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Federal Court of Australia |
COURT
IN THE FEDERAL COURT OF AUSTRALIACATCHWORDS
Income Tax - sale of equities by parent insurance company to subsidiary - whether profit assessable income - whether sale amounts to re-organisation of capital structure - disposal of assets on sale or cessation of a business.Income Tax - realisation of bonds bought at a discount - s.23J Income Tax Assessment Act 1936 - interpretation of s.23J(2).
Income Tax - sale of equities - whether profit on sale is assessable income or of a capital nature - whether profit obtained in the course of carrying on a business of investment in equities - whether investment in equities an integral part of insurance business of parent.
Income Tax Assessment Act 1936 ss.18(1), 23J, 25(1), 26(a), 26AAA, 36, 46.
AGC (Investments) Ltd v FCT (1991) 91 ATC 4180
Bresatz v Przibilla [1962] HCA 54; (1962) 108 CLR 541
Californian Copper Syndicate (Limited and Reduced) v Harris (1904) 5 TC 159
Chamber of Manufactures Insurance Ltd v FCT [1984] FCA 124; (1984) 84 ATC 4315
CMI Services Pty Ltd v FCT [1989] FCA 346; (1989) 89 ATC 4847
Colonial Mutual Life Assurance Society Limited v FCT [1946] HCA 60; (1946) 73 CLR 604
Commissioner of Inland Revenue v Nelson (1939) 22 TC 716
Commissioner of Taxation (WA) v Newman [1921] HCA 37; (1921) 29 CLR 484
Commissioner of Taxes (Vic) v Melbourne Trust Ltd [1914] UKPCHCA 5; (1914) 18 CLR 413
De Grey River Pastoral Co v Deputy Federal Commissioner of Taxation [1923] HCA 42; (1923) 35 CLR 181
Equitable Life and General Insurance Co v FCT (1989) 89 ATC 4972
FCT v Equitable Life and General Insurance Co Ltd (1990) 90 ATC 4438
FCT v Myer Emporium Limited [1987] HCA 18; (1987) 163 CLR 199
Federal Commissioner of Taxation v Whitfords Beach Pty Ltd [1982] HCA 8; (1982) 150 CLR 355
Lend Lease Corporation Ltd v FCT (1990) 90 ATC 4401
London Australia Investment Co Limited v FCT [1977] HCA 50; (1977) 138 CLR 106
Modern Permanent Building and Investment Society v FCT [1958] HCA 11; (1958) 98 CLR 187
National Bank of Australasia Limited v FCT [1969] HCA 11; (1969) 118 CLR 529
New South Wales Land and Agency Co Limited v Commissioner of Taxation (1926) 26 SR NSW 560
RAC Insurance Pty Ltd v FCT (1989) 89 ATC 4780 and (1990) 90 ATC 4737
Sun Newspapers Ltd v FCT [1938] HCA 73; (1939) 61 CLR 337
Western Gold Mines NL v Commissioner of Taxation (WA) [1938] HCA 5; (1938) 59 CLR 729
Unitraders Investments Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia (No. VG 99 and VG 100 of 1988)
GRE Insurance Ltd v The Commissioner of Taxation of the Commonwealth of Australia (V G104 and V G105 of 1988)
HEARING
MELBOURNECounsel for the Applicant: N.H.M. Forsyth QC with J.W. de Wijn
Solicitors for the Applicant: Corrs Chambers Westgarth
Counsel for the Respondent: D. Graham QC with H. Symon
Solicitors for the Respondent: Australian Government Solicitor
DECISION
GRE Insurance Ltd ("GRE") is a general insurer. It is a member of the worldwide Guardian Royal Exchange Insurance Group ("the Group") whose headquarters are in London. Since 1974 it has carried on the Australian operations of the Group. For over a century the Group had operated directly in Australia through branches.2. Prior to 1978 Unitraders Investments Pty Ltd ("Unitraders") was a wholly owned subsidiary of the Union Insurance Society of Canton Ltd, another member of the Group. In that year GRE acquired all the shares in Unitraders for the sum of $2.5 million.
3. GRE already held a portfolio of securities consisting of equities, that is to say shares in companies listed on stock exchanges, and bonds, by which I mean government, semi-government and company fixed interest securities. Between October 1980 and January 1982 GRE sold the equities in its portfolio to Unitraders. The bonds were retained.
4. GRE realised a profit on the sale of its equities to Unitraders and the first issue in these cases is whether that profit is assessable. GRE argues that it was not a profit in the ordinary course of carrying on business as an insurer but a special event of a structural kind in the reorganisation of its business.
5. A second issue arises in relation to the bonds retained by GRE. Some of these were sold at a profit and others redeemed at maturity. In some instances such bonds had been bought at a discount. GRE says that it is entitled to the benefit of s.23J of the Income Tax Assessment Act 1936 ("the Act") with the result that the profits are not assessable.
6. After Unitraders acquired the equities from GRE it made some disposals in 1983 and 1984 of these and other equities. (Both GRE and Unitraders have leave under s.18(1) of the Act to adopt as their accounting period the year ended 31 December. Accordingly any reference in this judgment to a year means a calendar year.) Some of those disposals were made at a profit and those profits have been treated by the Commissioner as assessable income. Unitraders says that the profits were of a capital nature.
7. The three issues I have briefly identified arise in two appeals by
Unitraders (V G99 and V G100 of 1988) and two appeals by GRE
(V G104 and V
G105 of 1988). In the case of each company the appeals concern the 1983 and
1984 years. By consent it was ordered
that all four appeals be heard together
and that the evidence in each of the appeals should be evidence in each of the
others.
GRE Investment Operations
8. The principal activities of GRE were described in its Directors' Report
for 1980 as "underwriting all principal classes of insurance
business (other
than life) and investment in stocks, shares, loans and properties". The
accounts for that year reported a holding
of the following investments:
$M
Government, municipal and other public securities 21.49. GRE's investments were controlled by the Investment Department of the Group in London. It was the practice of the Department in February or March of each year to publish internal memoranda which set out in broad terms the financial position of Australian operations including investment strategies. Such a memorandum was published on 24 February 1983 and included the following:
Debentures
Quoted 11.2
Unquoted 30.7
Shares
Quoted 3.7
Unquoted .8
Loans on mortgage 7.3
Fixed deposits .5
"5. INVESTMENT STRATEGY10. The memorandum published in the following year on 23 February 1984 contained a section on investment strategy in identical terms except that in relation to holdings in short-term assets the figure was increased from $6 million to $8 million.
The main aims are:
(i) To achieve an acceptable compromise between
income and capital appreciation consistent with
reasonable security of capital, in the context
of the anticipated insurance results.
(ii) The maintenance of adequate liquidity and
marketability due to the short-term nature of
the liabilities.
(iii) To achieve the highest possible return
consistent with the above.
Short-term Assets: Holdings of at least $6 million are
required to match near-term liabilities and to meet the
criteria for the marketability of the total portfolio.
Holdings should only be allowed to fall to the
$6 million level at times when inflows are expected;
when reinsurance, dividend, taxation and other outflows
are anticipated, larger holdings will be necessary.
Bonds: The average life of the bond portfolio should
be kept below five years. 60-70% of cash flow will
generally be available for investment in bonds.
Emphasis should be on marketability.
Mortgages: 10% of cash flow will be available for
investment in commercial mortgages of suitable term,
subject to yield differentials against fixed interest
securities.
Property: Because of the large property transfers to
the company on domestication and subsequent capital
issues and in view of the limitations on property
holdings under the proposed legislation, it is planned
to reduce the property content of the portfolio by
selective disposals.
Equities: 15-20% of new money will normally be
directed to the purchase of equities. However, timing
will be subject to market conditions. Emphasis should
be on marketability."
11. The only witness called on behalf of the taxpayers was Mr Maxwell Vernon
Morris who was at the relevant times the General Manager
(Finance and
Investment) of GRE as well as being an alternate director of GRE, a director
of Unitraders and company secretary of
both companies.
Investment Management and Reporting
12. A major internal re-organisation took place in May 1985 and the following deals with the structure prior to that date.
