Re Traknew Holdings Pty Ltd v Commissioner of Taxation [1991] FCA 129 (11 April 1991)

FEDERAL COURT OF AUSTRALIA

Re: TRAKNEW HOLDINGS PTY LTD
And: COMMISSIONER OF TAXATION
No. G427 of 1990
FED No. 125
Income Tax

COURT

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

CATCHWORDS

Income Tax - sale of shares in trustee company - price paid for shares equivalent to value of trust assets and far in excess of paid up capital of trustee company - shareholders of trustee company also eligible beneficiaries under trust - whether purchase price income under ss.25(1) or 26(a) Income Tax Assessment Act 1936 (Cth) - relation between second limb of s.26(a) and s.25(1) discussed - relation of two limbs of s.26(a) discussed - characteristics of a profit-making undertaking or scheme.

Income Tax - section 260 Income Tax Assessment Act - principles relevant to application of s.260 - extent of participation in scheme to avoid tax needed to attract s.260 - effect of annihilation - whether underlying transaction liable to tax - relationship between s.260 and specific anti-avoidance provision.

Income Tax - trust income - whether Division 6 of Income Tax Assessment Act exclusive code for assessability of trust distributions - application of ss.99B and 26(b) discussed.

Income Tax Assessment Act 1936 (Cth): ss. 25(1), 26(a), 26(b), 97, 99, 99A, 99B, 100A, 101, 260.

HEARING

SYDNEY
11:4:1991

Counsel and Solicitors R.J. Elliott QC and A.H. Slater
for Applicant: instructed by Mallesons Stephen Jaques

Counsel and Solicitors G.K. Downes QC and D.B. McGovern
for Respondent: instructed by the Australian
Government Solicitor

ORDER

The appeal be dismissed.

The appellant pay the respondent's costs of the appeal.

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

DECISION

The appellant, Traknew Holdings Pty Ltd ("Traknew"), appeals against the decision of the Administrative Appeals Tribunal constituted by Deputy President Mr Bannon QC, upholding an objection decision of the respondent Commissioner of Taxation for the year of income ended 30 June 1980. In dispute is the liability of the appellant to tax on an amount of $534,382, said by the appellant to have been a profit made by it on the sale of shares held by it in Puduba Pty Ltd ("Puduba"), which company at all times carried on no business other than as the trustee of certain family trusts associated with a Dr Wenkart.

2. The present is not the ordinary case where there is raised as the sole issue the question whether a profit on sale of shares is capital or income, although that issue is raised by a notice of contention filed by the Commissioner. The sale of the shares was no simple sale. Behind it lay an arrangement involving, what is colloquially referred to as "trust stripping", that can bear no label other than that it was entered into and carried out for the sole purpose of avoiding income tax. Of course it does not necessarily follow from the use of such a label that the appellant was liable to pay income tax on the amount in dispute.
The Facts

3. In the 1980 year of income, a company, Morlea Professional Services Pty Limited ("Morlea"), was the trustee of a unit trust known as the Morlea Professional Services Unit Trust, ("the Morlea Unit Trust"). Morlea, as trustee, carried on the business of providing pathology services. Its governing mind was that of Dr Wenkart. The unit trust had been settled in 1977 and the sole unit holder of the trust was Puduba, which held its units in the Morlea Unit Trust on the trusts of a discretionary trust.

4. The discretionary trust had been settled in 1977 and was known as the Morlea Discretionary Trust. Under the trust deed, the trustee was to stand possessed of the trust assets in trust for all or such one or more to the exclusion of the others or other of the eligible beneficiaries in such shares or proportions as the trustee should revocably or irrevocably from time to time before "the closing date" of the trust, appoint. In default of, and subject to any such determination, cl.4 provided that the trustee had discretion to pay or apply income for the benefit of the eligible beneficiaries at its discretion, or to accumulate that income during the infancy of the children of the parent and hold such accumulated income for those children. In default of an exercise of discretion or accumulation, the trustees were directed to pay or distribute the whole of the income of the trust fund for such one or more of the eligible beneficiaries and in such shares or proportions among them as the trustee in its absolute discretion determined. There was no further trust in default of determination.

5. The class of eligible beneficiaries under the trust included Dr Wenkart's wife, his children, grandchildren or great grandchildren, any spouse of his children, grandchildren or great grandchildren, the appellant, Richard Walter Pty Ltd, Hapday Holdings Pty Ltd ("Hapday"), (all being companies presumably associated with Dr Wenkart), any company in which Dr Wenkart and or any eligible beneficiary was entitled to exercise more than one half of the voting power at meetings of shareholders, the Wenkart Foundation, Health Care Research Institute Limited, Preventicare Pty Ltd and certain other beneficiaries. There was power, in Dr Wenkart, to add to the class of eligible beneficiaries, subject to certain restrictions not presently relevant.

6. Puduba had been incorporated on 26 July 1976 and the shares in it were acquired (as part of a reorganisation of Dr Wenkart's business affairs in that year) by two family companies, the appellant and Hapday. It was always intended that Puduba be a trustee company and that it act indefinitely in such a capacity. There was no doubt, as the Tribunal found, that the appellant did not acquire its shares in Puduba with a view to their being resold at a profit or at all.

7. The appellant itself was a family holding company, the only activities of which (save for those it undertook at the end of the year of income in question) have been the holding of shares in companies controlled by Dr Wenkart and the ownership of a home unit in Double Bay.

