Sun Alliance Investments Pty Ltd (In Liq) v Commissioner of Taxation [2004] FCAFC 11 (9 March 2004)

Last Updated: 9 March 2004

FEDERAL COURT OF AUSTRALIA

Sun Alliance Investments Pty Ltd (In Liq) v Commissioner of Taxation

[2004] FCAFC 11

INCOME TAX – capital gains tax – merger of holding companies of two major insurers – capital gains tax implications of merger arising from deemed acquisitions at market value as at merger date of shareholdings of wholly owned subsidiaries of merged parent companies – payment of four rebateable dividends by first subsidiary to merged holding company – payment of two rebateable dividends by second subsidiary to merged holding company – second subsidiary buys back from holding company all but two of its issued shares – resulting capital gains calculations in relation to holding company – losses pursuant to holding company buy back deducted from reduced cost base of dividends attributed to profits derived prior to merger – in estimating capital loss claimed by holding company in respect of first share disposal dividends attributed to pre-merger profits – Commissioner attributed additional sum to profits prior to merger and reduced cost base accordingly – in estimating capital loss of second subsidiary in respect of other share disposal Commissioner attributed dividends partly to profits derived up to merger date and reduced cost base accordingly – whether profits derived when not realised in any traditional sense – meaning of profits – meaning of ‘distribution... reasonably to be taken to be attributable to profits derived by company before RDA share’ – profits found to be derived in one set of circumstances but not another


Income Tax Assessment Act 1936 (Cth), 160ZK
Taxation Administration Act 1953, Part IVC, s 175A
Taxation Law Amendment Bill (No. 2) 1994
Income Tax Assessment Act 1922 (Cth)
Social Security Act 1947 (Cth). Section 18

Australasian Oil Exploration Ltd v Lachberg (1958) [1958] HCA 51; 101 CLR 119

Brent v Federal Commissioner of Taxation [1971] HCA 48; (1971) 125 CLR 418

CIC Insurance Ltd v Bankstown Football Club Limited [1997] HCA 2; (1997) 187 CLR 384

Clarke v Federal Commissioner of Taxation [1992] FCA 93; (1992) 92 ATC 4136

Clyne v Deputy Commissioner of Taxation [1981] HCA 40; (1981) 150 CLR 1

Commissioner of Taxes (SA) v Executor Trustee & Agency Co of South Australia Ltd [1938] HCA 69; (1938) 63 CLR 108

Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia Ltd [1938] HCA 69; (1938) 63 CLR 108

Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation [1981] HCA 26; (1981) 147 CLR 297

Dickson v Federal Commissioner of Taxation [1939] HCA 42; (1940) 62 CLR 687

Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] Ch 353

Evans v Deputy Federal Commissioner of Taxation (S.A.) [1936] HCA 2; (1936) 55 CLR 80

Federal Commissioner of Taxation v Clarke [1927] HCA 49; (1927) 40 CLR 246

Federal Commissioner of Taxation v Slater Holdings Limited [1984] HCA 78; (1984) 156 CLR 447

Hancock Family Memorial Foundation Ltd v Porteous (2000) FLR 249

Industrial Equity Ltd v Blackburn [1977] HCA 59; (1977) 137 CLR 567

Lembeke v SAS Trustee Corporation [2003] NSWCA 136; (2003) 56 NSWLR 736

MLC Ltd v Deputy Commissioner of Taxation (2003) 1996 ALR 502

QBE Insurance Group Limited v Australian Securities Commission (1992) 38 FCR 270

Re The Spanish Prospecting Co Ltd [1911] 1 Ch 92

Russell v Town and Country Bank (1888) 13 App Cas 418

Sun Alliance Investments Pty Ltd (In Liquidation) v The Commissioner of Taxation [2003] FCA 75

Tindal v Federal Commissioner of Taxation [1946] HCA 26; (1946) 72 CLR 608

Webb (Commissioner of Taxes (Vic)) v Australian Deposit and Mortgage Bank Ltd [1910] HCA 48; (1910) 11 CLR 223



























SUN ALLIANCE INVESTMENTS PTY LIMITED (IN LIQUIDATION) v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
N184 OF 2003


LEE, SUNDBERG AND CONTI JJ
9 MARCH 2004
SYDNEY

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY	N184 OF 2003

ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA.

BETWEEN:	SUN ALLIANCE INVESTMENTS PTY LIMITED (IN LIQUIDATION) APPELLANT
AND:	COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT
JUDGES:	LEE, SUNDBERG, CONTI JJ
DATE OF ORDER:	9 MARCH 2004
WHERE MADE:	SYDNEY

THE COURT ORDERS THAT:

1. The appeal be allowed.

2. The orders below be set aside and in lieu thereof it be ordered that the objection decision be set aside and the matter remitted to the respondent to determine according to law.

3. The respondent pay the appellant’s costs of and incidental to this appeal and of and incidental to the proceedings below.

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

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY	N184 OF 2003

ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA.

BETWEEN:	SUN ALLIANCE INVESTMENTS PTY LIMITED (IN LIQUIDATION) APPELLANT
AND:	COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT

JUDGES:	LEE, SUNDBERG, CONTI JJ
DATE:	9 MARCH 2004
PLACE:	SYDNEY

REASONS FOR JUDGMENT

THE COURT:

1 This is an appeal from a judgment of a Judge of this Court which dismissed an ‘appeal’ by the appellant under s 14ZZ of the Taxation Administration Act 1953 (Cth) from an ‘objection decision’ of the respondent (‘the Commissioner’) disallowing an objection by the appellant to an amended income tax assessment made and issued by the Commissioner on 24 December 1998 in respect of the appellant’s year of income ending 31 December 1997.

Introduction to issues arising on appeal – summary of factual background

2 The issues in the appeal involve the construction of s 160ZK(5) of the Income Tax Assessment Act 1936 (Cth) (‘the Tax Act’), part of the complex capital gains tax provisions of Division 3 of Part IIIA of the Tax Act, headed ‘Determination of Capital Gains and Capital Losses’. The central issue of statutory construction concerns the words could reasonably be taken to be attributable to profits that were derived by the company as they appear in s 160ZK(5). The findings of fact made by the primary judge are not contested.

3 The facts and circumstances giving rise to the present litigation are detailed and complex, involving internal corporate accounting entries relating largely to transactions of a non-arms length nature, which have been described at length in the reasons for judgment below (Sun Alliance Investments Pty Ltd (In Liquidation) v The Commissioner of Taxation [2003] FCA 75). For ease of reference, we reproduce the documentary and factual detail assembled by the primary judge, together with additional evidentiary references referred to in the course of the hearing of the appeal.

4 On 8 October 1992, (‘the merger date’), Royal Australia Holdings Limited, Sun Alliance Group Plc, Sun Alliance Holdings Limited and Sun Alliance Australia Limited entered into an agreement (‘the Merger Agreement’), the effect of which was that Royal Group merged its general insurance business in Australia with that of the Sun Alliance Group, to form the Royal & Sun Alliance Group of companies. Contributions to the capital of the merged undertaking were made by the Royal Group as to 40%, and by the Sun Alliance Group as to 60%, based on valuations of their respective assets as at the merger date.

5 As a result of the merger, Royal & Sun Alliance Insurance Australia Holdings Limited (‘the Holding Company’) was deemed, pursuant to s 160ZZS of the capital gains provisions, to have acquired at market values prevailing at the merger date shareholdings in certain subsidiaries, relevantly for present purposes, Sun Alliance Insurance Ltd (‘SAIL’) and Phoenix Securities Pty Limited (‘Phoenix’). As at the merger date the market value of the SAIL and Phoenix shares was $98,728,974 and $28,477,898 respectively.

6 After the merger SAIL paid two dividends to the Holding Company, namely:

(i) $50,000,000 on 30 October 1992; and

(ii) $36, 337,176 on 6 September 1996.

It was not disputed that the above dividends entitled the Holding Company to rebates pursuant to s 46 of the Tax Act. The minute of directors made in relation to the dividend of $50,000,000 paid on 30 October 1992 suggested that the directors had relevant unaudited accounts of SAIL but, as noted later in these reasons, the appellant contends that the only accounts then available were Group accounts and that no separate accounts had been prepared for SAIL.

7 By written agreement made on 11 December 1996, SAIL ‘bought back’ from the Holding Company all but two of the issued shares held by the Holding Company in SAIL for a sum of $11,108,952. For the purpose of calculating the capital loss incurred by reason of the buy-back, the Holding Company, pursuant to ss 160ZK(1B) and 160ZK(5) of the Tax Act, deducted from the ‘reduced cost base’ of the SAIL shares the amount of the dividends received said to be attributable to profits derived by SAIL prior to the merger date, being the date of deemed acquisition of the SAIL shares. The amount so deducted by the Holding Company comprised the dividend of $50,000,000 paid on 30 October 1992 and $9,562,000 of the dividend of $36,337,176 paid on 6 September 1996. The Holding Company calculated $28,058,022 as the amount of the capital loss it had sustained on disposal of the SAIL shares.

8 After the merger Phoenix paid four dividends to the Holding Company, namely:

(i) $12,000,000 on 30 October 1992;

(ii) $650,000 on 25 May 1994;

(iii) $3,100,000 on 28 December 1995; and

(iv) $20,891,449 on 6 September 1996.

Again there is no dispute that the Holding Company was entitled to rebates under s 46 in respect of those dividends. A minute of directors made in relation to the dividend of $12,000,000 paid on 30 October 1992 also referred to current unaudited accounts of Phoenix, but as noted above in relation to SAIL, the appellant contended that no separate accounts had been prepared for Phoenix at that time. Phoenix was placed in liquidation and dissolved on 30 December 1997 and the remaining capital of the company, $5,835,661, distributed to the Holding Company.

9 In calculating the capital loss incurred upon disposal of the Phoenix shares by dissolution, the Holding Company reduced the cost base of the Phoenix shareholding by attributing the whole of the $12,000,000 dividend paid to the Holding Company on 30 October 1992 to profits derived by Phoenix before the merger date. The later dividends paid to the Holding Company were attributed to profits derived by Phoenix after the merger date. The capital loss calculated by the Holding Company was $10,642,237.