13. The day to day operations of investment were handled by an Assistant Investment Manager and an Investment Secretary. The former was concerned with equities and the latter with bonds. Decisions to buy and sell were made in London. Normally the initiative for a proposed purchase or sale came from Melbourne but sometimes a broker or merchant banker in London might approach the Investment Department directly. In most cases London approved proposals which came from Melbourne. The genesis of those proposals included the Assistant Investment Manager's own ideas and advice from stockbrokers. The Assistant Investment Manager, whose name Mr Morris could not recall, was only in about his mid-20's, "so he did not have a lot of experience, but the Group of course had its investment policies and we knew how to operate within those". There was a "core" of brokers who dealt with GRE and who from time to time they mentioned proposed investments to the Assistant Investment Manager. The latter would also seek advice from the brokers. On very rare occasions an investment decision might be made in Melbourne and subsequently ratified by London. As far as Mr Morris was aware, this had only happened twice, one occasion being when Mr Rupert Murdoch was in the market for Herald and Weekly Times shares and a price was only available on that day. After each transaction had been effected a reporting telex was sent to London, together with copies of relevant documentation such as brokers' bought or sold notes. The person or persons who made the relevant decisions in London were not identified in the evidence, either by name or position held. Their responsibility was not confined to Australian investments of the Group.
14. Transactions were done on a case by case basis. There was no evidence of any policy or rule which required equities to be sold when their yield failed to meet some pre-determined criteria.
15. The GRE Board met quarterly and reports were submitted showing the investments acquired and realised during the previous quarter and the current holding of investments. In the case of equities which had been purchased this information included percentages of flat yield and price earnings ratios. The reports to the Board showed the cost and market value of investments held and the gains and losses realised in the case of sales but otherwise the reports did not contain any details as to the performance of individual investments. Decisions as to the acquisition or disposal of individual investments were not made at Board level, either in Melbourne or London.
16. Mr Morris agreed with the statement in Unitraders' particulars of grounds
of objection that all its investments "were acquired
with a view to long term
investment and an acceptable dividend yield". It was put to him in
cross-examination that dividend yield
was one of the matters taken into
account in arriving at a decision to sell a stock. His answer was "....in
most situations, no."
Sale of Equities to Unitraders
17. Unitraders was acquired by GRE specifically as a vehicle for holding the equities section of the GRE portfolio. The reason for this was to ensure that the benefits of rebates on dividends under s.46 of the Act could be retained. As that rebate is effectively a credit against tax payable, GRE would not get a rebate if there were no taxable income and no tax payable thereon, notwithstanding that dividends might have been included in its assessable income. Since insurance can be a volatile business, GRE faced the prospect that in years when it incurred an underwriting loss it would lose the benefit of the rebate on dividends received from its holding in equities.
18. The acquisition of Unitraders took place in 1978. Unitraders brought with it a dowry in the form of investments with a market value of $3.25 million. However no immediate steps were taken to transfer the equities in GRE's portfolio to Unitraders because, for the reasons mentioned, no real benefit from such a transaction would accrue to GRE until it appeared likely that an underwriting loss was looming and there was no point in paying stamp duty (which would have amounted to some $60,000) until that time was reached.
19. But, when it was finally judged appropriate for the sale to Unitraders to occur, the total transaction was effected in three tranches. Sales took place on 17 October 1980, 17 August 1981 and 17 January 1982. Evidence on behalf of the taxpayers did not advance any reason for this delay. One might have thought that a possible explanation was that the sale of equities which had been acquired within the previous twelve months was delayed so as to avoid the operation of s.26AAA, and indeed counsel for the taxpayers asserted that in his opening address. However Mr Morris said in evidence that this had not in fact been the reason.
20. The equities were sold at their then current market value and the purchase price was left owing on loan. Subsequent amounts were also lent by GRE to Unitraders for the purpose of further investment in equities. At the end of 1983 and 1984 the loans outstanding by Unitraders to GRE were $21 million and $30.3 million respectively.
21. After the sale to Unitraders, there was no relevant change in the
investment strategies and operations. The directors of Unitraders
had already
resolved to authorise the management of GRE to effect investment transactions
for and on behalf of Unitraders, such transactions
to be made after
consideration of advice received from the investment management of the
ultimate parent company in London. The functions
of the Assistant Investment
Manager and Investment Secretary continued as before. Decisions to buy and
sell were still made by the
Investment Department of GRE in London and
quarterly reports made to meetings of the Boards of GRE and Unitraders (which
took place
at the same time). Unitraders had no separate premises or staff of
its own. It paid annual management fees to GRE.
Insurance Liabilities
22. Throughout the period under consideration, GRE did not need to have
recourse to investments held by Unitraders to meet any insurance
liabilities.
The following table shows underwriting profit or loss and net profit for the
years 1979 to 1984. (The figures for 1980
and 1981 are after recoveries under
stop loss treaties within the Group.)
($ million)23. GRE was able to satisfy easily the solvency ratios required by the Insurance Act 1973 without recourse to assets of Unitraders. Section 29(1)(b) of that Act requires insurers to maintain the value of their net assets at not less than $1 million or 20% of their premium income for the preceding financial year, whichever is greater. The legislation allows an insurer to include in its net assets loans to a subsidiary although not the assets of the subsidiary. However, even excluding the loans to Unitraders and including only assets within Australia, GRE's solvency ratios were as follows:
1979 1980 1981 1982 1983 1984
Underwriting
Profit/Loss .1 (3.5) (4.5) (3.1) .9 3.7
Net Profit 8.5 7.0 5.0 10.4 17.1 17.0
1981 50.224. GRE maintained re-insurance for particular claims or events which would protect it in the event of catastrophes and also a stop loss re-insurance arrangement with its parent which covered underwriting losses between 10 and 20 per cent of net written premium.
1982 50.8
1983 44.4
1984 40.8
25. In 1982 a profit of $286,573 was made by GRE in selling or redeeming bonds bought at discount. (A further profit of $6,265 was made in such sales but is admittedly assessable under s.26AAA.) This profit has been included by the Commissioner in GRE's assessable income, thus reducing its carry forward losses for the year.
26. In 1983 and 1984 GRE was assessed on profits arising from the sale or
redemption of bonds purchased at a discount as follows:
1983 $1,082,18327. A table was submitted by Counsel for the Commissioner which analysed the evidence as to the realisation of bonds by GRE over the period 1978 to 1988. The table shows in each year the total number and value of bonds realised whether by sale or redemption and the number and value of sales and redemptions. The following is an extract from the table (money figures rounded to the nearest thousand dollars):
1984 $1,738,182
Realised Sold Redeemed28. The marked change from 1986 onwards was explained by Mr Morris as "a distinct change in our policy..... We decided that rather than being a passive investor and holding a lot of the stocks to redemption we would attempt to make more profit by turning the stocks over a lot more often".
Volume $Value Volume $Value Volume $Value
1978 15 7,713 6 7,420 9 293
1979 9 449 Nil Nil 9 449
1980 20 5,158 3 3,260 17 1,898
1981 26 17,454 10 13,227 16 4,226
1982 22 6,382 2 104 20 6,278
1983 50 26,044 5 4,537 45 21,507
1984 52 42,866 18 28,577 34 14,290
1985 44 40,987 28 31,170 16 9,817
1986 122 243,103 94 217,153 28 25,950
1987 284 1,467,435 282 1,461,935 2 5,500
1988 159 1,278,595 156 1,275,595 3 3,000
29. In 1983 profits on the realisation of equities which have been assessed by the Commissioner (excluding s.26AAA profits) amount to $427,282. The comparable figure for 1984 is $320,167.
30. Mr Morris said that the equities, the sale of which produced profits in 1983 and 1984, "were acquired by Unitraders as ordinary passive long term investments". However he did not have day to day knowledge of the purchase and sale of equities. Insofar as his affidavit gave reasons for particular sales, he did not have contemporaneous knowledge of the transactions when they accrued. He said that he did not have in mind any particular period when he used the expression "long term" but only that "it's a fairly generalised sort of statement meaning perhaps a long time in relative times (terms?).... I can't really be very specific about that, but it's just that the shares are acquired with a view to holding them for a long time, but not with a view to buying them and locking them away and forgetting about them and saying: 'Once we've bought them we'll hold them forever. One needs to review the portfolio from time to time.'" While the personal credibility of Mr Morris was not challenged, his admitted lack of knowledge as to the transactions under review limited the persuasiveness of his evidence. The onus of course rested on the taxpayer: s.190.
31. During 1983 Unitraders held equities with an approximate market value of $32 million in 47 companies. During the year it realised 9 holdings (19%) with a value of approximately $1.47 million (6%) of which approximately $1 million represented sales as a result of take-overs or redemptions.
32. For 1984 the comparable figures were:
Market value of equities $34 million33. (These figures are favourable to Unitraders because they exclude sales of Email which were subject to s.26AAA.)
Number of companies 56
Value of equities realised $2.5 million (7%)
Number of companies 9 (16%)
Take-overs or redemptions $1.7 million
34. The reasons given in Mr Morris' affidavit for the particular sales may be
summarised as follows: (As already noted, most of
this material was based on
information supplied to him rather than knowledge acquired from his personal
involvement in the transactions)
1983take-over
(a) Amalgamated Wireless Australasia. Investment had been built up
since 1966. 80,000 shares sold (25% of holding). The first
and only occasion of sales. Since 1983 there have been further
investments, currently totalling 717,032 shares.