8. The pathology practice conducted by Morlea was successful and indeed it was evident in June 1980 that there would be derived in the 1980 year of income an amount in excess of $1,250,000 of "net income" as that expression is defined in s.95 of the Income Tax Assessment Act 1936 (as amended) ("the Act"). In June, Dr Wenkart received advice from his solicitor concerning the arrangement which was subsequently entered into. Dr Wenkart understood, in general terms at least, the arrangement proposed, and assented to its implementation willingly, for he saw the overall effect as being to substantially improve the cash flow of the group by reducing its tax liability. The solicitor stressed upon Dr Wenkart the importance of the right steps being taken in the right order. All the steps to be taken were pre-ordained and all minutes and documents to record and implement them prepared in advance. Unfortunately a fire in the appellant's premises led to the loss of some records of the appellant which might have been helpful in explaining how the appellant viewed the transaction, but enough records survive to allow the transaction to be described relatively accurately.

9. So far as the arrangements affected the Wenkart interests, it involved the following steps:

1. A meeting of the directors of Morlea was held on Friday, 27 June
1980, wherein it was resolved that that company as trustee of the
Morlea Unit Trust make an interim distribution to its unitholders
of $1,260,000. The secretary of the company was authorised to
arrange payment. In fact, no cash payment was ever made.
2. Dr Wenkart, pursuant to a power conferred upon him so to do in the
deed establishing the Morlea Discretionary Trust, nominated Puduba
as the person with the power to appoint and remove trustees of
that settlement, and relinquished his own right so to do.
3. Dr Wenkart, pursuant to a power so to do conferred upon him in the
deed establishing the Morlea Discretionary Trust, appointed a
company known as Lobutu Pty Limited ("Lobutu"), an eligible
beneficiary of the Morlea Discretionary Trust. Until the time of
appointment, the name of Lobutu was not known to Dr Wenkart. It
was a company associated with the promoter of the trust stripping
arrangement, a Mr Wynyard.
4. On 29 June 1980, the directors of Puduba resolved that all the
income and capital of the Morlea Discretionary Trust be appointed
to Lobutu. It was further resolved that the trust come to an end
as at 1 July 1980. In fact it seems that as at 30 June 1980, the
only assets of the trust comprised $1,098,763, representing
settled funds of $100 and the distribution due from the Morlea
Unit Trust of $1,260,000. The discrepancy between $1,260,000 and
$1,098,763, is accounted for by a distribution of $145,000 of
income apparently made by the trustee of the Morlea Discretionary
Trust to an overseas beneficiary associated with Dr Wenkart prior
to 30 June 1980. This distribution is not in issue. There was
also a small amount for interest and bank charges which affects
the final figure.
5. On 30 June 1980, the appellant and Hapday, each holding half the
issued share capital of Puduba, entered into an agreement for the
sale of the whole of the issued capital of Puduba to Shareholder
Pty Limited ("Shareholder"), a company associated with Mr Wynyard.
The share purchase agreement recited that Puduba was the trustee
of the Morlea Discretionary Trust and the vendors warranted the
correctness of a balance sheet of the trust. The purchase price
payable under the agreement was $1,068,765 payable as to half to
the appellant and half to Hapday. It may be noted that Puduba had
no assets of its own other than its paid up capital of $2.
6. The arrangement with the Wynyard interests envisaged that a
"commission" would be payable to a Mr Goldspink, related to Mr
Wynyard, of $30,000. This commission was actually paid in cash by
a cheque from Dr Wenkart addressed to a firm of solicitors, Kerns
Newby Biddulph and Mitchell (hereafter referred to as "the
solicitors"). The $30,000 explains the discrepancy between the
net trust assets of $1,098,763 referred in 4. above and the
purchase price of $1,068,765.
7. Dr Wenkart signed a series of directions. These directions arose
because the parties were unable or unwilling to carry through all
the steps contemplated by cheque. As a substitute, the trust
account of the solicitors was utilised, it being intended,
apparently, that the parties would then give directions to that
firm which would make entries in accordance with those directions
and which would be effective. Directions signed by Dr Wenkart
were as follows:
(a) To Shareholder on behalf of each of Hapday and Traknew
directing that company to pay the amount of $534,382, being
the purchase price for the sale of the shares in Puduba, to
the trust account of the solicitors.
(b) To the solicitors on behalf of Hapday directing them to pay
to the appellant the sum of $534,382.
(c) On behalf of the appellant to the solicitors directing them
to pay to Dr Wenkart the sum of $1,068,765.
(d) To the solicitors on behalf of Dr Wenkart directing them to
pay to Puduba the sum of $1,098,765.

10. In addition to the movements in the trust account of the solicitors, there were drawn a number of cheques as follows:

(a) On 27 June 1980, Dr Wenkart drew a cheque for $1,260,000 in
favour of the appellant. This cheque appears to have been
treated as a loan by Dr Wenkart to the appellant.
(b) On the same day, the appellant drew a cheque for $1,260,000
to Morlea. The appellant says that this had no connection
with the arrangement at all.
(c) On 30 June 1980, Shareholder paid into the trust account of
the solicitors $9,705,266. This included an amount of
$1,068,765 being the purchase price payable by Shareholder
to the appellant and Hapday for the shares.
(d) On the same day the solicitors paid two cheques in favour of
Lockwing Pty Limited ("Lockwing"), totalling $9,979,642.
This included an amount of $1,068,765 intended as a payment
from Puduba at the direction of Shareholder to Lockwing.
There was a direction signed by Shareholder addressed to
Puduba, authorising payment to Lockwing of all monies held
in account on behalf of Puduba.