10 The Commissioner’s amended assessment adjusted the amount of the capital losses calculated by the Holding Company and allowed only $18,314,424 in that regard. In respect of the Phoenix shareholding the Commissioner did not accept that the whole of the dividends paid after 30 October 1992 could reasonably be taken to be attributed to profits derived after the merger, and treated $14,522,391 of that amount as profits derived by Phoenix prior to the merger date. Accordingly, pursuant to the amended assessment, no loss was allowed upon the disposal of the shareholding in Phoenix. Thus the amount which the Holding Company was able to transfer to the appellant for the 1997 year of income, being the amount remaining after transfer by the Holding Company of part of the loss in the preceding year of income, was a sum of $8,098,765, rather than the amount of $25,179,289 that the Holding Company had purported to transfer. The reduction in capital loss determined by the Commissioner resulted in a corresponding increase in the taxable income of the appellant for the 1997 year of income. The amended assessment issued to the appellant included other adjustments not relevant to the proceedings below or to this appeal.

The legislative scheme

11 Part IIIA of the Tax Act is a legislative scheme governing the treatment of capital gains and losses for taxation purposes. The object of Part IIIA is ‘... to provide for net capital gains to be included in assessable income’ (s 160AX). In broad outline, capital gains are calculated by subtracting the indexed cost base of an asset from the consideration received in respect of the disposal thereof (in the case of an asset owned for less than one year, no indexation is involved), whilst capital losses are to be calculated conversely by subtracting the consideration in respect of the disposal from the reduced cost base of an asset (s 160AY). A ‘net capital loss’ is to be ascertained pursuant to s 160ZC(2), which reads as follows:

‘For the purposes of this Part, a net capital loss is taken to have been incurred by a taxpayer in respect of a year of income if:

(a) the sum of any capital losses incurred by the taxpayer during the year of income;

exceeds:

(b) the sum of any capital gains that accrued to the taxpayer during the year of income.

The net capital loss is the excess.’

12 Section 160ZH governs the ascertainment of the cost base of an asset, and s 160ZH(3), in particular, provides for the determination of the ‘reduced cost base’ as follows:

‘Subject to the following provisions of this section, for the purposes of this part, the reduced cost base to a taxpayer of an asset is the sum of:

(a) the reduced amount of any consideration in respect of the acquisition of the asset;

(b) the reduced amount of the incidental costs to the taxpayer of the acquisition of the asset;

(c) the reduced amount of any expenditure of a capital nature incurred by the taxpayer to the extent to which it was incurred for the purpose of enhancing the value of the asset and is reflected in the state or nature of the asset at the time of disposal of the asset;

(d) the reduced amount of any expenditure of a capital nature incurred by the taxpayer to the extent to which it was incurred in establishing, preserving or defending the taxpayer’s title to, or a right over, the asset; and

(e) the reduced amount of the incidental costs to the taxpayer of the disposal of the asset.’

13 Section 160ZK of the Tax Act addresses, inter alia, the circumstances, in which the cost base of an asset consisting of shares in a company is to be reduced for capital gains tax purposes. The material provisions are subss 160ZK(1), (1B) and (5), which read as follows:

‘Reduction of amounts for the purposes of reduced cost base

(1) Subject to subsection (1B), a reference in subsection 160ZH(3) to the reduced amount of any consideration... in respect of an asset... is a reference to the sum of -

(a) the amount of the consideration, the amount of the costs or the amount of the expenditure, as the case may be, reduced by any part of the consideration, of the costs or of the expenditure that:

(i) has been allowed or is allowable as a deduction to the taxpayer...

(b) any amount that, as a result of the disposal of the asset by the taxpayer, is included in the assessable income of the taxpayer of any year of income by virtue of a provision of this Act other than this part and is attributable to the part of the consideration, the part of the costs or the part of the expenditure, as the case may be, that was allowed or is allowable as a deduction.

...

(1B) If the asset is a share, the amount worked out under subsection (1) is to be reduced by any rebatable dividend adjustment that arises in relation to the share (see subsection (5)).

...

(5) A rebatable dividend adjustment arises in relation to a share (the ‘RDA share’) if:

(a) under an arrangement, a company makes a distribution to the holder of the RDA share; and

(b) an amount (the ‘attributable amount’), being the whole or part of the distribution, could reasonably be taken to be attributable to profits that were derived by the company before the holder acquired the RDA share; and

(c) the holder of the RDA share is entitled to a rebate of tax (the ‘dividend rebate’) in the holder’s assessment for the year of income under section 46 or 46A in respect of an amount (the ‘dividend amount’) being so much of the distribution as is a dividend; and

(d) the holder of the RDA share is, at any time during the period in which the arrangement is made or carried out, a controller of the company or an associate of the controller of the company.’

14 The reference in s 160ZK to the ‘rebateable dividend adjustment’ is diagrammatically presented in subs 160ZK(6) as follows:

‘Attributable x Amount of the dividend rebate
amount Dividend x General company
amount tax rate’

15 The issue before the primary judge, and on the appeal, was whether, within the meaning of s 160ZK(5)(b) of the Tax Act, certain of the dividends, or parts thereof, paid by SAIL and Phoenix to the Holding Company after the merger date, could reasonably be taken to be attributable to profits that were derived... before 8 October 1992.

Elaboration upon the facts and circumstances concerning the claimed loss on the SAIL shareholding

16 At the time the Holding Company acquired its shareholding in SAIL, the latter carried on the business of general insurance. Integral to SAIL’s business operations were investments of a non-current nature. Included in SAIL’s assets at the time of the merger were land and buildings in Bridge Street Sydney ("the Bridge Street properties") occupied in part by Sun Alliance Group companies. SAIL’s financial statements as at 30 September 1992 disclosed that its investments were measured at market value at each annual balance date, and changes in market values were recognised as revenue or expense in the profit and loss accounts of SAIL. That accounting practice appears to have been occasioned by the pending merger, because the notes to SAIL’s so-called ‘completion accounts’ as at 30 September 1992 disclosed that in previous years, changes in the carrying amount of investments had been taken to an asset revaluation reserve.

17 The Merger Agreement included provisions which ensured that the value at the merger date of the Bridge Street properties would be preserved for the merged entity. In the conduct of its business the Royal Group owned minimal real estate. It considered the realty investments of the Sun Alliance Group represented an over-weighted risk for the merged entity and it required the Sun Alliance Group to protect the merged entity against that risk. Accordingly, to give effect to the requirements of the Merger Agreement, on 2 November 1992 the Sun Alliance Group caused a new company, ("BSB"), to enter an agreement with SAIL, and others, to provide, in effect, that the Sun Alliance Group, through BSB, would make up the shortfall if the Bridge Street properties were sold at less than the amount of the valuation pertaining at the merger date. That agreement ("the Bridge Street properties agreement"), in conjunction with the Merger Agreement, also provided that if the amount received upon sale of the Bridge Street properties exceeded that valuation, the excess would be paid to BSB. By a further agreement made between the Royal Group and the Sun Alliance Group, also executed on 2 November 1992, the Royal Group was empowered to direct SAIL to sell the Bridge Street properties at a time of the Royal Group’s choosing.

18 As at the merger date the Bridge Street properties were valued at $57,050,000. As a result of the Merger Agreement and the Bridge Street properties agreement, SAIL would receive that sum if it sold the properties within seven years of the merger. As noted above if the sale price was greater than the valuation at the merger date BSB would receive the benefit of the excess. If the sale price was less, BSB would pay the difference to SAIL. The historical cost of the Bridge Street properties was $29,550,000. Therefore, after providing for deduction of certain unrealised losses, at the date of the merger a balance of $21,345,000 was able to be recorded in the accounts of SAIL as an unrealised profit on the Bridge Street properties. This amount was transferred to an unrealised profits reserve. It was the policy of the merged group, however, that only realised profits would be treated as available for distribution.

19 On 31 August 1995 the Bridge Street properties were sold to a third party for a sum of $38,623.500. Pursuant to the Merger Agreement and the Bridge Street properties agreement, the difference between that sum and $57,050,000 was paid to SAIL by BSB, thereby realising the sum that had been taken into the accounts previously as an unrealised profit.

20 SAIL had incurred an operating loss of $7,732,000 for the year ending 31 December 1993. That loss was met from retained funds. In the years ending 31 December 1994 and 31 December 1995, SAIL earned operating profits of $11,896,000 and $1,265,000 respectively. Accordingly, as at 6 September 1996 the amount of distributable funds on hand stood at $36,337,000. The whole of that sum was distributed on that date to the Holding Company as a rebatable dividend.

21 Counsel for the Commissioner submitted that as at 6 September 1996 the sum distributed consisted of the following components:

Net operating profits 1993-1995	$5,430,000.00
Realised profits retained at merger date	$9,562,000.00
Unrealised profit derived at merger date	$21,345,000.00
	$36,337,000.00

22 Perhaps a better description of the composition of the funds available for distribution, may be said to have been as follows:

Operating profits earned and retained 1994, 1995	$13,162,000.00
Balance remaining of realised profits retained at merger date	$1,830,000.00
Unrealised capital profit derived at merger date (or capital profit realised after merger)	$21,345,000.00
	$36,337,000.00

Elaboration upon the facts and circumstances concerning the claimed loss on the Phoenix shareholding

23 Phoenix carried on the business of equity investments, consistently with the practice of insurance corporate groups holding equities in a separate vehicle in order to attract the benefit of dividend rebates pursuant to s 46 of the Tax Act. As at the merger date, Phoenix held shares in a number of companies listed on the Australian Stock Exchange (‘ASX’). These were valued at cost at $8,900,000 and were revalued at the time of the merger to a market value of $20,700,000. The revaluation reflected an unrealised gain of $11,800,000. The evidence adduced before the primary judge demonstrated that the value of the share portfolio was subject to daily market forces and significant monthly variations. Phoenix was not an insurer but an investment vehicle, and unlike SAIL it was not required to bring to account in its profit and loss accounts changes in valuation of those shares in accordance with Australian Accounting Standards Review Board requirement AASB 1023: Financial Reporting of General Insurance Activities. Rather, the increases and decreases in the value of Phoenix’s shares were recorded as increments and decrements in its asset revaluation reserve in accordance with ASSB 1010. Share investments were realised by Phoenix in the financial years ending 31 December 1992 to 31 December 1996.

24 The source of the rebatable dividends paid by Phoenix to the Holding Company on 25 May 1994, 28 December 1995 and 6 September 1996 were as set out below in a table prepared by the Chief Financial Officer of the Holding Company, the contents of which were not in dispute.