(b) BMI. Acceptance of "attractive" take-over by Boral on 3 for 4
basis.
(c) Kemptron. 20,000 shares and 20,000 options. Considered "not a
satisfactory long term investment". Sold at overall loss of
$2,706.
(d) Ingram Enterprises. Preference shares redeemed.
(e) William Adams. Take-over offer by Tubemakers accepted.
(f) Robe River. Sold when "as a result of a take-over offer, the
price increased beyond what Unitraders thought was their true
value".
(g) J. Gadsden. Same reason as Robe River.
(h) Duncan Holdings. Preference shares redeemed.
(i) Mayne Nickless. "The view was formed that the shares were over
priced". 50,000 sold leaving 115,000 unsold.
1984
(a) Energy Resources of Australia. Following an unsuccessful
bid by Pioneer Concrete "it was considered that these35. All the foregoing was relied on by Unitraders as pointing towards a pattern of low turnover in equities with a substantial portion of that low turnover arising out of takeover situations. The Commissioner however argued that, looked at over a longer period, the picture that emerged was that of a business in which some of the investments held were turned over quite rapidly. In particular, the disposals of equities which attracted tax by reason of s.26AAA were as follows:
shares were over priced and that due to the reluctance of major
shareholders to accept the bid a future take-over bid was
unlikely. Consequently, at that price it was decided to
realise the investment".
(b) EZ Industries. Sold on market after North Broken Hill made a
take-over offer.
(c) Mayne Nickless. Considered "no longer... a satisfactory long
term investment at that sale price".
(d) TNT Options. Price of TNT shares falling. Options sold for
fear they might become worthless.
(e) Western Mining. About one third of holdings sold "due to
concern for the long term outlook for commodity prices and
consequent effects on the value of (the) shares".
(f) Humes. Preference shares redeemed.
(g) Bradmill Industries. Preference shares redeemed.
(h) Duncan Holdings. Preference shares redeemed.
(i) Alliance Oil Development. Sold on market after a take-over
offer by Santos.
Sales No. Sold Retained at 31 Dec36. Another analysis in support of the Commissioner's argument showed the following as being held for two years or less:
1981 ANI 15,800 314, 700
ARC 102,200 Nil
*Duncan 20,000 60,000
+Dunlop 75,000 165,696
AOG 28,000 Nil
+CRA 31,333 28,900
+EZ 8,800 57,750
Acmil 102,270 Nil
+Pioneer Sugar 3,600 102,440
1982 +Boral 30,000 223,200
Caltex 50,000 Nil
+CSR 33,000 119,164
+ACI 131,345 Nil
Kemptron (prefs) 100,000 Nil
+Renison 18,515 Nil
1983 BMI 40,224 Nil
**J Gadsden 25,000 Nil
1984 Email 300,000 Nil
Mayne Nickless 203
1985 Amtel 81,800
Cheeltam 35,000
Bonds Coats Paton 8,800
Repco 300,000
Kern 500,000
1986 ANZ 53,580
Billy Guyatt 100,000
Bell options 20,457
Breakwater 1,000
Breakwater (options) 250
Bridge Oil 27,000
Pacific Dunlop 84,707
Lend Lease 12, 843
MIM 23,120
Santos 6,250
Tubemakers 96,466
Peko 8,000
Burswood options 50,000
Int. Income Property 640
John Perry 60,000
CSR 13,159
1987)
) None
1988)
+ Acquired from GRE
* Redeemed
** Take-over
Alliance Oil Development 1983-1984(I) GRE SALES TO UNITRADERS
Armada Resources 1987-1988
Billy Guyatt 1985-1986
Bond Coats Patons 1984-1985
Duncans Holdings 1983-1984
Email 1983-1984
Energy Resources 1983-1984
EZ Industries 1983-1984
First National Trust 1985-1986
ICI Australia 1984-1985
Johns Perry 1985-1986
Materials Technology 1985-1986
Peko Wallsend 1983-1984
Repco Corporation 1984-1985
Santos 1984-1985
Santos 1985-1986
TNT 1984-1985
Vamgas 1983-1984
Western Mining 1983-1984
37. The starting point is the proposition that "profits and losses on the realisation of investments of the funds of an insurance company should usually be taken into account in the determination of the profits and gains of the business": Colonial Mutual Life Assurance Society Limited v FCT [1946] HCA 60; (1946) 73 CLR 604 at p 618; see also pp 619-620. It was common ground that the application of this principle meant that profits on sale or realisation of equities and bonds by GRE would prima facie be assessable.
38. However GRE argued that the sales to Unitraders were not an ordinary incident of its business or part of its ordinary operations but rather a special re-organisation of the capital structure of the Group.
39. In support of its argument GRE relied on National Bank of Australasia
Limited v FCT [1969] HCA 11; (1969) 118 CLR 529 and also a line of cases dealing with the
disposal of assets of a business on termination.
National Bank
40. This authority was said to be directly relevant because the courts have dealt with the investments of banks in the same way as those of insurers. In 1948 the taxpayer agreed to merge with a Queensland bank and acquired from it certain shares owned by that bank in a pastoral company. It was found that the purpose of the acquisition of the shares was partly a desire to retain as customers the pastoral company and persons who transacted business with it, partly a desire to be identified with rural interests in Queensland, and partly a desire to receive dividends from its investments; but the governing consideration was the desire to move into the place of the Queensland bank as completely and with as little disturbance of existing relations with the public and public authorities as possible and as little apparent break as possible in the continuity of operations. In 1963 the National Bank accepted an offer for the purchase of the shares. It was held that the profit made on this sale was not within s.26(a) of the Act because profit making by a sale had not been a purpose of the acquisition of the shares and, secondly, the sale had not been part of the carrying out of a profit making scheme. It was held further that the profit did not otherwise form part of the income of the bank because it was a capital profit. The purchase and sale involved changes in the profit earning structure of the taxpayer and were not part of the profit earning activities within the structure.
41. In dealing with the question whether the profit on the sale should be
considered as bearing an income character Kitto J. said
(at p 538):
"The purchase of the shares bore no resemblance to an42. In my opinion National Bank turns on its own rather special facts. It seems that the National Bank, whose Head Office has always been in Melbourne, was concerned to assuage the sensibilities of rural Queensland and thereby enhance its prospects of doing business in that part of Australia. The importance was not so much in acquiring and holding the shares, as in being seen to do so. In the present case, it could not be said that GRE acquired the equities which it sold to Unitraders otherwise than in the ordinary course of investment of surplus funds inevitably associated with the conduct of the business of insurance.
investment of banking funds, made to earn income pending a need
for their deployment in the making of advances and the like; it
bore no resemblance to an investment by way of erecting a
second or third line of defence against a time of stringency or
emergency. It was an acquisition, not of the kind that might
be repeated in the course of the profit-earning process, but
made once and for all for the sake of enhancing, even if only
for the time being, the profit-earning potential of the
enterprise as a whole.... The acquisition of those shares did
not follow any pattern of investment that the National Bank had
followed; it is to be accounted for solely as part and parcel
of the take-over of the Queensland National Bank's whole
undertaking, so that in respect of purpose it was, as I have
suggested, akin to a purchase of good will rather than a
purchase of property to be turned over in the course of
business. As the purchase of the shares stood outside the
course of the banking business, the sale of them likewise
stands outside it. The profit from the sale was in my opinion
a capital profit according to ordinary business concepts."
43. The line of cases commences with Commissioner of Taxation (WA) v Newman
[1921] HCA 37; (1921) 29 CLR 484. Western Australian income tax legislation provided for a
tax on "all incomes... (a) arising or accruing to any person wherever
residing, from any profession, trade, employment or vocation carried on in
Western Australia...". The taxpayer carried on business
as a pastoralist. He
sold his station as a going concern, including stock and plant, for 16,000
pounds. The Commissioner apportioned
6,770 pounds of that price as being
referable to profit on the sale of stock and treated it as income. The High
Court regarded the
case as being determined it by the principle enunciated in
the Scottish Court of Exchequer in Californian Copper Syndicate (Limited
and
Reduced) v Harris (1904) 5 TC 159 at p 165:
"It is quite a well settled principle in dealing with questions44. That principle had been followed by the Privy Council in Commissioner of Taxes (Vic) v Melbourne Trust Ltd [1914] UKPCHCA 5; (1914) 18 CLR 413. After citing the above passage from Californian Copper, their Lordships concluded:
of assessment of income tax, that where the owner of an
ordinary investment choses to realise it, and obtains a greater
price for it than he originally acquired it at, the enhanced
price is not profit in the sense of Schedule D of the Income
Tax Act of 1842 assessable to income tax. But it is equally
well established that enhanced values obtained from realisation
or conversion of securities may be so assessable, where what is
done is not merely a realisation or change of investment, but
an act done in what is truly the carrying on, or carrying out
of a business.....