11. If the above account of the steps taken appears confusing, the problem is compounded by an attempt to analyse the entries made in the accounts of the solicitors and relate them to the directions given. Nevertheless, the steps intended to be taken were, on the balance of probabilities, as follows:

1. Shareholder paid $1,068,796 (part of the $9,705,266 referred to
above) to the solicitors with a direction that half was to be held
for the account of the appellant and half for the account of
Hapday. In the result the trust ledger of the solicitors shows
that the account of each of the appellant and Hapday was credited
with $534,382.
2. Pursuant to the direction to this effect, the solicitors then
credited the account of the appellant with the amount that
previously had been credited to the account of Hapday (debiting
that account) so that the account of the appellant was credited
with a total of $1,068,765.
3. The appellant paid the sum of $1,068,765 as a loan to Dr Wenkart.
This was achieved by debiting the account of the appellant and
crediting the account of Dr Wenkart in the books of the
solicitors, pursuant to the direction of the appellant to the
solicitors.
4. Dr Wenkart then paid Puduba the sum of $1,098,765. This was
achieved by debiting the account of Dr Wenkart and crediting the
account of Puduba in the trust account of the solicitors. The
intention was presumably to put Puduba in funds to meet the
liability (if called upon) to Lobutu pursuant to the resolution to
pay the income of the Morlea Discretionary Trust to that company.
In making this payment it logically has to be assumed that Dr
Wenkart was making the payment on behalf of the trustee of the
Morlea Unit Trust, Morlea Professional Services Pty Limited. This
step in the transaction was carried out by debiting the account of
Dr Wenkart and crediting the account of Puduba.
5. Puduba then paid Lockwing $1,098,765. Authority for this payment
was contained in a direction from Shareholder as purchaser
addressed to Puduba, authorising the latter company to pay all
moneys held by it to Lockwing. This payment, a blatant breach of
trust, was the step which actually stripped the trust. It was
given effect to by the solicitors crediting the account of
Lockwing in its trust ledger in the relevant amount and debiting
the account of Puduba.
6. A cheque was then drawn by the solicitors on the trust account in
favour of Lockwing for $9,705,266.43 which included the
$1,098,765, the subject of the payment from Puduba to Lockwing.
7. There is no evidence as to what happened as between Lockwing and
Shareholder, although it would seem likely, in the absence of
evidence, that the circle was completed by the moneys passing
directly or indirectly from Lockwing to Shareholder.

12. At this point of time in the scheme, Dr Wenkart would have owed the appellant $1,068,765 and Morlea would have owed Dr Wenkart the same amount. The cheque of $1,260,000 drawn by Dr Wenkart on 27 June, may have been a loan made by Dr Wenkart to the appellant in anticipation of this situation arising. In any event it had the effect of cancelling out Dr Wenkart's indebtedness to the appellant.

13. No doubt Dr Wenkart did not want $1,260,000 sitting in the bank account of the appellant. There is no evidence whether his own personal account was in debit as a result of this transaction. In any event a cheque was drawn by the appellant to Morlea for $1,260,000 by way, it would seem, of loan.

14. Thus, as at 30 June 1980, the accounts of the appellant showed that it had derived a capital profit on the sale of its shares, that it had a liability to Hapday of $531,635 and that it had lent $1,260,000 to Morlea. Although there is no evidence to this effect, it could easily be inferred that the $1,260,000 sitting in Morlea would find its way back, in some way, to Dr Wenkart to enable the circle of transactions to be completed.

15. It was in these circumstances that the Commissioner assessed the appellant to tax on the amount of $534,382.
The decision of the Administrative Appeals Tribunal

16. The Tribunal was of the view that the provisions of s.260 of the Act should be applied in the relevant circumstances. That section provided as follows:

"Every contract, agreement, or arrangement made
or entered into, orally or in writing, whether
before or after the commencement of this Act,
shall so far as it has or purports to have the
purpose or effect of in any way, directly or indirectly -
(a) altering the incidence of any income tax;
(b) relieving any person from liability to pay
any income tax or make any return;
(c) defeating, evading or avoiding any duty or
liability imposed on any person by this Act; or
(d) preventing the operation of this Act in any respect,
be absolutely void, as against the Commissioner,
or in regard to any proceeding under this Act,
but without prejudice to such validity as it may
have in any other respect or for any other purpose."

17. On the Tribunal's view the parties to the s.260 arrangement were Dr Wenkart, Puduba, the appellant, Hapday, Lobutu and Shareholder. Substituting the real names of the parties for those adopted for the purposes of secrecy in the Administrative Appeals Tribunal, the Tribunal said:

"The proper inference from the evidence is that
the arrangement was to transfer the income
derived by Puduba Pty Limited from the (i.e. as
trustee of) Morlea Discretionary Trust to the
appellant and Hapday Holdings Pty Limited, two
of the eligible beneficiaries under that trust,
without formally appointing the income to them,
by the stratagem of appointing Lobutu Pty
Limited as a new eligible beneficiary under the
Morlea Discretionary Trust and utilising the
money payable to Lobutu Pty Limited to fund the
sale by the appellant and Hapday Holdings Pty
Limited of the two shares in Puduba Pty Limited
for a sum roughly equivalent to half the income
of the Morlea Discretionary Trust so characterising
the receipt as capital rather than income."

18. According to the Tribunal, when s.260 applied, the proceeds in the hands of the appellant were an income receipt and not a capital receipt. The Tribunal was of the view that the receipt so exposed, after the application of s.260 of the Act, was assessable to tax under either or both of s.99B or s.25 of the Act.