No	Description	Profits Transfers from reserves $’000	Losses Transfers to reserves $’000	Total
1	Opening retained profits – 1993	438,842
2	Operating Profit - 1993	1,103,542
3	Amounts transferred to investment realization reserve - 1994		(3,235,228)
4	Operating Profit - 1994	4,313,187
5	Amounts transferred to investment realisation reserve - 1995		(1,604,683)
6	Operating Profit - 1995	2,774,904
7	Amounts transferred from investment realization reserve - 1996	7,461,902
8	Operating Profit - 1996	18,897,352
	Totals	34,989,729	(4,839,911)	30,149,818

25 Upon the liquidation of Phoenix, the Holding Company calculated for the purpose of s 160ZK the amount of the capital loss it had sustained. It reduced the cost base of the Phoenix shares, namely $28,477,898, by attributing the dividend of $12,000,000 paid on 30 October 1992 to profits derived by Phoenix before the merger date. The further dividends paid by Phoenix to the Holding Company on 25 May 1994, 28 December 1995 and 6 September 1996 were attributed by the Holding Company to profits derived by Phoenix after the merger. As noted earlier the Commissioner did not accept that calculation, and attributed $14,522,391 of the latter dividends to profits derived by Phoenix prior to the merger date. Application of that sum in further reduction of the cost base of the Phoenix shares eliminated the capital loss calculated by the Holding Company.

The appellant’s notice of objection and the Commissioner’s reasons for disallowing the objection

26 On 22 December 1999 the appellant objected to the amended assessment that had been issued on 24 December 1998. The delay in lodging the objection was caused by the need to reinstate the appellant as a registered corporation in liquidation, to enable it to object to an assessment made and served after the appellant had been dissolved.

27 The notice of objection included the following grounds:

’10. In making the amended assessment... the Commissioner has applied subsections 160ZK(5) and subsections 110-55(7) to reduce the cost base of [the Holding Company’s] shares in SAIL and [Phoenix] by the amount of certain rebatable dividends paid by SAIL and [Phoenix] to their shareholders after October 1992.

11. In making those cost base reductions, the Commissioner has incorrectly determined that certain dividends paid out of profits that were not realised until after October 1992, and which at October 1992 had not been recorded in any profit accounts of SAIL or [Phoenix], nevertheless represented dividends paid from profits derived by SAIL and [Phoenix] prior to the deemed acquisition date in October 1992 of the shares in those companies held by [the Holding Company] for the purposes of applying subsections 160ZK(5) and subsections 110-55(7).’

28 On 23 February 2000 the Commissioner disallowed the appellant’s objection to the amended assessment. The reasons provided by the Commissioner adopted a construction of s 160ZK(5) that applied a broad meaning to the word derived to include any unrealised profit. In so doing, the Commissioner relied upon a passage from the joint judgment of Rich, Dixon and Evatt JJ in Evans v Deputy Federal Commissioner of Taxation (S.A.) [1936] HCA 2; (1936) 55 CLR 80 at 101, where their Honours said that ‘[t]he word derived does not connote that the profit must be a realised profit’.

29 The Commissioner supported that construction of s 160ZK(5) by reference to part of the Explanatory Memorandum to the Taxation Law Amendment Bill (No. 2) 1994, which described the proposed subsection as addressing profits retained in the company at the time the shareholding was acquired, notwithstanding that the profit was unrealised, and also by reference to the following paragraphs thereof:

‘4.2 The amendment will prevent a controller of a company or an associate of a controller from being able to generate a capital loss on the disposal of shares in the company in circumstances where the controller or associate does not suffer an economic loss to the extent of that capital loss.

4.3 Under the current law, a capital loss could be generated in relation to the disposal of shares in a company where there is no equivalent economic loss. This could arise where the shares are sold after the pre-acquisition profits have been distributed in the form of rebatable dividends. Pre-acquisition profits, in relation to a shareholding in a company, are profits retained in a company at the time the shareholding was acquired.’

30 The Commissioner concluded as follows:

‘The deemed cost bases of shares held by [the Holding Company] in both SAIL and [Phoenix] for the purposes of section 160ZZS were calculated using the estimated Shareholders Equity of both companies (where increases in the value of the investments were recognised), it would be reasonable to conclude that [the Holding Company] had not suffered an economic loss to the extent to which it had received rebatable dividends that can reasonably be taken to be attributable to the unrealised (but subsequently realised) profits.’

31 The Commissioner construed the words could reasonably be taken to be attributable to profits...derived in s 160ZK(5)(b) as implying a so-called reasonable person test for resolving whether the rebatable dividends declared by SAIL and Phoenix in favour of the Holding Company were attributable to profits derived by SAIL and Phoenix prior to the merger date. That test was asserted by the Commissioner to fortify the conclusion that subs 160ZK(5) applies to rebatable dividends that are attributable to unrealised as well as realised profits.

The proceedings conducted before the primary judge

32 The principal contentions advanced by the appellant before the primary judge, were similar to those propounded in this appeal, and were as follows:

(i) the reference in s 160ZK(5)(b) to profits that were derived by the company before the holder acquired the RDA share does not apply to unrealised increases in the value of assets;

(ii) that part of the above statutory phrase profits that were derived should be construed as referring to ‘gains that have come home and are available for distribution’; and

(iii) even assuming that unrealised capital accretions in the market value of assets of a non-current nature may be characterised as profits derived prior to the merger date, the dividends paid by SAIL and Phoenix to the Holding Company could not reasonably be taken to be attributable to such profits.

33 The Commissioner responded to the effect that for the purposes of s 160ZK(5) of the Tax Act, it was possible for a distribution to be paid out of profits that were realised after the merger date and be reasonably taken to be attributable to profits that were derived before the merger. Thus the Commissioner contended that the unrealised accretions in the value of the Bridge Street properties of SAIL, and of the share portfolio of Phoenix, for the purpose of s 160ZK of the Tax Act, were profits derived by those companies prior to the merger date, notwithstanding that the capital assets the subject of such accretions were realised subsequent to the merger. That contention, upheld by the primary judge, represents the essence of the dispute in the present appeal.

34 As noted earlier the primary facts recorded above were not in dispute before the primary judge, and it was common ground that at all material times, pars (a), (c) and (d) of s 160ZK(5) were satisfied. Consequently, the issue between the parties, below and on appeal, was whether the dividends paid by SAIL and Phoenix to the Holding Company after the merger date could reasonably be taken to be attributable to profits that were derived by the [Holding Company] before the merger date, within the meaning of s 160ZK(5)(b) of the Tax Act. Senior counsel for the Commissioner described the principal issue raised in the proceedings below as in effect having two components, one of construction of the statutory expression profits that were derived...before the Holding Company acquired its shares in SAIL and Phoenix, and the other one of fact, namely whether the dividends received by the Holding Company from SAIL and Phoenix could reasonably be taken to be attributable to unrealised profits accrued as at the deemed acquisition date. We observe that the statutory word is not of course accrued but derived.

The primary judge’s reasons for dismissing the appellant’s appeal against the respondent’s objection decision - some initial observations thereon

35 It is appropriate to describe in some detail the carefully framed and comprehensive reasons for judgment of the primary judge the subject of the present appeal. The primary judge referred at the threshold of her reasoning to the circumstance that the reference to profits in s 160ZK(5) is unqualified. As a matter of plain English, the primary judge considered that there was no apparent reason why the same should not be taken to mean or include both realised and unrealised profits, and her Honour first pointed to the observation cited above from Evans. The primary judge acknowledged that the legislative purpose of s 160ZK was ‘highly relevant’ to the enquiry, and referred to the Explanatory Memorandum already partly extracted, and to the following passage thereof:

‘...a capital loss that would otherwise be derived by a controller of a company ... on the disposal of any share in the company will be reduced by any distribution made by the company to the controller ... that is a rebatable dividend paid out of pre-acquisition profits.’

36 The primary judge reproduced the following illustration of the operation of the legislation appearing in the Explanatory Memorandum, being an operation where ‘... a capital loss is generated where there is no equivalent economic loss’:

‘4.4 ...

Company X acquired all the shares of company Y for their market value of $10,000. At the time of acquisition of the shares, the balance sheet of company Y was as follows:

Share Capital $ 2,000
Retained profits $ 8,000
$10,000

Assets $10,000

Company Y continued business operations over the next four years. During this period, it distributed all of its current earnings as well as the retained profits. Company X then disposed of the shares in company Y for $2,000.

4.5 The dividends paid by Company Y to company X qualified for the dividend rebate under section 46 of the Act. Consequently, no company tax was paid on those dividends. Moreover, company X has recovered the full amount of its investment of $10,000 in company Y in the form of dividends ($8,000) and disposal consideration ($2,000). Nevertheless under the current law, company X may claim a capital loss of $8,000. This is the difference between the cost of the shares ($10,000) and the disposal consideration ($2,000).

4.6 The anti-avoidance provisions of Part IVA of the Act could apply where there is a scheme by way of or in the nature of dividend stripping or a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. However, it should be the general rule that a capital loss should not be able to be claimed where the result of the course of action is that there is no economic loss to the taxpayer.

4.7 The amendments to the law will have the effect that a capital loss cannot be claimed by company X in the circumstances shown in the example.’

The hypothetical accounting in the above example acknowledged by implication that the fund ‘retained profits’ was something capable of being distributed to the purchaser of the shares.

37 Thereafter the primary judge referred to the statement in the Explanatory Memorandum that a scheme amounting to dividend stripping may attract the anti-avoidance provisions of Part IVA, and the further reference to a general rule that:

‘... a capital loss should not be able to be claimed where the result of the course of action is that there is no economic loss to the taxpayer. The amendments to the law will have the effect that a capital loss cannot be claimed by company X in the circumstances shown in the example.’

38 The conclusion of the primary judge as to the operation of s 160ZK(5) was in the following terms:

‘Its effect is to reduce the capital loss by the amount of the tax-free dividend to the extent that the dividend is attributable to profits derived by the company before the taxpayer acquired the share. This purpose does not seem to require that any distinction be drawn between realised and unrealised profits.’

We would observe that the notion of ‘unrealised profits’ is potentially of a different dimension to the s 160ZK(5) notion of ...profits...derived.

39 In addition to Evans, her Honour cited passages from a number of well known authorities bearing upon the meaning of profits enunciated in fiscal contexts. No definition of the word profits is contained in the Tax Act. It has been a word of extensive controversy in fiscal litigation. Its fiscal application ultimately falls to be determined in the context of the Tax Act in which it appears, and otherwise according to the general law. There are many authorities which have construed that word in other fiscal legislative contexts, both in Australia and the United Kingdom. Initial reference was made by her Honour to the frequently cited dictum of Fletcher Moulton LJ in Re The Spanish Prospecting Co Ltd [1911] 1 Ch 92 at 98, as follows:

‘The word "profits" has in my opinion a well-defined legal meaning, and this meaning coincides with the fundamental conception of profits in general parlance, although in mercantile phraseology the word may at times bear meanings indicated by the special context which deviate in some respects from this fundamental signification. "Profits" implies a comparison between the state of business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates.’

That dictum seems to imply that such a comparison is to be determined by prevailing accounting principles and standards, to better enable the comparison to be determined conveniently by accountants.