....each case must be considered according to its facts; the
question to be determined being - Is the sum of gain that has
been made a mere enhancement of value by realising a security,
or is it a gain made in an operation of business in carrying
out a scheme for profit-making?"
"In the present case the whole object of the company was toIn Newman Knox C.J. said (29 CLR at p 489):
hold and nurse the securities it held, and to sell them at a
profit when a convenient occasion presented itself."
"... the transaction out of which the 16,000 pounds arose was enteredHiggins J. concurred. His Honour said (at p 489):
into, not in the course of carrying on the business or for the
purpose of carrying on the business, but for the purpose of
putting an end to the business. That being so, I am of the
opinion that neither the 16,000 pounds nor any part of it comes
within the provisions of.... the Act."
"The business carried on by the taxpayer was not that ofStarke J. said (at p 490) that the question was one of fact and that the business of the taxpayer was that of a pastoralist who
station jobbing or speculating: it was the business of a
pastoralist. The profit made, if any, was not made in carrying
on that business, but in parting with it."
"resolved to and did sell his station and all the land, plant45. The next case in point of time, although it was not referred to by Counsel for GRE, is De Grey River Pastoral Co v Deputy Federal Commissioner of Taxation [1923] HCA 42; (1923) 35 CLR 181. A pastoral company owned four large stations in Western Australia. Two of the stations adjoined one another, as did the other two, but the pairs of stations were 50 miles apart. The company was compelled by State legislation to reduce the area of its holding. It sold two of its stations and (to other purchasers) the bulk of the cattle upon those two stations. Starke J. held that the company was assessable to income tax in respect of the profit made on the sale of the cattle. The taxpayer relied on Newman but Starke J. held that the moneys were proceeds of the business carried on by the taxpayer. His Honour said (at p 183):
and stock connected with it. On that set of facts I am of
opinion that the proper conclusion to be drawn is that the
final transaction, in which he disposed of the station, plant
and stock, was not a carrying on or a carrying out of his
business, and the profit therefore was not derived from and did
not accrue from any trade or business carried on by the
taxpayer in Western Australia."
"The question, as Lord Buckmaster said in O'Kane and Co v46. After discussing some of the evidence as to the way the matter was treated in the books of the company, his Honour continued (at p 184):
Commissioners of Inland Revenue (1922) 126 LT 707, is whether
such proceeds arose from a method of realisation inconsistent
with a continuing concern."
"The sale to Copley and others was not, it may be admitted, an47. In New South Wales Land and Agency Co Limited v Commissioner of Taxation (1926) 26 SR NSW 560 the taxpayer was a company which owned a number of pastoral properties. In 1921 it decided to realise those properties as favourable opportunities presented themselves and pursuant to that decision it sold all of them except a part of Bangeek's station. The question arose as to the taxation liability in respect of profits made on the sale of stock from one of the stations sold, that sale having been on a walk-in walk-out basis. Street C.J. said (at p 563):
example of ordinary methods of trading on the part of the
company, but it was not for the purpose of ending the company's
trade. The company still carried on its business on the De
Grey and Mulyie Stations, and all that can be said, in my
opinion, is that it realised the sum of its stock in an unusual
manner, as a result of the Act passed by the Parliament of
Western Australia. "So far as the external world was
concerned," the company was engaged in trading and its sale of
cattle was merely a modification of its usual method, brought
about by the passing of the Act... These gains and profits
were not due to the mere realisation of an asset, or to the
change of an investment, or to the enhancement of capital.
They were the results of a business operation. The transaction
was no doubt forced upon the company by the Act of Parliament,
but the gains and profits nevertheless arose from the sale of
stock which it had acquired or bred for the purpose of
profit-making by sale. The company made a profit in accordance with
its scheme of business, though the method of realising that
profit was to some extent forced upon it by the Act."
"If (the facts) showed that the company had been in the habit48. Commissioner of Inland Revenue v Nelson (1939) 22 TC 716 was a departure from the pastoral setting which seems typically to give rise to issues of the kind under consideration. The taxpayer was a whisky broker. The main assets of his business were extensive stocks of whisky. On 15 July 1937, after several years of poor health, he closed his bank account and instructed his accountant to wind up his business. Creditors and customers were notified of his retirement. On 27 July one of his customers bought his stock of whisky. The price paid was treated as a trading receipt for the purpose of taxation assessment but on appeal the Special Commissioners found that the business ceased on 15 July and that the purchaser had no desire to acquire the business but only the stock of whisky and that the sale was a transaction entered into after trading had ceased and was a realisation not in the course of trade. It was held by the Court of Session there was evidence upon which the Commissioners were entitled to reach their findings.
of speculating or trafficking in pastoral properties, buying
them and holding them for re-sale as suitable opportunities
presented themselves, the question would be different, but
nothing of that kind is suggested in this case.... During all
that period (of 29 years) it has carried on business as a
pastoralist on these properties which it took over from the old
company, and is now putting an end to that business and is
realising the assets employed in it. Its policy for the future
is uncertain. It may go out of business as a pastoralist, or
it may invest in other pastoral properties; but at present it
is marking time, so to speak, and is waiting on events.
What has taken place is nonetheless a realisation or change of
investment because the company itself has not come to an end.
If it were carrying on half a dozen businesses and realised the
assets of any one of them for the purpose of putting an end to
it and investing the proceeds in either of the others or in a
new business, that would be just as much a realisation of
capital assets as if it were putting an end to all of its
businesses.... the sale of the station property was not a sale
made by the company in the course of carrying on its business
but was a sale made in the course of the gradual realisation of
the assets employed in its pastoral business, in order to put
an end to that business as at present carried on by it."
49. In Modern Permanent Building and Investment Society v FCT [1958] HCA 11; (1958) 98 CLR
187 a building society went into voluntary dissolution. Prior to doing so it
sold outstanding loans to another building society at a
price which involved a
ten per cent discount on the face value. It claimed a sum equivalent to the
ten per cent as a deduction from
its assessable income. It was held by
Williams J. that the sum was a capital loss and not allowable as a deduction.
His Honour said
(at p 191):
"But a loss incurred upon the realisation of such loans in50. (This is a convenient point to note that in the present case the Commissioner conceded the equities sold to Unitraders were not trading stock of GRE for the purposes of s.36.)
order to put an end to the business or part of it would, in the
absence of legislation to the contrary, be a capital loss.
Apart from that legislation, the profit or loss on the
realisation of trading stock, for the purpose of winding up a
business, would in most cases be a capital accretion or loss.
Section 36 of the Act in the case of trading stock to which it
applies converts such an accretion or loss into a profit or
loss on revenue account. But I can find no warrant for
applying its provisions by analogy or otherwise to the disposal
by sale of the appellant's outstanding loans with a view to
dissolution, even if money can be regarded for some purposes as
the stock-in-trade of a money lender and the appellant was a
money lender."
51. His Honour expressed the view that the building society was not a money
lender but was carrying on an investment business. His
Honour concluded (at p
192):
"Whatever the position might be if a profit or loss was made52. In Equitable Life and General Insurance Co v FCT (1989) 89 ATC 4972 the taxpayer was a member of the QBE group of companies and carried on a life insurance business. It ceased that business in 1977 but up until 1984 retained an investment portfolio consisting predominantly of equities which it bought and sold from time to time. After a re-organisation of the group, the taxpayer sold all of its equities, those sales occurring partly in 1983 and partly in 1984. Other aspects of this case will be considered elsewhere in this judgment but its immediate relevance lies in part of the judgment at first instance of Wilcox J. who held that in relation to the 1984 sales there was a closing down of the business previously carried on. His Honour held that the profits realised were capital profits obtained upon the disposal of the business, not profits realised in the course of carrying it on (at p 4982). On appeal (90 ATC 4438) the case was resolved on other grounds. However Pincus J. (with whom Gummow J., at p 4461, agreed on this point) discussed Newman. His Honour said (at p 4460):
upon an assignment of one or more of the loans in the course of
the appellant's business, a mass sale of them in order to put
an end to that business could not be other than a sale of
capital assets."