19. The Tribunal rejected a submission of the Commissioner that the profit on the sale of the shares (absent s.260) was assessable to tax under s.26(a) or s.25.
The appellant's Appeal on the Facts

20. It was critical to the reasons of the Tribunal that the appellant actually received from Shareholder the amount of $1,068,796. As the Tribunal saw it, the scheme had the result that the income of the Morlea Discretionary Trust (subject to the minor exceptions which I have already noted) was distributed equally to the appellant and Hapday, each of whom was a beneficiary of income under the trust, albeit without the benefit of a formal appointment to them.

21. By its notice of appeal, the appellant challenged the application of s.260 of the Act to the facts as found by the Tribunal. However, it also challenged the finding of fact by the Tribunal that approximately one half of the income received by Puduba from the Morlea Unit Trust, was eventually received by the appellant. It was said that there was no evidence before the Tribunal upon which such a finding could be based.

22. This latter point may be disposed of shortly. It must firstly be said that the accounts of the appellant disclosed that the appellant had made a capital profit from the sale of the shares. That statement does not of course require the conclusion that the moneys on the sale of the shares had been received by the appellant. However, the accounts of the appellant disclosed also that no moneys were owing to it by Shareholder. From this it follows clearly enough that the accounts of the appellant admit the receipt of the moneys on the sale of the shares. The admission in the accounts was repeated in argument by counsel for the taxpayer before the Tribunal. It simply was not an issue below whether the appellant had received moneys on the sale of the shares. Further, the admissions are consistent with the book entries in relation to the transactions.

23. It is one thing, however, to say that the appellant received the moneys on the sale of the shares, it is another thing to say that those monies represented the income of the Morlea Discretionary Trust. When regard is had, however, to the cheque payments, the directions and the book entries made, and despite the absence of evidence as to what happened between Lockwing and Shareholder, it is clear that there was evidence upon which it was open to the Tribunal to find that the transaction among the various parties took place by a circular movement of funds, not a movement of funds in the sense of credits passing through bank accounts, but a movement that took place partly by the cheque transactions which I have described and partly by the transactions in the trust account of the solicitors pursuant to authorities given by the various parties to the transactions to carry them out.

24. The precise order in which the transactions were intended to take place can no longer, of course, be determined with precision. Nevertheless, in my view it was clearly open to the Tribunal to find that the steps taken had the effective result of ensuring that moneys available for distribution in the Morlea Unit Trust were distributed to Puduba and that through the transactions which I have described they ended up in the hands of the appellant and Hapday. This is so notwithstanding that if the transactions are given effect in accordance with their tenor, that in so doing these moneys ended up as purchase price of the shares sold by the appellant to Shareholder.
The Commissioner's Notice of Contention: s.26(a) or s.25(1)

25. By a notice of contention the Commissioner challenged the Tribunal's finding that the profit arising to the appellant on the sale of the shares in Puduba was not assessable income under either s.26(a) or s.25 of the Act. The Tribunal gave no reasons for rejecting the Commissioner's submission based on s.25. However, its rejection of the Commissioner's argument on s.26(a) was consequent upon an acceptance by the Tribunal of the appellant's submissions below which were in the following terms:

"2. The first limb of s.26(a) has no
application. For the first limb to apply, the
property in question must have been acquired
with the dominant purpose of resale at a profit.
Burnside v Federal Commissioner of Taxation
[1977] HCA 66; (1977) 138 CLR 23, 28, 35.
3. The second limb of s.26(a) is also
inapplicable. For the second limb to apply in
respect of an asset not acquired for resale at a
profit, there must be a scheme to employ that
asset to profit-making advantage. Where the
asset is not committed to a scheme or
undertaking, but is simply sold, s.26(a) has no
application. Burnside v Federal Commissioner of
Taxation [1977] HCA 66; (1977) 138 CLR 23, 27.3, 37.3, 49.3,
50.4, 28.2; White v Federal Commissioner of
Taxation [1968] HCA 41; (1971) 120 CLR 191, 219.7, 217.4;
Federal Commissioner of Taxation v Williams
[1972] HCA 31; (1972) 127 CLR 226, 245-6, 249.3; McGuiness v
Federal Commissioner of Taxation (1972) 72 ATC
4024, 4027-8."

26. There has been considerable controversy as to the relation between s.25, which brings into assessable income that which is income in ordinary concepts, and the second limb of s.26(a) which, at the relevant time, brought into assessable income the profits arising from the carrying on or carrying out by the taxpayer of a profit-making undertaking or scheme. Courts have, however, not found it necessary to reconcile that controversy when considering the facts of a particular case. Reference may be made to discussion of the question in Federal Commissioner of Taxation v Bidencope [1978] HCA 23; (1978) 140 CLR 533 and Federal Commissioner of Taxation v Whitfords Beach Pty Limited [1982] HCA 8; (1981-82) 150 CLR 355 per Gibbs C.J. (at 362-367), per Mason J (at 379-383) and the cases cited by the full court of this court in Moana Sand Pty Limited v Federal Commissioner of Taxation (1988) 88 ATC 4897 at 4902. Again in the present case it is unnecessary to resolve the controversy.