40 The primary judge acknowledged the observation of Gibbs CJ (with whose reasons the other members of the High Court agreed) in Federal Commissioner of Taxation v Slater Holdings Limited [1984] HCA 78; (1984) 156 CLR 447 at 460, to the effect that the meaning of profits as postulated in Spanish Prospecting is more useful as a guide than as a rule of general application, and that each case must depend on its own circumstances. In particular, of course, those circumstances may be constrained by the context or purport of applicable legislation. Reference was also made by the primary judge to QBE Insurance Group Limited v Australian Securities Commission (1992) 38 FCR 270, where the observations in Spanish Prospecting were considered by Lockhart J. His Honour described in QBE the notion of profits as an elusive concept, and further said (at 286) as follows:

‘Profits refer to a comparison between the state of a business at the beginning and end of the relevant financial period. It is the amount of gain made by the business during the year or the net balance of all gains earned and losses incurred during a relevant accounting year... The statement of principle that profit should be calculated by reference to changes in the value of assets of a business during the relevant financial period in Spanish Prospecting is as relevant today as it was in 1911 when it was expounded.’

The issue in QBE was not of course fiscal in character. We will return later to other passages in QBE.

41 The relevance of context, as acknowledged in the passage from Spanish Prospecting set out above, to the particular enquiry before a court was emphasised by the primary judge, who next referred to the dictum of Higgins J in Webb (Commissioner of Taxes (Vic)) v Australian Deposit and Mortgage Bank Ltd [1910] HCA 48; (1910) 11 CLR 223 at 241, where the following appears:

‘It does not follow, however, that because the difference between assets and liabilities is in some cases to be treated as profits, it is to be so treated in all cases... The truth is, that the meaning of "profits" is not rigid and absolute; it is flexible and relative – relative to each company and in ascertaining the meaning of the word in any context, we must consider the whole context.’

That dictum emphasises the need for examination of the particular circumstances of each individual case, a proposition which was common ground between the parties.

42 The primary judge next observed that in the context of the proceedings before the Court, a material consideration is the meaning of the word profit as used in corporations law, and in particular the provisions thereof relating to the payment of dividends. The primary judge cited the following further passage from the judgment of Lockhart J in QBE (at 286):

‘Thus dividends may be paid out of all assets of a company which are profits in a legal sense. When dividends are declared there must be profits to meet them. When s 201 uses the words "payable... out of profits" it does not require the existence of a separate fund from which the profits are to be extracted for the purpose of the payment of dividends. All it requires is that at the date of declaration of the dividend the company’s profit and loss account must disclose profits out of which the dividend can be paid.’

The reference above to ‘profit and loss account’ implicitly requires recourse to applicable accounting principles. The following two further passages from the judgment of Lockhart J in QBE at 287 are also relevant:

‘The position with respect to unrealised accretions to the value of assets has been considered, though to a limited extent, in certain of the authorities. It has been held that unrealised accretions to the value of a company’s capital assets may be available for dividend where it is clear (and, by inference, only where it is clear) that the accretion in value is of a permanent character...

... the authorities attach the rider that capital profits of this kind cannot be utilised for payment of a dividend unless its paid up capital is intact. There must upon a balance of account be an accretion to the paid-up capital.’

His Honour’s reference to the requirement that an accretion have a permanent character was emphasised by the appellant.

43 The primary judge made the observation, in relation to the first of the foregoing passages from QBE, that Lockhart J was there drawing a distinction between profits from which the dividend is to be derived, and profits from which it must be paid, and in that context her Honour made further reference to the joint judgment of the High Court (Rich, Dixon and Evatt JJ) in Evans, where in the context of an issue as to whether a taxpayer should be assessed on the market value of certain shares derived, pursuant to a section of the former Income Tax Assessment Act 1922 (Cth) to the effect that distributions out of profits from any source were assessable, their Honours stated (at 101) as follows:

‘In the first place, the fact that the shares contain no profit on the sale of the leases does not mean that they represent capital and not profit of the company. Actually they represented surplus assets, that is, assets not required to make good issued share capital. This appears from the last preceding balance sheet. In the second place, sec 16(b)(i)(1) brings into charge all dividends and distributions out of profit, whatever be the nature of the profit. The word "derived" does not connote that the profit must be a realized profit. It is enough at least if it is an ascertained profit, ascertained by a proper account. Under the articles, the 5s. 6d. contained in the share could not lawfully be distributed, except as a dividend satisfied by specific assets, and the dividend must be out of profits. The meaning of profits in sec 16(b)(i)(1) is no narrower, and the state of the company’s affairs, as disclosed by its balance-sheet, permitted such a dividend. It follows that the whole amount of the 5s. 6d. per share should be included in the appellant’s assessable income.’

The reference to ascertained by a proper account appears to form an important component of their Honours’ reasoning, and reflects the traditional emphasis upon ascertainment of profit by applicable accounting principles. The litigation in Evans concerned a shareholder in a company who had received from that company a distribution of shares held in another company. The former company had acquired the shares in consideration of the assignment of certain leases. The High Court rejected the taxpayer’s argument to the effect that the former company had derived no profit because the distribution of the shares constituted a mere distribution of capital. The source of the distributed capital, as disclosed by its balance sheet, was the critical factor in the case.

44 The above cited passage from Evans was accepted by the primary judge as material, not only for its observations on the nature of profits, but also in relation to the meaning of derived, a meaning not spelt out in the Tax Act. The primary judge observed that derived is not a technical word, and may be paraphrased as obtained, or got or acquired (citing thereby Federal Commissioner of Taxation v Clarke [1927] HCA 49; (1927) 40 CLR 246 at 261 per Isaacs ACJ), or as arising or accruing or coming in by way of income, not necessarily actually received (citing Tindal v Federal Commissioner of Taxation [1946] HCA 26; (1946) 72 CLR 608 at 642), and as not necessarily equivalent in meaning to ‘earned’, but rather in its ordinary sense... means ‘to draw, fetch, get, gain, obtain (a thing from a source)’ (citing Brent v Federal Commissioner of Taxation [1971] HCA 48; (1971) 125 CLR 418 per Gibbs J at 427). The primary judge also cited Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia Ltd [1938] HCA 69; (1938) 63 CLR 108 at 155, where Dixon J said as follows:

‘Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form.’

45 The primary judge next referred to reported authorities, albeit not decided in a fiscal context, including in particular Australasian Oil Exploration Ltd v Lachberg (1958) [1958] HCA 51; 101 CLR 119 at 133 (Dixon CJ, McTiernan and Taylor JJ) and Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] Ch 353 (Buckley J as he then was) in support of the view that ‘the term profits should be given a broad meaning and that the term includes capital profits, both realised and, in some circumstances, unrealised’. Senior Counsel for the appellant sought to make the point that the primary judge did not identify the circumstances controlling resolution of the present issue. In any event, in whatever form they might take, the primary judge continued, ‘it is important to realise that profits (realised or unrealised) are not created by the way in which they are treated in company accounts’, and further that ‘[a]ccounts describe the substance of what is happening with the company’s capital, income and assets. They may do it more or less well’. So much was said by the primary judge to have been recognised in the reasons for decision of Latham CJ in Dickson v Federal Commissioner of Taxation [1939] HCA 42; (1940) 62 CLR 687 at 705, where his Honour said:

‘The relevant sub-section evidently contemplates that profits may arise from a revaluation of assets. It is, I think clear that profits cannot be produced, caused or brought about by a mere process of revaluation. But, though revaluation cannot create profits, it may reveal or disclose profits.’

46 We would add in the present context the following further passage from the reasons for judgment of the majority of the High Court in Lachberg at 133:

‘It is enough on this point to say that a company has no capital profits available for dividend purposes unless upon a balance of account it appears that there has been an accretion to the paid-up capital.’

We would also extract for completeness the following passage from the reasons for judgment of Buckley J in Dimbula at 372:

‘As a general rule only that which could be distributed in dividends can be capitalised... the exception to this general rule [being] that a sum standing to the credit of a share premium account or of a capital redemption reserve fund may not be distributed, except as provided by... the Companies Act... but may be capitalised... pursuant to the provisions of that Companies Act as there set out.’

47 In the context in which the primary judge stated that ‘[i]t is clear that dividends can only be declared out of profits’, her Honour also referred to a passage in the decision of the High Court in Industrial Equity Ltd v Blackburn [1977] HCA 59; (1977) 137 CLR 567 per Jacobs J at 580 which reads as follows:

‘The special distribution needed to be made out of profits earned up to a date which was either the date of the declaration of the special distribution as a dividend or the date of the making of that distribution... I am satisfied that the relevant profits earned must be profits in the company itself, that undistributed profits from subsidiaries cannot as such be taken into account. I do not wish to add anything to the reasons which Mason J has given for this conclusion.’

Jacobs J acknowledged elsewhere in the course of his reasons the correctness of the reasoning of Buckley J in Dimbula at 133.

48 Moreover in the reasons for judgment of Mason J (as he then was) in Industrial Equity, with whose reasons Stephen, Murphy and Aickin JJ agreed, there appears the following (at 578):

‘Underlying the rule that dividends are payable out of profits is the notion that the profits in question have already accrued in the company and that upon the declaration of a dividend by the directors or the company in general meeting there immediately springs into existence, fully armed so to speak, a debt owing by the company to each shareholder... However, it is accepted that a company may declare a dividend which is to be paid or payable to shareholders at some future date. This has evidently inspired the thought that the requirement as to the existence of profits is satisfied if they exist at the time stipulated for payment. It is incorrect.’

49 The appellant referred the primary judge to the High Court’s decision in Read v Commonwealth [1988] HCA 26; (1988) 167 CLR 57, where the circumstances involved social security entitlements, and the issue arising was whether a pensioner had earned, derived or received income which should be taken into account as a basis for reducing her pension. That case concerned an issue as to whether a pensioner’s receipt of additional units under a commercial unit trust scheme, in circumstances where the trust’s assets were periodically revalued, and any resulting accretion in value distributed to beneficiaries by the issue of the additional units, was a receipt of income under the Social Security Act 1947 (Cth). Section 18 of that legislation defined income as:

‘any personal earnings, moneys, valuable consideration or profits earned, derived or received by that person for his own use of benefit by any means from any source whatsoever, within or outside Australia...’

50 The question in Read, whether the additional units distributed to a citizen constituted profits was appraised in the joint judgment of Mason CJ, Deane and Gaudron JJ (at 66) in terms of whether they resulted in consequential financial gain to the appellant. Answering that question in the negative, their Honours said:

‘In our opinion a mere increase in the value of an asset does not amount to a capital profit. A profit connotes an actual gain and not mere potential to achieve a gain. Until a gain is realised it is not "earned, derived or received". A capital gain is realised when an item of capital which has increased in value is ventured, either in whole or in part, in a transaction which returns that increase in value.’

