shares. These rights to call for shares were capable of being exercised subsequent to the termination of his employment or after his death. It was these contractual rights, and his entitlement as an option holder, which enabled him to deal with Delhi International in relation to the surrender arrangements. The mere existence of an employer-employee relationship in November 1981 was nothing to the point if he had not been the holder of options. As previously mentioned he or his personal representatives could have exercised the right to call for shares, to call for a cash payment under the LSAR agreements or to negotiate some other arrangement with Delhi International even if the taxpayer's employment had earlier ceased. If, in accordance with the dicta of Brennan J. in Smith's case, one looks to the consideration for the payment of $1,100,000, this consideration was the surrender, or perhaps more strictly the extinguishment or abandonment, of his rights to acquire shares or alternatively to obtain cash under the LSAR agreements. That consideration passed from the taxpayer as the holder of options and not by virtue or in consequence of the employer-employee relationship.

42. Counsel for the Commissioner argued that the surrender agreement was motivated by or was the consequence of the taxpayer being an employee. He said in effect that such a beneficial agreement would not have been made by Delhi International but for the fact that the taxpayer was in the employ of its subsidiary. A person other than an employee, he submitted, would only have received from Delhi International his strict entitlement under the Stock Option and LSAR Agreements. However, in my opinion, the Commissioner has been unable to establish a factual foundation for this contention. There was no evidence to support such findings of fact and no basis or justification for the drawing of any such inference. I must accept, as I do unreservedly, the evidence of the taxpayer that he was concerned about the implications of United States Securities law if he exercised his rights under either of the two classes of agreements at the time of a takeover. Justification for this concern is to be found in the letter of the United States solicitors. The fact that he also saw the prospect of a "tax exempt capital fund" as a more beneficial result notwithstanding the fact it was somewhat less than that he would otherwise have received, is nothing to the point. Furthermore there was no evidence that Delhi International was motivated by other than commercial considerations in entering into the "surrender" transaction.

43. To my mind the approach of Bowen J. as he then was in Donaldson's case and Lord Radcliffe in Abbott v Philbin [1960] UKHL 1; (1961) AC 352 can very appropriately be applied to determine this matter, at least under s.26(e), in the taxpayer's favour. Bowen J. distinguished between the grant of an option to an employee and its exercise by the employee when he said on page 4207 in reference to the assessability under 26(e) of option rights, namely

"To say the option rights could not be exercised in the
year of income is no answer to the application of
s.26(e). Indeed it is to confuse the enjoyment of the
fruits of the rights with the enjoyment of the rights,
a mistake made in argument on behalf of the Crown in
Abbott v Philbin."

44. In the latter case Lord Radcliffe made the same point when he said on page 379:

"The advantage which arose by the exercise of the
option, say 166 pounds, was not a perquisite or profit from
the office during the year of assessment: it was an
advantage which accrued to the appellant as the holder
of a legal right which he had obtained in an earlier
year, and which he exercised as option holder against
the company. The quantum of the benefit, which is the
alleged taxable receipt, is not in such circumstances
the profit of the service: it is the profit of his
exploitation of a valuable right. Of course, in this
case the year of acquiring the option was only the year
immediately preceding the year in which, pro tanto, it
was exercised. But supposing that he holds the option
for, say, nine years before exercise? The current
market value of the company's shares may have changed
out of all recognition in that time, through retention
of profits, expansion of business, changes in the
nature of the business, even changes in the market
conditions or the current rate of interest or yield. I
think that it would be quite wrong to tax whatever
advantages the option holder may obtain through the
judicious exercise of his option rights in that way as
if they were profits or perquisites from his office
arising in the year when he calls the shares."

45. The taxpayer in entering into the surrender agreement can correctly be said to be enjoying "the fruits of the rights" and not the rights themselves. Alternatively in the words of Lord Radcliffe he was engaged in "exploitation of a valuable right" earlier granted to him.

46. The Commissioner finally contended that if the sum in question was not assessable under s.26(e), it was brought to tax under sub.s.25(1) as an item of gross income. I can not accept this submission. Whether or not a particular receipt is income depends upon its quality in the hands of the recipient; Scott v Federal Commissioner of Taxation [1966] HCA 48; (1966) 117 CLR 514 at 517. As Kitto J. said in The Squatting Investment Co. Ltd. v Federal Commissioner of Taxation [1953] HCA 13; (1953) 86 CLR 570 at pages 627-628 -

"The question whether a receipt comes in as income must
always depend for its answer upon a consideration of
the whole of the circumstances."

47. Furthermore a significant matter, although not necessarily a decisive consideration, is the regularity and periodicity of the payment; Dixon's case supra at page 568. In this matter the amount in question was a single lump sum, for which consideration passed from the payee to the payer, without being referable to any period or any suggestion that it formed part of a regular series of payments. In my opinion all the relevant circumstances indicate that it has the character of a capital receipt. The only element pointing to a contrary conclusion is the fact that the payee was in the employ of the payer at the time of the receipt. Any inference that might be drawn from this fact is far outweighed by a consideration of all the other relevant circumstances.

48. In my opinion the taxpayer's appeal must be allowed and his objection upheld. The Commissioner must pay the taxpayer's costs of this appeal.