27. The controversy is in part complicated by the relation of the two limbs of s.26(a). The first limb of that sub-section is concerned with the profit arising on the resale of property acquired for the purpose of profit-making by sale. As a matter of construction, therefore, it would seem logical that a profit-making scheme must consist of more than the sale of property acquired for the purpose of resale at a profit, otherwise all cases falling within the first limb would be subsumed by the second. Equally, as a matter of logic, the mere sale of property that was not acquired for the purpose of profit-making by sale could not be rendered taxable as a profit-making undertaking or scheme. The latter point becomes more significant when it is realised that, as was held in Moana Sand, it is not necessary that profit-making be the sole or dominant purpose of a profit-making scheme. It is necessary only that profit-making be one of the purposes of the scheme.

28. In Burnside v Federal Commissioner of Taxation [1977] HCA 66; (1977) 138 CLR 23, the Commissioner sought to allege a profit-making scheme in circumstances where shares not acquired for resale at a profit were merely sold at a profit. The court unanimously rejected the Commissioner's approach. Barwick C.J. (at 27) said:

"Where nothing more appears than that an asset
acquired, but not for the purposes of profit-making
by sale, has been sold at a price in
excess of the price at which it was acquired,
there can in my opinion be no basis for holding
that that gain is a profit arising from a
profit-making undertaking or scheme. The
circumstances lack not only the elements of an
undertaking or scheme but the profit-making
purpose of any undertaking or scheme which is
essential to satisfy what is generally referred
to as the second limb of s.26(a)."

29. In the same case, Mason J (at 37) said:

"In the first place, where the profit in
question arises from the purchase and subsequent
sale of an asset and it is found that the asset
was not acquired for the purpose of profit-making
by sale it is very difficult to see how
the profit can be said to arise from a profit-making
undertaking or scheme (see McGuiness v Federal
Commissioner of Taxation (1972) 46 ALJR
279). In this case the difficulty becomes
insurmountable because the finding in connexion
with the first limb of s.26(a) denies the
existence of the relevant profit-making
undertaking or scheme which is alleged to bring
the profit within the second limb. For the
Commissioner's claim is that the essence of the
profit-making scheme lies in the purpose of
acquiring the Samin shares and selling them at a
profit. According to the Commissioner it is
that purpose and that purpose alone which stamps
the scheme with a profit-making character."

30. Reference may be made as well to the comments of Jacobs J (at 38-39) and of Aickin J (at 49-50).

31. At the very heart of the view taken by their Honours in Burnside is the principle that a mere realisation of a capital asset is not a profit-making undertaking or scheme. Cases which may be cited in support of this principle include Scottish Australian Mining Co v Federal Commissioner of Taxation [1950] HCA 16; (1950) 81 CLR 188; White v Federal Commissioner of Taxation [1968] HCA 41; (1968) 120 CLR 191; Federal Commissioner of Taxation v Williams [1972] HCA 31; (1972) 127 CLR 226; and McClelland v Federal Commissioner of Taxation (1970) 120 CLR 487 at 494-95. Some of these cases have, in more recent times, come under close scrutiny. See for example the judgment of Mason J in Whitfords Beach (supra at 378-79) doubting the conclusion in McClelland's Case and (at 385) discussing Scottish Australian Mining, Official Receiver v Federal Commissioner of Taxation (Fox's Case) [1956] HCA 63; (1956) 96 CLR 370 and the decision in White. See also the judgment of Wilson J in Whitfords Beach (at 397-400). The concept of a mere realisation and its converse are relevant to the question whether the gain made on the sale of an asset is a mere enhancement of capital or income: Californian Copper Syndicate v Harris (1904) 5 TC 159 just as they are relevant to determining whether there has been a profit-making undertaking or scheme.

32. With respect, the admonition of Mason J in Whitfords Beach (supra at 378) to return to the statutory language of the second limb of s.26(a) and construe it directly must steadily be born in mind. As the High Court said in Fox's Case (supra at 387):

"... although s.26(a) is founded on language
which was used in judicial decisions... it
provides a statutory criterion which must be
applied directly and cannot be treated as going
no further and producing no different result
than would a criterion expressed as 'exercising
trade' or 'carrying on a business'."

33. Cases which have been decided under s.26(a) establish a number of principles. First, there must be found a "scheme" or "undertaking"; that is to say "some programme or plan of action": Clowes v Federal Commissioner of Taxation [1954] HCA 10; (1954) 91 CLR 209; Bernard Elsey Pty Limited v Federal Commissioner of Taxation [1969] HCA 46; (1969) 121 CLR 119. Second, the undertaking or scheme must be one carried on or carried out by the taxpayer or on his own behalf. It is not sufficient if the scheme in question is the scheme of some other person: Clowes v Federal Commissioner of Taxation (supra); Milne v Federal Commissioner of Taxation (1976) 50 ALJR 412; Xco Pty Limited v Federal Commissioner of Taxation [1971] HCA 37; (1971) 124 CLR 343; and cf Bidencope (supra). The scheme in question may involve repetition but need not do so: Premier Automatic Ticket Issuers Limited v Federal Commissioner of Taxation [1933] HCA 51; (1933) 50 CLR 268. It must be one of profit-making, that is to say it must be characterised by a profit-making purpose or, as Mason J put it in Whitfords Beach (supra at 384), it must exhibit characteristics of a business deal.

34. Finally, as appears above, it will be necessary to determine whether what has been done by the taxpayer consists of no more than the mere realisation of a capital asset or whether it is something more. In this context it should be noted that a profit-making scheme may involve the taxpayer venturing a capital asset, not acquired for purpose of profit-making, into a scheme in circumstances where his acts amount to more than a mere realisation but the actual carrying on or carrying out of a scheme. One example is the case of Bernard Elsey (supra). In Whitfords Beach, Murphy J held that the second limb of s.26(a) applied where a capital asset not acquired for the purpose of resale to profit was sub-divided in a large scale sub-division and the sub-divided lots sold. The majority of the court, however, applied s.25 with the same result.