51 The primary judge characterised that dicta in Read as ‘fundamentally and relevantly different from the context in which the issues in this case must be decided’, for the following reasons :

‘In a case where the issue was whether there should be a reduction in the appellant’s pension if she had acquired additional income it is not surprising that the Court should have focused on actual financial gain to the appellant. The position here is the opposite. The purpose of the statutory provisions under consideration here is discussed above... As that discussion indicates the purpose of the provisions is to preclude a taxpayer from claiming a capital loss where there is no economic loss to the taxpayer. The issue is whether at the Merger Date there existed profits to which subsequent dividends ‘could reasonably be taken to be attributable’ and by recourse to which the purchase price could be recouped. In relation to this issue the decision in Read does not assist. The legislative purpose would, in my view, be defeated by applying the analysis in Read.’

The Commissioner supported, but the appellant disputed, the dictum of the primary judge that the decision in Read was of no assistance. It may be noted that the focus of the High Court in Read was upon the profits...derived component of the statutory definition of income contained in the Social Security Act, and reference was made, in the course of the reasons of the majority, to the passages in both Spanish Prospecting and Slater Holdings discussed above.

52 On the basis of the evidence placed before the primary judge, her Honour concluded as follows:

(i) there were profits, realised and unrealised, available to both SAIL and Phoenix as at the merger date, which were ‘reflected in the market value cost base attributed to their shares’;

(ii) those profits were subsequently, to the extent necessary, ‘realised and distributed to the shareholder in the form of dividends (or distributions treated as dividends). They were ‘profits derived by the companies before [the Holding Company] acquired their shares’;

(iii) the submission of the appellant, namely, that even if increases in the value of the Bridge Street properties could be identified as profits that were derived within s 160ZK(5) it was not reasonable to attribute the source of dividends paid thereafter to profits made before the acquisition of SAIL when the Bridge Street properties substantially declined in value after the merger, did not address the issue at hand;

(iv) nor did the further submission of the appellant, to the effect that the source of any profit was the merger agreement, or that there were significant fluctuations in the value of the Phoenix shareholdings until the same became fixed by realisation after the merger, address the issue;

(v) at the time of the merger, the critical facts in relation to SAIL were that the value of the Bridge Street properties was significantly greater than the historical cost, and there was an unrealised profit which was recognised and adopted at the time of the merger, the value of which was protected by the terms of the Merger Agreement and the Bridge Street properties agreement; in those circumstances, the profit realised on the sale of the Bridge Street properties was directly attributable to the unrealised profit that existed at the time of the merger, and the circumstance that a lesser purchase price was paid by a third party was irrelevant;

(vi) similarly in relation to Phoenix, there was an unrealised profit that was recognised at the time of the merger, being a profit to which the dividends were attributable, even if the fund out of which the dividends were subsequently paid was different, in that it consisted of profit since realised.

53 In upholding the Commissioner’s decision in disallowing the appellant’s objection to the Commissioner’s assessment, the primary judge concluded as follows:

‘The evidence in the case of both SAIL and Phoenix indicates that the profits that were unrealised at the merger date were realised after that date. Those profits, together with profits derived after the Merger Date, were distributed to the shareholder, [the Holding Company]. Consequently the dividends paid by the companies can to the relevant extent be attributed to profits derived by the companies before the merger date. Section 160ZK therefore applies and gives rise to a rebatable dividend adjustment which, as explained previously has an effect on the cost base of the shares. This result is consistent with the policy of the legislation. Any other result would allow [the Holding Company] (and consequently the [appellant]) to claim a capital loss in circumstances where it had not suffered a financial loss.’

The learned primary judge’s statement that ‘the dividends paid...can to the relevant extent be attributed to profits derived by the companies before the merger date’ may be taken to compress the relevant words of s 160ZK(5)(b) namely, an amount..., being the whole or part of the distribution, could reasonably be taken to be attributable to profits that were derived by the company before the holder acquired the RDA share.

The submissions of the appellant

54 The submissions of senior counsel respectively for the appellant and respondent comprehensively addressed the documentary material and other circumstances of the appeal outlined above, the legislation and authorities, and the findings and conclusions of the primary judge.

55 The principal submission of the appellant was that although the primary judge considered that the critical word profits, appearing in the context of s 160ZK(5) of the Tax Act, may include accretions in the value of assets, both realised and in some circumstances unrealised, the primary judge did not identify or define the circumstances in which an unrealised gain is capable of being treated as a profit. Instead, so the submission continued, the primary judge equated all accretions in value of assets above cost of acquisition thereof with the notion of profits appearing in s 160ZK(5), whereas an unrealised accretion in value was submitted by the appellant to only constitute or qualify as profits in circumstances where it is demonstrated that such accretion in value is of a permanent character (as per the dictum in QBE at 287 cited earlier), and does not constitute a mere potential for derivation of gain. That submission, broadly speaking, relates to the principal area of controversy outlined by the appellant.

56 In encapsulating its central submission in that way, the appellant both acknowledged and outlined the following propositions as to the notion of profits established by the authorities already cited above:

(i) dividends can only be declared out of profits (Industrial Equity);

(ii) the word profits connotes a gain or increase measured by comparison of the financial position of an entity at different points in time (Slater);

(iii) profits cannot be produced, caused or brought about by a mere process of revaluation (Dickson);

(iv) the general law notion of profits may be given a broad meaning, which may include capital profits both realised, and in some circumstances, unrealised (Lachberg, Dimbula).

The review of the authorities already undertaken indicates support for those propositions. The notion of profit enunciated in Slater largely reflects that made earlier in Spanish Prospecting. Moreover the Slater formulation tends to reflect the emphasis made in Evans of the need for ascertainment by proper accounting. The notion emerging from Executor Trustee reflects the importance of identification of realised or realisable gains having come home during the accounting period.

57 The appellant contended that the primary judge did not define the circumstances in which an unrealised gain is capable of being treated as a profit, and further did not satisfactorily identify any such circumstances yielded by evidence in the present proceedings. Instead, so the appellant contended in that regard, her Honour purportedly equated all accretions in value with profits, and thereby fell into error. As has been foreshadowed already, the appellant attributed perhaps predominant emphasis, in the context of the evidence concerning the financial circumstances and results of SAIL and Phoenix respectively, to that aspect of the dictum of Lockhart J in QBE to the effect that unrealised accretions are only available for characterisation as profits where ‘it is clear (and, by inference, only where it is clear) that the accretion in value is of a permanent character’. At the merger date, so the submission of the appellant continued, neither the unrealised accretion in the market value of the Bridge Street properties, nor the unrealised accretion in the market value of the Phoenix share portfolio as recorded in the merger completion accounts, was permanent. Instead those accretions represented merely the potential for the time being to achieve gain. Reliance was partly placed by the appellant, in the context of that submission, upon Read in addition to QBE. Though as already indicated, the context in Read related to disqualifying provisions under the Social Security Act, the context of the authorities cited in the judgments of the High Court in Read related, at least for the most part, to relevant concepts of income. The observation of the majority of the High Court in Read (Mason CJ, Deane and Gaudron JJ) (at 67) that ‘a mere increase in the value of an asset does not amount to a capital profit...[a] capital profit is realised when an item of capital which has increased in value is ventured, either in whole or in part, in a transaction which returns that increase in value’ cannot be dismissed from the application in principle to the issues arising in the present appeal because of the different legislative contexts.

58 The appellant submitted that the Bridge Street properties were subject to the vagaries, or value trends, of the commercial property market in Sydney, which had experienced decline in values below that prevailing at the merger date, and that the value of the Phoenix share portfolio rose or fell according to the daily market forces of ASX trading throughout the corresponding period. It was submitted that fluctuations in the value of the Bridge Street properties, and in the ASX listed share portfolios, periodically occurred, until their respective values crystallised by the realisation of the assets about five years after the merger date. The Phoenix shareholdings were valued on a monthly basis, and the reports disclosed monthly variations in the value of the portfolio as a whole, as well as of individual shareholding components. In the light of that evidence, the appellant submitted that on no view could the accretions and reductions in values that did occur be characterised as permanent in character, nor were they so regarded or treated by Phoenix, and no dividends were declared in respect of any accretions in value until accretions were ‘clearly permanent, namely realised’. Consequently, so the appellant’s submissions concluded, there was no profit properly attributable to profits derived prior to the merger as propounded by the Commissioner in respect of SAIL and Phoenix.

59 The appellant challenged the conclusion of the primary judge as to the absence of any distinction drawn by s 160ZK between realised and unrealised profits and pointed to certain passages in the Explanatory Memorandum to the Taxation, Laws Amendment Bill headed ‘General Outline and Financial Impact’, and its sub-heading ‘Capital gains tax: Rebatable dividends out of pre-acquisition profits’, where the following appears:

‘Amends the CGT provisions so that a capital loss that would otherwise be incurred by a controller of a company or an associate of the controller on the disposal of any share in the company will be reduced by any distribution made by the company to the controller or the associate that is a rebatable dividend paid out of pre-acquisition profits’ (page 3).

In that accompanying document (Chapter 3) headed ‘Capital Gains Tax-Payment of rebatable dividends from certain share premium accounts and revaluation reserves’, and under the sub-heading ‘Explanation of the amendments’, the following appears:

‘Revaluation reserves

3.19 A revaluation reserve, or part of a revaluation reserve, to which the proposals apply is a reserve representing profits on the revaluation of an asset where, if the company had disposed of the asset immediately after the revaluation:

• any profit that would have arisen on the disposal of the asset would have been included in the company’s assessable income or any loss would have been allowed as a deduction from assessable income;

• the CGT provisions of Part IIIA would have applied, or would have applied but for a roll-over relief available under Division 17 of that part...’.

Under Chapter 4 of the Explanatory Memorandum headed ‘Capital Gains Tax-Rebatable dividends out of pre-acquisition profits’, and under the sub-heading ‘Purpose of the amendments’, the following appears:

‘4.2 The amendment will prevent a controller of a company or an associate of a controller from being able to generate a capital loss on the disposal of shares in the company in circumstances where the controller or associate does not suffer an economic loss to the extent of that capital loss.

4.3 Under the current law, a capital loss could be generated in relation to the disposal of shares in a company where there is no equivalent economic loss. This could arise where the shares are sold after the pre-acquisition profits of the company have been distributed in the form of rebatable dividends. Pre-acquisition profits, in relation to a shareholding in a company, are profits retained in the company at the time the shareholding was acquired.’