"I am of the opinion that the learned primary judge fell into53. Some general comments can be made on the Newman line of cases. Apart from Equitable Life at first instance, all the cases where the profit was held to be of a capital nature involved the sale or cessation of the whole of a discrete business. NSW Land might at first glance seem to contradict that assertion, but on analysis I think the correct view is that it was concerned with a disposal of one business, even though it was a disposal that was to take place over a substantial period of time and involved the selling at different times of different properties and the stock thereon. De Grey, where the profit was held to be income, was different because out of the one business, two properties and the stock thereon were sold and two retained. The business continued otherwise as before.
error in treating the line of authority of which Newman's case
is an example, as governing these circumstances. The
respondent did not go into liquidation, as did the taxpayer in
Joshua's case, but remained in business of some sort. It
continued to hold assets including a substantial parcel of
shares. Those shares which were sold were not suggested to
have been sold in other than the normal way, except that the
sales were accelerated; the sales took place on market, over a
substantial period of time. I think that the proper course is
to confine Newman's case to its own facts and not to extend it
so as to make it authority for a general principle that sales
of property effected by the means which would ordinarily be
used in carrying on a business cannot produce income if such
sales were made with a view to abandoning the business."
54. In Equitable Life it is clear that Pincus J. regarded the continued
holding of assets, including a substantial parcel of shares,
as an important
factor pointing against the application of the Newman principle. This is but
another way of saying that the taxpayer
continued to carry on the same
business. Viewed that way, I respectfully suggest his Honour's decision was
both correct and in no
way inconsistent with Newman.
GRE's Business
55. It might be said that GRE carried on the business of investment, although such a business was in reality no more than the inevitable concomitant of its business of insurance. Indeed, it is rather difficult to imagine an insurance business which does not involve investment, since premium moneys not required to meet claims must be turned to account to generate profits to assist in the meeting of claims and production of net profit.
56. But GRE did not, prior to the sales of equities to Unitraders, carry on two investment businesses, one of investment in equities and the other of investment in bonds. None of GRE's Annual Reports describes its operation in that way. The London memorandum deals with both bonds and equities, together with other forms of investment, under the heading "Investment Strategy". While it may be conceded that in some contexts, such as insolvency, the difference between bonds and equities issued by the same institution may be of great moment to the holder, viewed as investment commodities they are in many respects similar. Both depend for their present and potential value on the intrinsic worth of the institution which issues them. Both are usually acquired for the purpose of producing regular income, be it in the form of dividends or interest. Also the prospect of capital growth is involved, not only for equities but quite frequently for bonds - as this case demonstrates.
57. Therefore I think that when GRE sold its equities to Unitraders it was not in any relevant sense terminating a business. After the sales GRE continued in the same premises with the same staff under the same management. The only difference was that it did not invest in some of the types of investment commodity that it had previously. There was not "a realisation inconsistent with a continuing concern" (De Grey, supra). What happened seems to me analogous to the case of a greengrocer selling fruit and vegetables who decides to quit the vegetable side of the business and concentrate on fruit. He sells his stock of vegetables to another trader but continues on at the same premises, with the same name, the same staff and the same business organisation, except that he is now selling fruit only. In such a case I do not think any profit on the sale of the vegetables would be a capital profit within the Newman principle.
58. This conclusion is, I think, strengthened by the circumstance that the sales to Unitraders took place over a fifteen month period. The longer the period over which such sales take place, the harder it is to say that they are not of a trading nature but rather a capital restructuring - given of course the application in this case of the Colonial Mutual principle which makes any sale of investments prima facie a transaction on revenue account.
59. It was argued on behalf of GRE that the sales to Unitraders were not "normal" in that they were sales to a subsidiary and did not generate cash and were not made to "capture a profit". But I think this argument overlooks the fact that a profit was, without doubt, made. The equities were sold to Unitraders for more than they cost GRE. I do not know of any authority, and none was cited, to suggest that what would otherwise be a profit to a vendor is not a profit because the purchaser happens to be a subsidiary of the vendor or that there is no profit if the purchase price is not paid in cash but is left owing on loan.
60. Indeed in Californian Copper it was argued that there was no realised
profit because the price took the form of fully paid shares
in another
company. Lord Trayner said (at p 168):
"I cannot think that Income Tax is due or not according to the61. It may be granted that the transactions under consideration were not "normal" in the sense that GRE doubtless usually sold its equities on the stock exchange. But since any profit on the sale of equities by GRE, prima facie governed, as I must reiterate, by the Colonial Mutual principle, would be to revenue account, it does not seem to me to matter that collateral considerations led to the sale being made to a particular purchaser and the price paid for in a particular way. De Grey provides a close analogy. In that case also the sale was not "an example of ordinary methods of trading". The decision to sell was provoked by a collateral event, viz the passing of the Land Act 1917 (WA), just as the GRE equities were sold to Unitraders because of a decision based on the potential effect of s.46. The fact that GRE was not compelled to sell, as the taxpayer in De Grey was, does not to my mind constitute a relevant distinction.
manner in which the person making the profit pleases to deal
with it. Suppose, for example, a seller made a profit on a
trade transaction, but leaves the price (including the profit)
in the hands of the buyer at so much per cent interest. That
he so deals with it, rather than take the cash into his own
pocket, would not affect the claim of the Revenue for the tax
payable on the profit."
62. Reference was made by GRE to FCT v Myer Emporium Limited [1987] HCA 18; (1987) 163 CLR
199 but I do not regard anything in that case as inconsistent with the
conclusion I have reached, namely that these profits arising out
of the sales
to Unitraders form part of the assessable income of GRE. On the contrary, the
High Court (at p 210) makes it clear
that:
"... profit or gain may be income, notwithstanding that the(II) REALISATION OF BONDS BY GRE - S.23J
transaction was extraordinary judged by reference to the
ordinary course of the taxpayer's business."
"(1) Subject to this section, no part of an amount received63. It was common ground that sub-section (1) applied. The question was whether GRE came within sub-section (2) and in particular whether the business of GRE could be said to include the buying and selling of eligible securities.
by a person upon the sale or redemption of eligible
securities purchased or otherwise acquired at a
discount on or before 30 June 1982, other than any part
of that amount received as accrued interest, shall, for
any purpose of this Act, be taken to be income derived
by the person.
(2) Sub-section (1) does not apply in relation to an amount
received by a person by virtue of a transaction that is
part of, or is incidental to, the carrying on by the
person of a business that includes buying and selling
eligible securities of any kind.
(3) Sub-section (1) does not affect the operation of
section 25A, 26AAA or 26C.
(4) In this section, "eligible securities" means -
(a) bonds, debentures, stock or other securities;
and
(b) any other document evidencing or acknowledging
the indebtedness of a person, whether or not
the debt is secured."
64. Section 23J has been considered in two recent decisions of Judges of this Court: RAC Insurance Pty Ltd v FCT (1989) 89 ATC 4780 (Lee J.) and Lend Lease Corporation Ltd v FCT (1990) 90 ATC 4401 (Hill J.). In both those cases it was held that s.23J(2) postulates a composite notion, that is to say a business which includes buying and selling eligible securities.
65. It was not suggested that I should not follow these decisions as to the construction of s.23J, and I would in any event do so because with respect I think they are correct.
66. In both cases all relevant eligible securities had been held to maturity. It was therefore held that ss.(2) did not operate because the business of the taxpayer did not include the selling (as distinct from redemption) of securities.
67. However, on the facts of the present case, it is clear that GRE did engage in selling bonds in the course of its business, and to a significant degree. For example, the table appearing earlier in this judgment reveals that in 1984 of the 52 bonds realised, 18 were sold and the value of those sales ($28.6 million) was about twice the value of bonds redeemed at maturity.
68. I therefore hold that s.23J(2) applies to prevent GRE obtaining the
benefit of s.23J(1).
(III) DISPOSAL OF EQUITIES BY UNITRADERS
69. The argument of the Commissioner was that profits made by Unitraders on the disposal of equities was income according to ordinary concepts and usages and within s.25(1). The first limb of s.26(a) was not relied on. The second limb was not expressly disclaimed, but no argument was directed toward it.
70. The argument was put on two distinct bases which need to be considered
separately. First it was said that the profits were obtained
in the course of
carrying on a business, namely investing in shares for a profit, and that
ordinary principles produced the result
that those profits were assessable.
Particular reliance was placed on London Australia Investment Co Limited v FCT
[1977] HCA 50; (1977) 138 CLR 106. Secondly, it was put that Unitraders' business of
investment in equities was an integral part of the business of insurance
carried
on by GRE and therefore the Colonial Mutual principle applied.
(i) Investment Profits
London Australia
71. As the actual facts of this case assume some importance for present
purposes, I shall quote the following summary from the judgment
of Gibbs J.