35. There is little doubt in the present case that there can be found a scheme or undertaking. One of the purposes of the scheme, and indeed a substantial purpose of the scheme, was the making of a profit by the appellant. It may be said that what was done in the present case involved more than the mere sale by the appellant of its shares in Puduba, it involved a great deal of activity designed to bring about the circumstance where a purchaser, Shareholder, would be prepared to pay a large sum of money for a company which, unless there were a gross breach of trust, could be worth only $2.

36. The difficulty, from the point of view of the Commissioner's submission, is whether it is correct to say that it was on the present facts the taxpayer's scheme. So far as the taxpayer is concerned, all it did was sell its shares and give a direction to the purchaser as to the payment of the purchase price and make a loan to Dr Wenkart. All of the other steps that were taken, and indeed the critical steps were taken not by the appellant but by other companies under the control of Dr Wenkart. Thus the case is rather analogous to the forestry bonds in Clowes and Milne (supra) where there was a profit-making scheme conducted by a person other than the taxpayers, and where all that the taxpayers did was to acquire and hold bonds until fruition.

37. No doubt, if the evidence in the present case had enabled the Tribunal to make a finding of fact that all the steps taken by other parties in appointing income to Lobutu were taken at the request of and as agent for the appellant, a different result could follow. However, there is no such finding and indeed the evidence would not, in any event, justify such a finding.

38. It follows therefore, in my view, that the profit cannot be brought to tax under the second limb of s.26(a).

39. The same process of reasoning leads to the result that the amounts in question are not income in ordinary concepts. Once it is found that the shares in question were purchased other than for the purpose of resale at a profit, it would only be where the taxpayer did something more than merely realising the profit inherent in the capital asset, that the profit would be income in ordinary concepts. This is clear from both Whitfords Beach (supra) and Federal Commissioner of Taxation v Myer Emporium Limited [1987] HCA 18; (1987) 163 CLR 199 at 209-210. It follows, in my opinion, that the Commissioner's notice of contention must be dismissed.
The application of s.260

40. In Davis v Federal Commissioner of Taxation (1989) 89 ATC 4377 at 4400-4402 and in Bunting v Federal Commissioner of Taxation (1989) 24 FCR 283 at 299 ff, I set out a number of propositions which must now be taken to have been accepted by the leading authorities on s.260. There is no need here to repeat what I there said. The comments that follow accept the correctness of these propositions.

41. The present is a case where there can clearly be identified an arrangement, which bears upon its face the stamp of tax avoidance. It was an arrangement entered into to ensure that the overall tax payable, either by the trustee or by the beneficiaries of the Morlea Discretionary Trust, would be reduced. The first step of the arrangement was not, of course, the interim distribution made by the Morlea Unit Trust, because that was not a step which in any way operated to avoid the tax of the trustee or beneficiary of the discretionary trust.

42. It was submitted for the taxpayer that the arrangement must be one specifically to avoid the tax of the particular taxpayer. That submission cannot as so stated be accepted.

43. In Hancock v Federal Commissioner of Taxation [1961] HCA 90; (1959-61) 108 CLR 258, a case concerned with dividend stripping, Dixon C.J. pointed out (at 278) that the essential feature of the scheme to Mr Hancock was the escaping of tax that:

"... must attach either to the company or to the
shareholders if the profits were undistributed
and alternatively of the tax which as
shareholders they would pay if the profits were
simply distributed as dividends."

44. The same analysis is true here. Under the provisions of Division 6 of Part III of the Act, the assessability to tax will depend upon whether, at least in the ordinary case, there is a beneficiary who is presently entitled or whether there is no such beneficiary. In the case of a discretionary trust, such as the present, where the trustees may either exercise a discretion or accumulate for the benefit of income beneficiaries, the liability to tax will depend upon how that discretion is exercised. If the discretion is exercised to pay or apply income to a beneficiary, then either s.97 or s.101 will operate to cause an amount to be included in the assessable income of the beneficiary. If, on the other hand, a discretion be exercised to accumulate, then to the extent that there is no beneficiary presently entitled to income of the trust estate, the trustee will become assessable and liable to pay tax pursuant to the provisions of s.99A. It does not seem to me to matter that, if the trustee resolves to distribute or apply income for the benefit of beneficiaries, there are a potentially large class of beneficiaries. The scheme is one to avoid the tax either of the trustee or the beneficiaries (which include the appellant) and, to that extent, s.260 can be said to apply to it.

45. The parties to the proposal, in the present case, were the appellant and Dr Wenkart on the one hand, and Shareholder, Lockwing and Lobutu on the other, together with Mr Wynyard. Each of the parties to the arrangement freely agreed to do what was necessary to effect it. The present is not a case where it can be said that the scheme was a scheme of the trustee alone carried out without the participation of the beneficiary: cf Davis (supra) and Stamp v Federal Commissioner of Taxation (1988) 88 ATC 4803.

46. The present case involves the elements of circularity and of conversion of income into capital, both of which assist in characterising the arrangement as one to which s.260 applies: cf Oakey Abattoir Pty Limited v Federal Commissioner of Taxation (1984) 55 ALR 291 at 304; Donebus Pty Ltd v Federal Commissioner of Taxation (1988) 81 ALR 635 at 643 per Davies J, at 650 per Wilcox J; Pettigrew v Federal Commissioner of Taxation (1990) 90 ATC 4124 at 4143 per Hill J; Federal Commissioner of Taxation v Gulland [1985] HCA 83; (1985) 160 CLR 55 at 110 per Dawson J. In such a case the avoidance of tax is constituted by the alteration of the incidence of tax and the conversion of an income receipt into a capital receipt.