Thereafter the Explanatory Memorandum set out paragraphs already extracted above. The appellant contended that the primary judge failed to observe or apply that extrinsic material, which was said by the appellant to be inherently referable to pre-acquisition profits that had been derived, and that were identifiable.

60 The appellant next addressed the legislative context of Division 3 of Part IIIA of the Tax Act. It was submitted by the appellant that account should be taken of the circumstance that s 160ZLA, formerly part of Division 3 and contemporaneously enacted with s 160ZK but subsequently repealed by s 32 of Act No 170 of 1995, addressed the subject of payment of rebatable dividends from revaluation reserves. It was pointed out that not only was specific provision made by s 160ZLA in relation to rebatable dividends from revaluation reserves, but that the same used distinctly different language, in that it specifically addressed profits arising from the revaluation of the asset, and any profit that would have arisen on the disposal of an asset. Thus it was submitted that the Legislature had previously drawn a distinction in language by the previous provisions of ss 160ZK and 160ZLA when read together, between the expressions profits arising or that would have arisen contained in s 160ZLA, and the expression profits that were derived contained in s 160ZK, and therefore that those respective expressions could not have been previously intended to have the same meaning. It could not be said rationally, so the submission continued, that the removal of s 160ZLA was intended to change the meaning of s 160ZK, the latter continuing to address a revaluation reserve (or part thereof) representing profits on the revaluation of an asset where, if the company had disposed of the asset after the revaluation, any profit arising on the disposal of the asset would have been included in the company’s assessable income or given rise to a taxable capital gain. It was further submitted by the appellant that the former s 160ZLA had been concerned with profits that were unrealised, and not therefore derived. By way of contrast, it was submitted by the appellant that s 160ZK has always been concerned only with realised or retained profits.

61 Section 160ZLA was replaced by an amending statute containing s 46H(1)(d) of the Tax Act. Consistently with the approach previously adopted in s 160ZLA, so it was submitted by the appellant, s 46H(1)(d) applies to profits from the revaluation of assets of the company that have not been disposed of by the company, and is not directed to derived profits. In fact, so the appellant’s submissions continued, if profits have been derived, it is apparent that s 46H does not apply to prevent a dividend being rebatable under ss 46 or 46A. It was further submitted that s 46H(1)(d), when read with s 46G, makes it apparent that whereas s 160ZLA had adopted a proportional approach in determining whether there was to be a rebatable dividend adjustment, s 46G adopts a different approach, and looks to the accounts against which the taxpayer corporation has chosen to debit the dividend distribution. That approach was said to reflect the principle that a company is entitled to choose from where, and when, it declares dividends. In the present case of course, the dividends which SAIL and Phoenix did ultimately declare were so declared from retained and operating profits, and not from an unrealised profits reserve.

62 The appellant further submitted that the former s 160ZLA addressed the circumstance of a revaluation reserve wholly or partly representing profits on the revaluation of an asset where, if a company had disposed of the asset immediately after revaluation, any profit arising on the disposal of that asset would have been included in the company’s assessable income, or given rise to a capital gain. It was therefore concerned, so the appellant’s submission further emphasised, with ‘profits that were by their nature unrealised’, and thus profits not derived in the normal sense. By way of contrast, s 160ZK remains concerned with profits that have been derived.

63 The dictum of the primary judge that the ‘purpose of the provisions is to preclude a taxpayer from claiming a capital loss where there is no economic loss to the taxpayer’ was contended by the appellant to ‘take a few words’ from the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 2) 1994, which introduced s 160ZK(5), out of context, and in any event to ignore the words of the statute. The appellant emphasised that the Explanatory Memorandum cannot of course replace the words of the section as enacted, which do not provide that a capital loss cannot be claimed where there is no economic loss to the taxpayer. On the contrary, so the appellant’s submission continued, s 160ZK(5) provides that the cost base of a share is to be reduced if an amount (being the whole or part of a distribution) could reasonably be taken to be attributable to profits that were derived by the company before the company acquired the RDA share, and contemplates, consistently with commercial reality, that there may be amounts later recovered by a shareholder that may have the effect of reducing the economic loss of the taxpayer for the time being, yet would not satisfy s 160ZK(5), because at the time of the acquisition of the share, the conditions for the application of s 160ZK had not been satisfied.

64 The appellant further submitted that the illustration in the Explanatory Memorandum referred to above provides the context in which the statement concerning no economic loss was made, together with an indication of the kind of situation intended to be caught by s 160ZK(5). In that example, at the date of acquisition (or deemed acquisition), there were profits that were derived in the form of so-called retained profits. In the present case, it was emphasised moreover that the companies continued business operations over the ensuing four years and distributed current earnings as well as retained profits. That those distributions over that period were attributable, in part, to retained profits, was duly acknowledged by the appellant. It was submitted that the view that the phrase ‘profits that were derived’ in s 160ZK refers only to retained profits is confirmed by the fact that the Explanatory Memorandum defines pre-acquisition profits as retained profits, a matter said to have been overlooked by the primary judge.

65 The appellant next submitted that the alleged misunderstanding on the part of the primary judge of the concept of economic loss, in the context of s 160ZK(5)(b) of the Tax Act, was illustrated by her Honour’s view that a profit was derived simply if the market value of investments had increased after the date of acquisition, being an approach which necessarily involved the proposition that a loss is suffered if the value of investments declines after acquisition. If it be the case that a loss is suffered when the market value of investments decline, so the appellant’s submissions continued, there would have been an economic loss sustained by the Holding Company which the primary judge has implicitly ignored in the course of her reasoning. The asserted fallacy in that approach was said to be illustrated by the following examples, formulated by the appellant:

‘Example 1: if shares were acquired in year 1 which included an unrealised gain arising on the revaluation of certain assets, her Honour would have concluded that a profit was derived before acquisition. However, if immediately after the acquisition, the assets lost 50% of their value, stayed at that value for the next 20 years, and then subsequently the value of the assets returned to the value at acquisition, the primary judge would have held that the taxpayer had suffered no economic loss.

Example 2: if shares were acquired in year 1 at a price which included an unrealised gain arising on the revaluation of certain assets, her Honour would have concluded that a profit was derived before acquisition. However if immediately after acquisition, the assets lost 50% of their value, and the position of the company was restored by way of gift, her Honour would have determined that the taxpayer had suffered no economic loss.’

66 It was contended by the appellant that in each of the two examples, the conclusion reached as a result of the application of the construction of the Tax Act, as found by the primary judge, demonstrates the error in her Honour’s approach. In each of the two examples, the taxpayer did obviously suffer economic loss. The errors exemplified were said to arise from the fact that her Honour took the phrase ‘no economic loss to the taxpayer’ out of context and ignored the literal words of the statute; the cost base of an asset was not subjected to reduction, according to an implicit outcome of the reasons of the primary judge, when a taxpayer suffered no economic loss over the period during which the taxpayer held the asset. The appellant emphasised that the legislation requires that there be ‘profits that were derived by the company before the holder acquired the RDA share’. The appellant’s submission was of course that there were no such profits actually derived in the events which happened.

67 The word derived in relation to profits, where used in s 160ZK(5)(b), is not of course an expression defined by the Tax Act. Interpretations in different curial contexts have been as follows:

(i) obtained, got in or acquired: Federal Commissioner of Taxation v Clarke [1927] HCA 49; (1927) 40 CLR 246 at 261 (Isaacs ACJ);

(ii) arising or accruing or coming in by way of income, not necessarily actually received but ordinarily that is the mode of derivation: Tindal v Federal Commissioner of Taxation [1946] HCA 26; (1946) 72 CLR 608 at 624 (Starke J);

(iii) to draw, fetch, get, gain, obtain: Brent v Federal Commissioner of Taxation [1971] HCA 48; (1971) 125 CLR 418 at 428 (Gibbs J citing from the Oxford English Dictionary);

(iv) gains that have, during the relevant period, come home to the taxpayer in a realised or immediately realisable form: Commissioner of Taxes (SA) v Executor Trustee & Agency Co of South Australia Ltd [1938] HCA 69; (1938) 63 CLR 108 at 155 (Dixon J).

68 The appellant thus submitted that the critical word derived in s 160ZK(5)(b) should take its meaning from and subject to the proper interpretation therein of profits, and for that purpose, should be construed in the context of the other provisions of the Tax Act simultaneously enacted, and in particular the subsequently repealed s 160ZLA. It was submitted by the appellant by way of conclusion that s 160ZK(5) could only apply to profits already realised and retained in a company at the time of acquisition by the holder of the RDA share referred to in the subsection. Furthermore it was submitted by the appellant that in construing the s 160ZK(5) phrase profits that were derived by the company, and in particular the word derived, the distinctions drawn by the primary judge ‘between the profits from which the dividend is to be derived and the profits from which it must be paid’ and ‘between the source from which the dividend is paid and the derivation of that source’ are not relevant, since s 160ZK(5) is directed at determining whether there were profits that were derived, and if so, to then determining whether there is a connection between a particular distribution made, and what have been identified as the particular profits that were derived.

69 The issues here arising are concerned with unrealised accretions in the value of particular assets as at 8 October 1992, in the case of SAIL the Bridge Street properties, and in the case of Phoenix, the value of the share portfolio as at the same date. The appellant submitted that neither could be said to have come home in a realised or immediately realisable form. Moreover neither was treated by the Royal & Sun Alliance Group as available for distribution as dividends. On that footing, the appellant submitted that upon no view could the unrealised accretions in value be described as profits that were derived by the company within s 160ZK(5).

70 Accordingly the appellant submitted that the proposition that profits were derived at the time of the merger was contradicted by the objective circumstances that profits were not in reality derived until the Bridge Street properties, or the shares held by Phoenix, were sold. The appellant’s case was that the sums in dispute could not reasonably be taken to be attributable to profits derived within s 160ZK(5), that is to say, derived before the Holding Company was deemed to have acquired the shares in SAIL and Phoenix. There is a distinction between deriving assessable income and deriving profits, in that the latter normally or generally requires that profits will crystallise in quantification only when sums required to be deducted therefrom have been ascertained.

71 The appellant submitted alternatively that if the unrealised accretions in the values of the investments prior to the merger were profits that were derived, it was not reasonable to attribute the source of each dividend in question to those profits for the following reasons:

(i) the distributions that were made by each company were not attributable to those movements in book value;

(ii) each distribution was wholly attributable to later realised profits;

(iii) post December 1992 operating profits were sufficient themselves to fund the dividends declared post December 1992;

(iv) in relation to SAIL:

(a) although the merger completion accounts accounted for SAIL’s assets at purported market value, the Bridge Street properties declined substantially in value after the merger; and

(b) events after the deemed acquisition of the shares were the source of the profit distributed in the dividend paid on 6 September 1996.