(at pp 114-115):
"(The taxpayer's) principle object was to invest mainly or72. A majority of the High Court (Gibbs and Jacobs JJ.) held that the profits formed part of the company's assessable income. Gibbs J. considered that neither limb of s.26(a) applied but that the profits fell within s.25(1) because the company was carrying on the business of investing for the purpose of producing income and the buying and selling of the shares was done as part of that business. Hence the resulting profits were profits of the business and income within ordinary usages and concepts. Jacobs J. held that the profits were within the second limb of s.26(a) and also within s.25(1) on the ground that it was proper to conclude from the scale and frequency of the sales and that the acquisitions and disposals were part of a business of acquisition and disposal.
wholly in Australian securities, for the purpose of producing
dividend income which it could distribute to its shareholders.
The taxpayer in fact held a large portfolio of Australian
shares. During the years in question the directors of the
taxpayer met each month to decide whether shares should be
bought or sold, and during that period, as Helsham J. found,
the taxpayer engaged in a continuous large scale activity in
the buying and selling of shares. In deciding what shares
should be bought, sold or retained the taxpayer was guided by a
number of principles, but one important consideration in buying
shares was that the shareholding should immediately or within a
reasonable time produce a dividend yield of four per cent or
better. The dividend yield is the return on the shares
calculated as a percentage of their market value. In buying
shares the taxpayer was influenced by their "growth potential",
that is, the expectation that they would produce a greater
dividend yield. Although a share which is likely to produce an
increased dividend is for that very reason likely to increase
in value, the taxpayer never bought shares for the purpose of
profit-making by sale, or with the intention of selling them,
or simply because their market value was likely to increase.
It bought shares to hold as an investment to yield dividends,
but it foresaw that it was likely that the shares would
increase in market value, and of course hoped that this would
occur. If the shares did increase in value, but the dividend
rate did not correspondingly increase, the dividend yield would
fall, and the taxpayer would then be likely to sell the shares.
In the years in question there was a steady rise in share
prices and in consequence the dividend yield of many shares
held by the taxpayer fell and many shares were sold. The
shares sold in each of the years in question exceeded a million
dollars in value and amounted to at least one-tenth of the
total value of the shares held in that year. The moneys
realised on the sale of the shares were not under the articles
of the taxpayer available for dividend but could be used to buy
further shares or to make up a future capital loss."
73. Gibbs J. cited the statement in Californian Copper already referred to
and said that he considered:
"... that if the sale in question is a business operation, carried74. After noting the finding of the primary Judge that the shares had not been bought for the purpose of selling them at a profit, Gibbs J. continued (at p 117):
out in the course of the business of profit-making, the profit
arising on the sale will be of an income character." (at p 116).
"Helsham J. found that during the three years in question it was anJacobs J. said (at p 130):
integral part of the taxpayer's business to deal in shares, in the
sense that switching of investments was desirable to produce the best
dividend returns and was indeed necessary if the taxpayer's policy of
investing in shares with great potential was to be adhered to. In my
opinion it is impossible to controvert that finding; it was clearly
right. Although the company's business was to invest in shares with
the primary purpose of obtaining income by way of dividends, the
conduct of the investment business required that the share portfolio
should be given regular consideration, and that shares should be
frequently be sold when the dividend yield dropped, which for
practical purposes usually meant when the shares went up in value.
The taxpayer systematically sold its shares at a profit for the
purpose of increasing the dividend yield of its investments. The
sale of the shares was a normal operation in the course of carrying
on the business of investing for profit. It was not a mere
realisation or change of investment."
"The evidence taken as a whole strongly supports a conclusionAfter discussing Colonial Mutual and other cases, his Honour (at p 118) expressed the view that:
that a purpose or intention or expectation implicit in the
carrying into effect of its investment policy was that shares
acquired would be resold if and when an occasion arose which
would make it desirable so to do and an element of desirability
was that there would be greater financial benefit in disposing
of the shares at an enhanced value then in retaining them. The
fact that enlargement of dividend income was the dominant
purpose does not gainsay the existence of a concurrent purpose
of resale if and when that resale would throw up a profit which
could be used to enlarge the dividend income. The massive
scale of the activities in the years in question practically
compels the inference that the investment policy was one which
in its inception and throughout the course of carrying it into
effect would in the expected state of the rising market require
frequent and regular realisations of shares whether they rose
in market price before dividends from them increased."
"....if the sale of the shares is an act done in what is trulyCases after London Australia
the carrying on of an investment business the profits will be
taxable just as they would have been if the business had been
that of banking or insurance."
75. In FCT v Myer Emporium Limited [1987] HCA 18; (1987) 163 CLR 199 the High Court was
concerned that with assignments in connection with a loan to an associated
company of the taxpayer. The facts
therefore are not directly comparable with
the present case, but the case contains some important re-statements of
principle. Mason
ACJ, Wilson, Brennan, Deane and Dawson JJ. said (at p 209):
"Although it is well settled that a profit or gain made in the76. After reviewing the authorities, including the "celebrated decision" in Californian Copper, their Honours said (at p 213):
ordinary course of carrying on a business constitutes income,
it does not follow that a profit or gain made in a transaction
entered into otherwise than in the ordinary course of carrying
on the taxpayer's business is not income. Because a business
is carried on with a view to profit, a gain made in the
ordinary course of carrying on the business is invested with
the profit-making purpose, thereby stamping the profit with the
character of income. But a gain made otherwise than in the
ordinary course of carrying on the business which nevertheless
arises from a transaction entered into by the taxpayer with the
intention or purpose of making a profit or gain may well
constitute income. Whether it does depends very much on the
circumstances of the case. Generally speaking, however, it may
be said that if the circumstances are such as to give rise to
the inference that the taxpayer's intention or purpose in
entering into the transaction was to make a profit or gain, the
profit or gain will be income, notwithstanding that the
transaction was extraordinary judged by reference to the
ordinary course of the taxpayer's business. Nor does the fact
that a profit or gain is made as the result of an isolated
venture or a "one-off" transaction preclude it from being
properly characterised as income: Federal Commissioner of
Taxation v Whitfords Beach Pty Ltd [1982] HCA 8; (1982) 150 CLR 355 at
pp 366-367, 376. The authorities establish that a profit or
gain so made will constitute income if the property generating
the profit or gain was acquired in a business operation or
commercial transaction for the purpose of profit-making by the
means giving rise to the profit."
"The proposition that a mere realisation or change of77. In CMI Services Pty Ltd v FCT [1989] FCA 346; (1989) 89 ATC 4847 the assets in question were not securities but residential properties. The nature of the case is sufficiently explained in the following passage from the judgment of Woodward J. (at p 4861):
investment is not income requires some elaboration. First, the
emphasis is on the adjective "mere": Whitfords Beach (1982)
150 CLR at p 383. Secondly, profits made on a realisation or
change of investments may constitute income if the investments
were initially acquired as part of a business with the
intention or purpose that they be realised subsequently in
order to capture the profit arising from their expected
increase in value: see the discussion by Gibbs J. in London
Australia (1977) 138 CLR at pp 116-118. It is one thing if the
decision to sell an asset is taken after its acquisition, there
having been no intention or purpose at the time of acquisition
of acquiring for the purpose of profit-making by sale. Then,
if the asset be not a revenue asset on other grounds, the
profit made is capital because it proceeds from a mere
realisation. But it is quite another thing if the decision to
sell is taken by way of implementation of an intention or
purpose, existing at the time of acquisition, of profit-making
by sale, at least in the context of carrying on a business or
carrying out a business operation or commercial transaction."
"I think it is true that the facts of the present case can beHis Honour then made what seems to me with respect a useful comment on London Australia:
distinguished from those of London Australia. There the sales and
investments were in accordance with an accepted principle and were
regular. Here the sales resulted from an exercise of judgment in
each case, based on a number of different factors, and at the time of
the subject sales only two other properties had been sold, of the
twenty-five that had been bought. ....the first was sold at a 12.5%
loss after four years, and the other at a 4% profit after two and a
half years - a loss in real terms. In each case the difficulties in
managing a number of tenants caused problems that led to low returns
on investment. It was obviously sensible for (the taxpayer), wishing
to retain its capital structure, to cut its losses and quit these
investments. No question of profitable trading was involved.
The subject properties were, as I have said earlier, sold for two
main reasons. The first was poor returns on investment which were
likely to get worse; the second was concern about structural
stability. These factors had influenced management and directors in
differing degrees. Had structural stability been the only factor,
the sale would not have had the appearance of 'a business operation,
carried out in the course of the business of profit-making'."