47. There is assistance to be obtained from the decision of the full court of this court in Federal Commissioner of Taxation v Gregrhon Investments Pty Limited (1987) 76 ALR 586, a case concerned with the sale of shares in a company with a current year tax liability. In that case, as in this, the taxpayer had been aware of a tax problem. In each case no real assets left the hands of the taxpayer or his associates; neither could be described as mere sale of shares. There is one matter of difference, although no mention was made of it by the appellant, namely that in Gregrhon the agreement for the sale of shares obliged the vendors (the taxpayers) to hand on settlement to a nominee of the purchaser of their shares (it happened to be Lockwing) a cheque for the total assets of the company the shares of which were being sold. The present share purchase agreement did not require the vendors to cause Puduba to hand over the trust assets to Lockwing or to any other person. Indeed there was little point in so doing. There was no finding of fact as to the extent of participation of the vendors in the present circumstances and in the absence of any argument to the contrary, it is inappropriate to explore the point further. The judgment further presupposes such participation and such participation not having been excluded by the appellant, it was open to the Tribunal to so find.

48. The appellant did not really challenge the possibility that s.260 of the Act could have operation on the present facts. The difficulty, so the appellant submitted, to paraphrase Dixon C.J. in Hancock (supra at 275-276) lay not in saying whether s.260 might apply to avoid some transactions against the Commissioner, but to say what is the consequence upon the taxpayer's liability if it does so.

49. For the appellant, it was submitted that once s.260 was applied to annihilate all of the steps taken under the arrangement, which of necessity included the exercise by the trustee of the discretion to pay or apply income to Lobutu, and the intervening steps involving book entries and the like, nothing at all was exposed to tax in the hands of the appellant.

50. As a matter of principle at least, it seems well established that s.260 is an annihilating section only, and does not permit the Commissioner to construct a new and fictitious set of facts creating a liability for tax of a taxpayer: Gulland per Gibbs C.J. (supra at 67). It follows from this principle that when s.260 is applied and the arrangement struck down, there must be left exposed sufficient facts which enable the conclusion to be reached that a particular amount is included in assessable income.

51. As I commented in Davis (supra at 4402), in the application of s.260 it may be said that the courts have applied some elements, at least, of reconstruction, while nevertheless saying that reconstruction should be eschewed. These observations were referred to without disapproval by Gummow J in Bunting v Federal Commissioner of Taxation (supra at 295) and in the same judgment I discussed in some detail the problem of the inability to reconstruct. Although I dissented in the result in that case, I did so only on the basis that I could find no relevant factual finding in the Administrative Appeals Tribunal and would have remitted the matter to the Tribunal rather than decide it, as the majority did, adversely to the taxpayer. There was no real issue of principle between the view of the majority and my judgment.

52. A related submission on behalf of the taxpayer was that s.260, as it were, erased all of the bookkeeping entries as well as the underlying transactions which they reflected, with the result that the taxpayer was left not receiving any moneys at all. With respect, that cannot be so. The actual transactions, which operate to avoid tax, are, of course, to be treated as of no effect, but it does not follow that if, as part of an arrangement, a payment is made to a taxpayer upon which the taxpayer's liability to tax depends, that payment is as well set aside by force of s.260. The reason it is not, of course, is that it does not operate to avoid the taxpayer's tax. The arrangement is only void "to the extent" that it so operates; cf Rowdell Pty Limited v Commissioner of Taxation [1963] HCA 61; (1962-3) 111 CLR 106 at 125 where Kitto J said:

"The section cannot be treated as having an
operation extending beyond its expressly
delineated function of defeating the purpose of
tax-avoidance by the shareholders which it was
the overtly manifested nature of the arrangement
to achieve ... To grasp that s.260 defeats as
against the Commissioner the tax-avoiding
efficacy of an arrangement, and not any part of
the arrangement itself or anything done under
it, is to see at once that it cannot support an
assessment made against Rowdell ..."

53. See too per Menzies J (at 135). The payment received by the taxpayer in Gregrhon was similarly not disregarded. Thus at the end of the day, the question becomes whether when s.260 is exposed and so much of the arrangement is set aside as has the purpose or effect referred to in the sub-section, the facts then remaining leave exposed in the hands of the appellant a liability to tax.

54. What is left exposed when s.260 applies is a receipt of a credit by the appellant operating in law as a payment in circumstances where that credit emanates from the income of the trust, and in circumstances which operate to the obvious benefit of the appellant, who is a beneficiary of the trust. The trust deed itself, of course, empowers the trustee, at its discretion, to make payments for the benefit of beneficiaries. These facts, being the only facts known (and in the absence of any facts left which point to there having been a breach of trust), it seems clear that the receipt is one which can fall within s.101 of the Act, which provides:

"For the purposes of this Act, where a trustee
has a discretion to pay or apply income of a
trust estate to or for the benefit of specified
beneficiaries, a beneficiary in whose favour the
trustee exercises his discretion shall be deemed
to be presently entitled to the amount paid to
him or applied for his benefit by the trustee in
the exercise of that discretion."