(v) in relation to Phoenix:

(a) the unrealised accretions in the value of the total portfolio was a figure subject to constant variation (including reduction) until fixed by realisation; and

(b)	the unrealised accretion in the value of an individual shareholding within the portfolio was a figure subject to constant variation, including reduction, until fixed by realisation.

The submissions of the Commissioner

72 Counsel for the Commissioner framed the issues which the Commissioner perceived to arise on the appeal as follows:

(i) whether upon the true construction of s 160ZK(5) of the Tax Act, the dividends received by the Holding Company from its subsidiaries SAIL and Phoenix could reasonably be taken to be attributable to profits that were derived by SAIL and Phoenix before the holder, being the Holding Company, was deemed to have acquired the shares in SAIL and Phoenix;

(ii) whether in the context of s 160ZK(5), the expression profits that were derived by the company before the deemed acquisition date included unrealised profits accrued as at that date;

(iii) whether the dividends received could reasonably be taken to be attributable to the unrealised profits accrued as at the deemed acquisition date.

The issues so framed coincide essentially with the structure, as well as the order, of the appellant’s submissions. The words in italics reproduced above pick up of course part of the text of s 160ZK(5). The first and second issues involve essentially the task of statutory construction. The third is more of a factual one to resolve. The threshold rejoinder of the appellant was that those questions posed by the Commissioner ignored the fact that a pre-requisite to the application of the section is that profits be derived; furthermore those issues, so framed by the Commissioner, assumed, contrary to the Tax Act and what Parliament was said to have clearly intended, that unrealised profits, as at the date the Holding Company is deemed to have acquired the shares in SAIL and Phoenix, constituted profits that were derived by the company before the holder acquired the RDA share.

73 Senior counsel for the Commissioner prefaced his response to the appellant’s submissions upon the meaning and operation of s 160ZK(5), and in particular the expression could reasonably be taken to be attributable to profits that were derived, by reference to principles of statutory construction, and submitted that the mischief which s 160ZK was intended by the Parliament to address was initially to be distilled from the objects clause of the relevant subdivision of the Taxation Laws Amendment Act (No 2) of 1994 (Act 82 of 1994), reading as follows:

‘The object of this Subdivision is to remove the capital gains tax advantages of dividend rebate arrangements.’

Reference was made to dictum of Hill J in MLC Ltd v Deputy Commissioner of Taxation (2003) 1996 ALR 502 that ‘...the English language is seldom so clear and unambiguous that only one construction is open’, and his Honour proceeded to emphasise that in recent times, great importance has been attached to context and the process of construction. His Honour cited extensively in that regard from the High Court’s decision in CIC Insurance Ltd v Bankstown Football Club Limited [1997] HCA 2; (1997) 187 CLR 384 per Brennan CJ, Dawson Toohey and Gummow JJ at 408.

74 The Commissioner submitted that the primary judge had correctly identified the mischief addressed by s 160ZK, as illustrated by the example in the Explanatory Memorandum and by her Honour’s reference to the ‘general rule’ concerning ‘no economic loss’. Upon that footing, the Commissioner submitted that it would defeat the legislative intent, and thus not give effect thereto, to construe the legislation as not applying to a rebatable dividend paid out of profits reflected in the purchase price, and cost base, of the shareholding involved in the present context, unless the s 160ZK(5)(b) use of the word derived admitted of no other meaning than that of realised. To read the legislation otherwise, the submission continued, would produce so ‘absurd’, ‘extraordinary’, ‘capricious’ or ‘irrational’ a result as to lead to the conclusion that ‘the legislature could not have intended such an operation and that an alternative interpretation must be preferred’. (see Cooper Brookes (Wollongong) Pty Ltd v Federal Commissioner of Taxation [1981] HCA 26; (1981) 147 CLR 297 per Mason CJ and Wilson J at 320-1.)

75 The Commissioner’s submission continued that it was unnecessary to resort to such reasoning in the present case, because as the primary judge was said to have correctly observed, the reference to profits in s 160ZK(5)(b) is unqualified, and would seem to include, as a matter of plain English, both realised and unrealised profits. However, it is to be kept in mind that the mischief addressed by s 160ZK(5) is not to remove the capital gains tax advantages of all dividend rebates, but only those where the dividend could reasonably be taken to be attributable to profits that were derived by the company before the holder acquired the RDA share.

76 The Commissioner pointed out that the word derived is encountered in the Tax Act in three principal differing contexts, first in relation to the source from which income arises (s 23(p) or the former 23(g)), secondly in relation to the time at which assessable income is derived for the purposes of ss 25 or 26(a), and thirdly in relation to the nature of the fund from which dividends are paid for the purposes of s 44. Upon that footing, the Commissioner submitted that in terms of principle, a word may not necessarily have the same meaning in the various statutory contexts in which it appears, particularly in revenue statutes (Clyne v Deputy Commissioner of Taxation [1981] HCA 40; (1981) 150 CLR 1 per Mason J at 15.)

77 Senior counsel for the Commissioner next emphasised that the words could reasonably be taken to be attributable to profits that were derived by the company before... were referable to circumstances prior to the acquisition date of the RDA share, thereby requiring an identification of the existence of a fund of profits derived by the company to which the dividend subsequently paid may reasonably be attributed. The Commissioner further submitted in that regard that the word derived in s 160ZK(5)(b) served the function of identifying the fund of profits to which the post acquisition dividend is reasonably attributable, being profits, whether realised or unrealised, accrued to, or obtained by the company before that acquisition date. It may be observed that s 160ZK(5) contains no explicit reference to notions of profits which are yet to crystallise. Cited in that context of the Commissioner’s submissions was the dictum in Evans referred to earlier, namely that ‘[t]he word derived does not connote that the profit must be a realised profit’. However it is to be further observed that further dicta in Evans also emphasised that although a profit need not be, in the income tax context thereby involved, a realised profit, it must be at least an ‘ascertained profit’. The statutory phrase addressed in Evans was that part of the Income Tax Assessment Act 1922-1930 comprising s 16(b)(i)(1), which brought to charge all dividends and distributions out of profits, whatever be the nature of the profit (see the passage in the reasons of the majority at 101).

78 The Commissioner referred next to the authorities of Lachberg and Dimbula, to which reference has been made above. Those cases were cited by the Full Court of the Supreme Court of Western Australia in Hancock Family Memorial Foundation Ltd v Porteous [2000] WASCA 29; (2000) 156 FLR 249 at 277, for the propositions that the term profits appearing in corporation law statutes has a ‘broad meaning, and requires a comparison to be made of the entire accounts of a company at the beginning and end of a period to assess the amount of the gain during that period [and] includes capital profits, both realised and, in some circumstances, unrealised’. The Commissioner submitted in that context that Read was correctly distinguished by the primary judge as being of little assistance in construing s 160ZK(5), since it was a decision referable to the policy of the Social Security Act to the effect that gains which had come home and represented disposable income should be taken into account in determining the level of pension provided to a pensioner, but that unrealised gains which had not yet and might not come home should not be similarly taken into account. The principle in Read as to a gain not being realised until it is earned derived or received was implicitly adopted by Davies J in Clarke v Federal Commissioner of Taxation [1992] FCA 93; (1992) 92 ATC 4136 at 4140. The judgment of Davies J in Clarke was upheld on appeal (92 ATC 4562), though Read was not mentioned by the Full Court in its reasons.

79 The Commissioner accepted the appellant’s contention that unrealised profits by way of an accretion in value of capital assets may only be distributed as dividends in circumstances where ‘the accretion is of a permanent character’, but dismissed the relevance of the contention. The issue arising on the present appeal, so the Commissioner contended, was not whether at the merger date, SAIL and Phoenix could have paid a dividend out of recognised but unrealised profits derived prior to that date, but whether the dividends actually paid by the companies after the unrealised profits had crystallised by realisation could reasonably be taken to be attributable to unrealised profits that had accrued at the merger date.

80 It was emphasised by the Commissioner that the example in the Explanatory Memorandum referred to earlier merely illustrates the nature of the mischief which the legislation was intended to remedy, and did not purport to confine the operation of the statute to that example, nor define the s 160ZK(5)(b) expression profits that were derived as profits realised. Moreover the Commissioner emphasised that the primary judge was not concerned simply with whether a profit was derived, or an economic loss suffered, but with the issue whether a dividend actually paid was reasonably attributable to a profit derived before the merger date. Thus if the subject assets depreciated in value after the deemed acquisition date, so that the unrealised profits were lost, so the Commissioner hypothesised, it would not be reasonable to attribute a subsequent dividend to the profits accrued at acquisition, and s 160ZK(5) would not apply.

81 The Commissioner’s submissions then addressed the controversy concerning the operation of the now repealed s 160ZLA, and submitted that no assistance could be obtained from the wording thereof in construing s 160ZK(5), nor could any limitation on the meaning thereof be imputed. As has already been indicated, s 160ZK(5) defines a rebatable dividend adjustment for the purposes of s 160ZK(1B), as the language of s 160ZK(1B) was said to make plain, and thereby for the purpose of ascertaining the reduced cost base of shares in a relevant company. The Commissioner further submitted that the provisions of s 160ZK(5) apply only for the purpose of reducing capital losses which are recouped by rebatable (and thus tax-free) dividends, and by virtue of par (d) thereof, only then to receipts by a controller of the company.

82 The Commissioner next pointed out in relation to s 160ZLA that the section provided a different definition of the same term for the purposes only of two different provisions, in order to prevent conversion of capital gains into rebatable (ie tax-free) receipts, those two different provisions being:

(i) Sub-section 160ZA(4A), enacted in 1994, which excluded ‘rebatable dividend adjustment’ amounts from otherwise assessable income, in respect of which relief was afforded by s 160ZA(4), by way of reducing a capital gain to the extent of the overlap; and

(ii) Sub-section 160ZL(5), which treated a ‘rebatable dividend adjustment’, as defined in s 160ZLA, as a return of capital for the purpose of that section.

83 The Commissioner thereafter submitted that the definition in s 160ZLA, for the purposes of the reduction of amounts for calculation of a reduced cost base, was confined to distributions carrying an entitlement to a dividend rebate made by a company in respect of a disposal of its shares or a reduction of capital or a winding up, or under an arrangement:

(i) under which the same or other shares were issued at a premium, to the extent that the premium recouped the dividend; or

(ii) which included the revaluation of assets, the sale of which would have generated an assessable profit, whether or not the distribution was made out of the revaluation reserve.

A different but similarly limited definition of rebatable dividend adjustment was included for the purpose of the share buy-back provisions of the Tax Act, by the insertion of s 159GZZZMA.