"On the other hand, I think London Australia makes it clearHis Honour concluded (at p 4864) that, although the case was not as clear as London Australia, the sale of the properties:
that, if one of a series of investments is sold by an
investment company because it is not performing as well as
others - particularly if the reason for that failure is that an
increase in value has lowered the rate of return - then such a
sale is in the course of the business of profit-making."
"....was a normal operation in the course of carrying on the business78. The judgment of Woodward J. was upheld on appeal to the Full Court: (1990) 90 ATC 4428. The Full Court rejected an argument of the taxpayer that London Australia established that the profit on the realisation on investments is assessable as income under ordinary concepts only if the investments have been acquired with a purpose (not necessarily a dominant purpose) of profit-making by sale. Lockhart J. (with whom Jenkinson and Gummow JJ. agreed) said (at p 4437):
of investing for profit. It was an operation which was carried out
in a professional, orderly and business-like way."
"The fact that the taxpayer did not buy real estate for the purpose79. The Full Court did not find it necessary to consider the alternative submission of the Commissioner that the principle of the insurance cases should apply on the ground that the taxpayer's business was simply part of the investment activities of its parent's insurance business. Lockhart J. said (at p 4438):
of selling it at a profit is an important consideration. But, as the
primary Judge found, there was a pattern discernible in the policy of
the taxpayer in investing in real estate which involved it being
resold if its prospective returns from retail fell below acceptable
levels. Although the taxpayer's business was to invest in real
estate for the primary purpose of obtaining income by way of rental,
the conduct of that investment business required that the real estate
portfolio should be considered and monitored on a fairly regular
basis and that real estate should be sold when its rental yield,
measured in relation to market value, dropped to an unacceptable
level. The purchase of the Belmont properties is the directly
relevant example of the application of that policy.
The taxpayer was carrying on the business of investing for the
purpose of producing income; but the facts disclose that the buying
and selling of real estate was done as part of that business so the
taxpayer of investing for the purpose of producing income. The
profits which were realised on the sale of the Belmont properties
were profits of the business and income within ordinary usages and
concepts and so fell within s.25."
"The activities of the taxpayer cannot, of course, be divorced from80. In FCT v Equitable Life and General Insurance Co Ltd (1990) 90 ATC 4438 the decision of the Full Court was handed down in Sydney one day before the judgment of the Full Court in CMI was given in Melbourne. In Equitable Life the taxpayer was a member of the QBE Insurance Group. For many years prior to 1977 it had carried on a life insurance business. Between 1977 and 1984 the taxpayer retained an investment portfolio consisting predominantly of equities which were bought and sold from time to time. In 1984 the portfolio was liquidated and the funds used elsewhere within the Group. At issue were the profits from share sales in 1983 and 1984. Wilcox J. held that the 1983 profits were taxable on the London Australia principle but that the 1984 profits escaped liability because the sales "represented a closing down of the business previously carried on": 89 ATC at p 4982. As to the 1983 year his Honour found (at p 4981) that the evidence showed that the taxpayer:
those of CMI, but I do not find it necessary to approach the facts of
this case as if the taxpayer was but an investment arm of its parent
and fell broadly within the description of the business of insurance."
"....was willing to sell particular shares from time to time, no81. On appeal ((1990) 90 ATC 4438), a majority of the Full Court (Davies and Gummow JJ.) held that neither the 1983 or 1984 profits were assessable. The principal judgment was that of Davies J. His Honour placed considerable weight on the concession made by the Commissioner that the taxpayer was not a share trader. His Honour said (at p 4447):
doubt whenever it was thought sensible to do so having regard to the
performance of the shares and the price available. Such periodic
sales must be regarded as a normal operation in the course of
carrying on the business of investing for profit."
"As the taxpayer.... was not a trader in shares and did not carry onHis Honour distinguished London Australia on the grounds that the taxpayer there:
a business of or involving dealing or trading in shares, it follows
from the principles I have outlined that the profits made from its
investment activities do not form part of its assessable income. Its
profits were capital profits derived from an activity of investment
that was not a business."
"....was listed on London Exchange and made regular returns to its82. It is relevant to note here that in the present case the London memorandum stated that one of, indeed the first of, the "main aims" was "to achieve an acceptable compromise between income and capital appreciation". Thus both aspects were present.
shareholders. Its activities, including its share dealings,
constituted a business and the issue was whether, as its share
dealings were designed to maintain dividend income, the profits
arising from the dealings were assessable. In the present case, as
my colleague Pincus J. has pointed out, the taxpayer had no portfolio
management plan directed to maintaining dividends but was rather more
concerned to enhance the capital value of its portfolio."
83. It follows from the sequence in which the two Full Court decisions were handed down that the Full Court in Equitable Life did not have the opportunity of considering what was said by the other Full Court in CMI.
84. In AGC (Investments) Ltd v FCT (1991) 91 ATC 4180 the taxpayer was a
member of an insurance group. It was incorporated as a vehicle for investment
of funds provided to it by its
parent company, a general insurer. The
criterion for investment in equities was "the ensuring of long-term dividend
investment income
and the maximisation of potential growth". The investments
of the taxpayer were regarded by the Board of its holding company as
part of
its reserve fund. The share portfolio was managed by a company within the
Westpac Group. There were relatively few sales
in comparison with
acquisitions and generally the occasion of the sales was a takeover offer
although often shares, the subject of
the offer, were sold on the market.
Sales were usually a small percentage of the total value of the portfolio, for
example in 1982
only 2.36% and sales for 1983-1985 inclusive were
proportionately no greater. In 1986 sales were about 16%. In September 1987
the
taxpayer, with commendable prescience, came to the view that the share
market was greatly over valued and gave instructions for substantial
sales.
In that year about 50% of the portfolio was sold. Although accepting that the
taxpayer was a separate legal entity from its
parent company, Hill J.
considered that it was nevertheless relevant, in considering the correct
characterisation of the profits
in the hands of the taxpayer, that the assets
of the taxpayer were treated by its parent as part of its reserve fund and
were relevant
for the purpose of calculating solvency ratios. His Honour
discussed London Australia and accepted (at p 4191) that there is a
distinction
between a business of investment, that is to say a business where
there is no intention to re-sell at a profit, and an investment
business,
where there is. His Honour pointed out that:
"....there is no general principle of taxation that the mere85. His Honour discussed Equitable Life and CMI and said (at p 4192) that there might be "some difficulty" in reconciling what was said in the two cases - a difficulty which, with respect, I have also encountered. His Honour said (at p 4192):
management of a share portfolio, conducted in a systematic and
concerted way, brings about the result that all the surpluses
of that activity are income in ordinary concepts." (at p 4191)
"If CMI stands for a general principle that a taxpayer who as86. His Honour thought it was unnecessary to attempt to resolve the differences. He posited the issue in the case before him as one in which the taxpayer had to show:
part of an activity properly characterised as a business
derives income in ordinary concepts when it realises
investments made by it at a profit notwithstanding that it had
no purpose at all of so doing when it acquired the investment,
(the Commissioner) must succeed in the present case. But if it
does, it is only capable of reconciliation with Equitable Life,
on the basis that the latter case is to be seen as a case where
the activities of the taxpayer involved no business at all.
However, all that was said on that matter by Davies J. is that
the taxpayer was not carrying on a business of dealing or
trading in shares."
(His Honour's emphasis)
"....despite the scale of its activities and the relationship87. After a detailed review of the evidence his Honour found that the burden had not been satisfied by the taxpayer. His Honour's conclusion was that the taxpayer:
which its activities had to the insurance business of its
parent, that on the balance of probabilities, in acquiring its
portfolio of shares, it had no purpose of ultimate re-sale at a
profit and conversely that it will fail if it does not satisfy
the burden of proof of showing that re-sale of the portfolio
out of profit was not one of its purposes." (at p 4193)
"....was carrying on a business, that business being integralThe Present Case
to the insurance business of its parent, and in the course of
this business it acquired a portfolio of shares having at the
time of acquisition a profit-making purpose in so doing. It
realised a large part of that portfolio to preserve the gain
which had accrued to it, and the profits it made in doing so
were income in ordinary concepts." (at p 4194)
88. A number of factors seem to me to require that I should reach the same conclusion as did the High Court in London Australia.
89. Unitraders was carrying on the business of investment in equities. It was a serious business. Large sums of money were involved. Decisions to buy and sell were taken by persons who had, or at least professed to have, the relevant expertise and it was part of the work they were employed to do.
90. Whether or not the number and value of the sales in relation to the total value of the portfolio might have warranted the description of "massive" used by Jacobs J. in London Australia, they were nevertheless significant and of course they procured the substantial profits, the assessibility of which are at issue.