55. The consequences of s.101 applying is to deem the beneficiary to be presently entitled to the amount so paid, and thus bring into operation the provisions of s.97 of the Act, which operate to include the amount in the assessable income of the taxpayer (at least in circumstances where there is no discrepancy between trust law income and "net income" as defined in s.95 of the Act). On this basis, the decision of the Tribunal must be confirmed.

56. The Tribunal however, was of the view that the amount received by the appellant was assessable income under either or both of ss.25(1) and 99B. There are difficulties in applying both these sections, which lead me to prefer to rest my decision on the joint operation of ss.101 and 97.

57. In so far as s.25(1) is concerned, there can be little doubt that a payment received by a beneficiary from a trustee out of trust income, not being a voluntary payment, would have the character of income in the hands of the beneficiary: Drummond v Collins (1915) AC 1011. However, the question remains whether s.25(1) may operate independently of Division 6 and s.26(b) of the Act, to render an amount assessable income where it is a distribution of income to a beneficiary or whether these latter provisions are an exclusive code for assessability of trust distributions. Although it is not necessary, in the view I take, to determine this issue, there are strong indications in the Act that Division 6 together with s.26(b) form an exclusive code for the assessability of trust distributions. In particular, the provisions of ss.97 and 98 on the one hand, which apply where there is present entitlement, and ss.99 and 99A on the other, which apply where there is some trust income to which a beneficiary is not presently entitled, are mutually exclusive in the sense that if present entitlement exists in respect of the whole or part of the trust law income, ss.99 and 99A can have no operation. Conversely, to the extent that present entitlement is absent, s.99A(4) and related sections or s.99(2) and related sections operate to render the trustee liable to be assessed and pay tax.

58. Both s.99B, discussed below, and s.26(b) which include in assessable income beneficial interests in income derived under a will or settlement exclude from their operation amounts which are included in the assessable income of a beneficiary under s.97 or upon which the trustee is assessed and liable to pay tax in pursuance of ss.98, 99 or 99A. Thus, if the case be one where there is no present entitlement to the whole of the trust law income, s.99A would operate to render the trustee liable to pay the tax. In these circumstances, to apply s.25(1) to include an amount in the assessable income of a beneficiary, would have the consequence that both the trustee and the beneficiary would be taxable, a result that obviously is inconsistent with the policy of the Act.

59. The application of s.99B also presents difficulty. Literally, the section is capable of applying in the circumstances of the present case. However, the section was not enacted to render assessable payments or applications to the benefit of discretionary beneficiaries. Such payments or applications were already made assessable income by force of s.97 alone or in combination with s.101, leaving aside a case where s.98 applies but the presently entitled beneficiary is under a legal disability where the trustee is assessable.

60. The provisions of s.99B can only be understood in their historical context. The need for some such provision was discussed by the Taxation Review Committee (the Asprey Committee) in its report of 31 January 1975. The problem exposed by cases such as Union Fidelity Trustee Co of Australia Ltd v Federal Commissioner of Taxation [1969] HCA 36; (1969) 119 CLR 177 was that ss.99 and 99A had no application where accumulated income was derived from a source outside Australia. If the trust income was accumulated and became capital, its subsequent receipt by a beneficiary was neither assessable income under ss.25 or 26(b). Section 99B together with ss.99C and 99D were introduced into the Act by the Income Tax Assessment Amendment Act No.5 of 1978. As the Explanatory Memorandum circulated with that Act discloses to deal:

"... primarily with the receipt by resident
beneficiaries of distributions from non resident
trust estates of previously untaxed foreign
sourced income."

61. The Explanatory Memorandum makes the following relevant comments on s.99B:

"The proposed section 99B will require the
inclusion in a beneficiary's assessable income
of amounts paid to or applied during a year of
income for the benefit of a resident beneficiary
where that amount represents trust income of a
class which is taxable in Australia but which
has not previously been subject to Australian
tax in the hands of either the beneficiary or
the trustee. It will normally apply where
accumulated foreign sourced income of a non
resident (or of a resident trust estate that
previously was not able to be taxed in Australia
in the light of the Union Fidelity decision) is
distributed to a resident beneficiary."

62. It is not necessary to decide for the purposes of the present case whether the extreme width of s.99B and associated sections require it to be read down having regard to the obvious legislative purpose in enacting it.

63. During the course of argument, I raised the question whether, having regard to the presence in the Act of s.100A, it was appropriate as a matter of construction to apply s.260 to a case which otherwise would fall within s.100A. As presently advised, there seems to be much to be said for the view that s.100A is a specific anti-avoidance provision to deal with trust stripping. Indeed, s.100A only operates where there is an agreement, arrangement or understanding not entered into in the course of ordinary family or commercial dealing. The agreement etc to which s.100A refers must be entered into for a purpose of ensuring that a person pay less income tax than that person would otherwise be liable to pay: s.100A(8). Faced with a specific anti-avoidance provision and a general anti-avoidance provision, there is something to be said for the view that the legislature must have intended that the specific anti-avoidance provision apply rather than the general provision. If that argument be correct, then on the facts of a case such as the present the true liability for tax should be on the trustee of the trust estate rather than the beneficiary.

64. This point, however, was not raised in the Administrative Appeals Tribunal, nor was it raised in the appellant's grounds of appeal. It was not an issue of law upon which the Tribunal passed. Since the appeal to this court from the Administrative Appeals Tribunal is an appeal only on a question of law (being clearly enough a question of law necessarily or by implication dealt with by the Tribunal), and since the point was not raised by the appellant's grounds of appeal, it is inappropriate to consider the question further.

65. In my opinion the appeal should be dismissed and the appellant pay the respondent's costs of it.