91. To my mind the fact that decisions to sell, and thus realise profits, were made fairly well down the line, in that neither the Board nor Mr Morris was aware of the individual transactions, tends to show that the taking of profit by the sale of equities in this way was an ordinary part of Unitraders' business; it might not have been literally an everyday event, or sufficiently frequent to warrant the characterisation of Unitraders as a share trader, but it happened often enough to be properly regarded as a routine and unremarkable part of the business carried out in accordance with the standard instructions contained in the London memorandum.
92. Looked at another way, Unitraders' argument must implicitly involve the assertion that the sales which produced the relevant profits were a re-arrangement of the profit-earning "business entity, structure, or organisation" of the company (Sun Newspapers Ltd v FCT [1938] HCA 73; (1939) 61 CLR 337 at p 359 per Dixon J.). Such a re-arrangement would have been of some moment both because of the sums involved and because investments were made on a "long term" basis. Yet such transactions seem to have been decided on by the Assistant Investment Manager, a gentleman in his mid-20s, whose name has been forgotten, telephoning someone in London, whose identity and position are not revealed by the evidence, and it might have been up to three months before Mr Morris or the Unitraders Board were even aware of what had happened.
93. The evidence shows that between 1983 and 1986 a substantial number of equities were turned over within two years of acquisition and that quite a number were sold within twelve months with profits attracting assessment under s.26AAA. All things considered, this was a business were the sale of equities was no unusual thing. The picture I get is that if it was considered a good idea to take a profit, that profit would be taken.
94. The fact that a substantial part of the relevant profits made in 1983 and 1984 came from sales made in takeover situations does not, in the circumstances of this case, point to a conclusion that the profits thereby made were of a capital nature. One of the features of investment in listed equities is that a takeover bid may be received. This will usually involve a premium offered by the bidder and hence gives the investor an opportunity for return beyond what might normally be expected. As has been pointed out in a different context, not all vicissitudes of life are harmful: Bresatz v Przibilla [1962] HCA 54; (1962) 108 CLR 541 at p 544 per Windeyer J. From the point of view of an investor in equities, a takeover bid can be a welcome vicissitude. Moreover, it is an occurrence which need not be totally dependent on the whim of fortune. There are some objective criteria which might enable skilled investors to conclude that some companies are more likely than others to be takeover targets. Whether or not this was so in the case of Unitraders, one cannot tell. There was no evidence from whoever made the decision to purchase the equities which later became the subject of takeover bids. But whether or not bids were predictable, they were nevertheless in my view a feature which might be expected to occur from time to time in a business of this sort and the acceptance of bids, or sale on the market at a price influenced by bids, seems to me something in the ordinary run of this kind of business.
95. Counsel for the Commissioner, correctly in my view, attached significance to the "emphasis... on marketability" in the London memorandum. Given the more than adequate solvency ratios which GRE enjoyed and its comprehensive reinsurance arrangements, I do not think "marketability" in the context of the London memorandum referred primarily to a need for Unitraders to be able to sell equities in a hurry to meet GRE's insurance liabilities (even though the memorandum does speak of "the context of the anticipated insurance results"). Also the term must in my view mean something more than the bald fact that listed equities can be sold on a stock exchange. In the context of detailed investment guidelines, I think it means rather that in selecting equities regard is to be had to the ability to move in and out of holdings as circumstances dictate, or, in other words, to have the facility to switch investments. When profits arise in the course of disposing such marketable equities, it seems to me to follow that such profits are part of the ordinary course of the business and were intended and contemplated as such.
96. I find that one of the purposes for which Unitraders acquired equities
was to gain the benefit of their capital appreciation.
The repeated stress in
the London memorandum on marketability (which, incidentally, applied in
relation to other forms of investment
as well) shows that it was also
intended, or at the very least contemplated, that such capital appreciation
might be realised by
sales whenever appropriate. Unitraders' actual method of
operation was in my view consistent with the implementation of that purpose.
The Present Case and London Australia
97. There are of course some differences between the facts of the present case and London Australia. A somewhat smaller proportion of the portfolio was turned over (about 6-7% as against 10% or more) and there was no equivalent of the direction to achieve a specified dividend yield. However, looked at broadly, the similarities between the two businesses involved in the two cases seem to be much more important. Like Tolstoy's happy families, they resemble one another.
98. Predictability and consistency are important values in the law and particularly, one would think, in revenue law. While accepting of course that each case ultimately turns on its own facts and that each case calls for a "wide survey and close scrutiny" of the taxpayer's activities (Western Gold Mines NL v Commissioner of Taxation (WA) [1938] HCA 5; (1938) 59 CLR 729 at p 740), it does not seem to me satisfactory that the result should turn on distinctions of the kind I have mentioned. In both cases profits were gained from the disposal of equities in the ordinary course of business. Such differences as there were probably stemmed largely from the fact that the London Australia Company was itself a listed company. It is understandable that the company might have adopted a more structured approach so as to present a distinctive investment policy to the outside world and in particular to existing and potential shareholders. Hence the four per cent yield rule and the practice of the Board deciding on purchases and sales at monthly meetings. But the Unitraders' investment business was an in-house operation carried on as part of a large international insurance group with, one might reasonably infer, large resources of experience and expertise. In that context business methods could be more informal and flexible. From the point of view of business administration there are no doubt arguments for and against each approach, but the legal characterisations of the two businesses for the purposes of this case do not seem to me to be relevantly different.
99. In my view London Australia points strongly to the conclusion that the
profits made by Unitraders in the present case are assessable.
(ii) The Insurance Connection
100. Since I have reached the conclusion that Unitraders' profits are assessable on general principles, it is not strictly necessary to consider the alternative argument of the Commissioner which was to the effect that Unitraders' activities were so integrated with the insurance activities of GRE that the Colonial Mutual principle should apply.
104. I think all I need say is that, of all the cases I was referred to, none seemed to involve the taxpayer being quite as removed from the "taint" of insurance business as the present case.
105. In Chamber of Manufactures Insurance Ltd v FCT [1984] FCA 124; (1984) 84 ATC 4315 the
taxpayer itself was an insurer. The Full Court found that the investment
portfolio in question:
"....constituted the necessary reserve fund for the taxpayer's103. The Full Court said (at p 4318):
insurance business. It was, and was intended to be,
immediately available for the purpose. No other funds of the
taxpayer could be pointed to as fulfilling this role, because
the "hard core" was the fund called upon, on a day to day
basis, to meet normal commitments." (at p 4317).
"Even in such a case as the present, the position might have104. In RAC Insurance Pty Ltd v FCT (1990) 90 ATC the taxpayer was agai n an insurer itself and the Full Court held that the investment in shares:
been different had the taxpayer maintained two quite separate
funds - the first acknowledged as a reserve fund and
demonstrably sufficient to meet claims and expenses in all
reasonably foreseeable contingencies - the second categorised
and dealt with as an investment fund. Whether the profits from
the sale of investments in the second fund were taxable would
depend on factors unrelated to insurance such as those referred
to in the London Australia Investment Co case."
"....was simply an overall part of the investment of the105. The Full Court inferentially adopted the comment of Lee J. at first instance (1989) 90 ATC 4780 at p 4789 that the taxpayer:
insurance reserve, much of which was invested in medium or even
short-term securities. All the investments were acquired in
the course of carrying on the insurance business and all
investments were available for realisation as and when
required. While held, the shares produced dividend income.
When sold, the profits made or losses incurred added to or
reduced the profits of the insurance business. In brief, the
investment of the reserve was an ordinary part of the insurance
business." (at p 4742)
"....took no step to identify any part of its reserve funds as being106. In the present case Unitraders was a separate entity. It did not carry on the business of an insurer and was not licensed to do so. Its assets were not required by its parent to meet statutory solvency ratios or any other requirements under the Insurance Act. While doubtless Unitraders assets were available as a last resort, the evidence does not show that they were treated in any way as a reserve for the purposes of GRE's insurance business. About all that can be said really is that the assets of Unitraders formed part of the corporate wealth which GRE presented to the world and therefore might have been likely to play some part in generating confidence in GRE as a substantial insurer. But the cases do not seem to me to indicate that this is enough.
excess to the requirements of the insurance business, nor did it
apply it, or earmark it for application, to the acquisition of some
new profit-earning activity or structure to expand the nature and
content of its business..... Nor did the taxpayer quarantine any
excess funds by investing them in a distinctive manner that showed
such funds had been excised from the normal run of investments
maintained for the purposes of the business."
107. I find therefore that the Commissioner succeeds on all of the issues identified at the outset of this judgment. The appeals also included some other issues, not mentioned in this judgment, which were resolved by agreement. Thus the assessments will need some variation and the orders which I make will need to reflect that. Therefore I shall simply adjourn the hearing to enable Counsel to speak to proposed minutes of orders.
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