84 The Commissioner thus submitted that although concurrently introduced, and having some similarity of language, the legislative schemes of subs 160ZK (1B) and subs 160ZK(5) on the one hand, and ss 159ZZZMA, 160ZLA, 160ZA(4A) and 160ZL(5) on the other hand, had distinct and separate fields of operation, and differed in several important aspects, as follows:

(i) the amendments to s 160ZK reduced the amounts of claimed capital losses, whereas the other provisions increased taxable capital gains;

(ii) the amendments to s 160ZK applied only to controllers of the distributing company, whereas the other provisions were applicable to all shareholders; and

(iii) the amendments to s 160ZK applied (to reduce the calculation of a loss) to a disposal however occurring, whereas the other provisions applied (and then only to increase a gain) to a disposal or partial disposal, in the nature of a transaction between the shareholder and the company.

85 The Commissioner therefore submitted that the distinction between the statutory schemes of s 160ZK and the former s 160ZLA was manifest, not only from their language, but also from the separate treatment given to them in the Explanatory Memorandum; it was pointed out by the Commissioner in that regard that the s 160ZK provisions are contained within Chapter 4 thereof, and the other provisions in Chapter 3 thereof. For all the foregoing reasons, the Commissioner submitted that no assistance was to be derived in construing s 160ZK(5), and no limitation was to be placed on the meaning thereof from the wording of the now repealed s 160ZLA of the Act. We think that there is force in the Commissioner’s responses and that the s 160ZLA contention of the appellant should be put aside.

86 In the course of the Commissioner’s contentions, certain evidentiary issues arose in the course of the presentation thereof, which the appellant sought to correct.

87 The first contention related to the Commissioner’s assertion that the unaudited accounts of SAIL could not be produced at the hearing, and that instead reconstructed accounts were provided. In response, the appellant pointed to the following matters as established by the evidence:

(i) the ‘Completion Accounts’ prepared for SAIL’s parent Sun Alliance Australia Limited and its controlled entities, including SAIL, related to the period of nine months ended 30 September 1992, and no separate completion accounts were prepared for SAIL;

(ii) however a set of unaudited accounts as at 30 September 1992 was identified in the minutes of the SAIL directors’ meeting on 30 October 1992 and in the minutes of the meeting of directors of Phoenix held on the same date; the evidence of witnesses adduced by the appellant was to the effect, without challenge by any cross-examination, that no accounts of those descriptions had been located; moreover each of those witnesses further deposed to an absence of recall of the existence of any such SAIL or Phoenix financial statements prepared as at 30 September 1992; and

(iii) moreover what the Commissioner described as ‘reconstructed accounts’ were prepared by the appellant in the context of the Commissioner’s audit undertaken at the Commissioner’s request.

88 The second matter related also to SAIL, and in particular the Commissioner’s contention that the unrealised accretion in the value of the Bridge Street properties, as at the merger date, was not disclosed in the accounts of SAIL as at that date; however for the reasons stated in the preceding paragraph, there were no accounts relevantly of SAIL per se, but only the completion accounts for Sun Alliance Australia Limited and its controlled entities.

89 It was said that the statement that when SAIL sold the Bridge Street properties, it received market values, was misleading, in that the Commissioner failed to state in that context as follows:

(i) after 31 December 1992, and before the Bridge Street properties were disposed of, the actual market values fell by $18,426,000;

(ii) the right to the receivable under the merger agreement, for any potential deficit payment to be made to SAIL on the disposal of the Bridge Street properties, did not arise until after the Holding Company was deemed to have acquired the shares, namely after 8 October 1992;

(iii) the Commissioner’s assertion that ‘[i]n September 1995 SAIL sold the properties and received the market value, and thereby realised the unrealised gain, disclosed at the merger date’ was incorrect, in that the receipt in 1995 did not constitute the realisation of an unrealised gain disclosed at the merger date, and no right to any such receipt existed as at the merger date of 8 October 1992; and

(iv) The Commissioner’s assertion that ‘[the] final dividend is attributable to the following sources:
‘$’000
Reported operating profits 1993-5 calendar years 5,430
Profits realised before the merger date 9,562
Unrealised profits at merger date 21,345
$36,337’

did not involve a correct identification of the sources of the final distribution; instead, for reasons appearing in the preceding paragraph of these reasons, the unrealised profits at the merger date were not the unrealised profits when the final dividend was declared and paid; the profit from which the final dividend was declared did not exist as at the merger date, and its source arose after the merger date.

90 The further corrections sought to be made by the appellant related to Phoenix, and were as follows:

(i) the Commissioner’s statement that all profits realised by Phoenix were on revenue account was incorrect, in that the same were taxed on a capital gains basis; the evidence of Mr Hardy, the Sun Alliance Group taxation manager, was as follows:

‘Most insurance companies held equities in a separate subsidiary to preserve the benefits of rebates under section 46 of the ITAA. Sun Alliance Investments Pty Ltd ("SAIPL’) and Phoenix Securities Pty Ltd (‘PSPL’) were the entitles which primarily held equities for the Sun Alliance Group. In November 1997, SAIPL and PSPL received a letter from the Commissioner advising of the decision of the Commissioner that the profits derived by them on the sale of equities were to be taxed on a capital gains basis... These entities have always transferred increases or decreases in the value of investments to an asset revaluation reserve.’

(ii) contrary to the Commissioner’s assertion, Phoenix did not produce audited accounts for each calendar years from 1991 to 1996; instead for the financial years ended 31 December 1992 and following, Phoenix produced a so-called special purpose financial report; nor did Phoenix produce unaudited accounts for the period ended 30 September 1992; moreover in relation to the balance sheet of Phoenix as at 8 October 1992, the same was prepared by the appellant in the context of an audit request; and

(iii) the assertion of the Commissioner that the so-called ‘realised’ profits (relied upon by the appellant as the fund from which the dividends were paid) constituted principally a realisation of the unrealised profits recognised as having accrued at the time of the merger, was described by the appellant as misleading, in that it did not take account of the facts that:

(a) the assets held by Phoenix were shares in a number of companies listed on the ASX, where their values were subjected to daily market forces; and

(b) there were likely to be, and there were in fact, significant fluctuations in the value of the whole of the Phoenix share portfolio, as well as in the value of individual parcels of shares in the portfolio, until ‘fixed by realisation’ some five years after the merger’; those fluctuations were recorded in detail in the affidavit of Mr Bentley, the chief financial officer of the Holding Company and its subsidiaries.

Conclusions

91 It is appropriate to deal first with the claimed loss on the Phoenix shareholding. It may be that profits can be derived, in the present statutory context, in the absence of completion of all requisite accounting steps needed for a complete or precise calculation. However, if a sum is to be accorded the status of profits for the purposes of s 160ZK(5), it would normally be necessary for accounting to have been at least sufficiently advanced to establish the existence of a minimum sum required to be designated as monies or other value reasonably ascertained and obtained, or got in, to the virtual exclusion of at least known liabilities. Those are of course somewhat imprecise expressions, but they reflect the various statutory concepts of profits discussed over decades of authorities.

92 In that regard it is appropriate to pay regard to the Explanatory Memorandum relating to s 160ZK, which exemplifies a simple accounting calculation containing reference to ‘Retained Profits’. Explanatory memoranda do not in principle attract the shortcomings mentioned by Meagher JA in Lembeke v SAS Trustee Corporation [2003] NSWCA 136; (2003) 56 NSWLR 736 at 738 concerning parliamentary second reading speeches. The very notion of retained profits implies an outcome calculated from all reasonably available criteria.

93 The authorities which have been already reviewed in some detail tend to provide support for the meaning of profits in the context of s 160ZK(5) for which the appellant has contended. Thus Spanish Prospecting speaks of ‘comparison between the state of business at two specific dates’; QBE speaks of ‘net balance of all gains earned and losses incurred’ and of clarity of ‘accretion in value...of a permanent character’; Evans speaks of ‘ascertained by a proper account’; Lachberg speaks of the apparency of ‘an accretion’ from ‘a balance of account’; Industrial Equity speaks of ‘already accrued in the company’ and by way of contrast speaks against qualification on the footing merely that ‘the existence of profits...at a future time stipulated for payment’; Read speaks of ‘actual gain’. The longstanding dictum of Lord Herschell in Russell v Town and Country Bank (1888) 13 App Cas 418 at 424 remains relevant:

‘The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts... Unless and until you have ascertained that there is such a balance nothing exists to which the name "profits" can properly be applied.’

94 No such ascertainment can occur or determination be made on the basis of the evidence relating to the loss on the Phoenix shares. Increments in value emerging from valuations for the time being of the Phoenix share portfolio cannot realistically be characterised as having been derived pending ultimate realisation. Put another way, the evidence does not yield a conclusion in favour of the Commissioner as to accretions of value of the share portfolio of a permanent character (QBE), or of gains having come home, during any relevant accounting period, in a realised or realisable form (Executor Trustee and Agency). The evidence does not appear to travel beyond circumstances of the ‘mere process(es) of valuation’ (Dickson). It follows that in respect of that first segment of the objection decision, the Commissioner erred and the amended assessment must be set aside.

95 With regard to the loss claimed in relation to the SAIL shares, the evidence presents a different picture. As discussed in Evans a profit that, according to a proper account, is a profit that has been derived, will become a sum available for distribution. Although it was the policy of the Royal & Sun Alliance Group not to distribute an unrealised profit, the adoption of that policy had no bearing on the issue of construction as to whether a profit had been derived for the purpose of s 160ZK(5)(b).

96 Determination of whether a profit has been derived is a question of fact. The relevant facts in this case show that at the date of the merger, SAIL had obtained a gain from the proprietorship of Bridge Street properties in that, pursuant to the terms of the Merger Agreement and the Bridge Street properties agreement, that gain had been ‘locked-in’ for the purposes of the merger. In accounting terms the gain could be regarded as fixed or accrued as at that date. It followed that for the purposes of s 160ZK(5)(b), the gain could reasonably be attributable to profits derived by SAIL as at the merger date.

97 The means used in the Bridge Street properties agreement to fix the gain was a put option granted by BSB to SAIL. Although the option was limited to a term of seven years, the Merger Agreement made it clear that the gain identified by the valuation obtained at the merger date was to be treated as a gain that had accrued to SAIL at that time.

98 The Commissioner assessed only $17,688,000 of the total dividend of $36,337,000 distributed on 6 September 1996 to the Holding Company to be an amount that could reasonably be taken to be attributable to profits derived by SAIL before the merger date, and, as set out above, that was a conclusion available to the Commissioner. It follows that in respect of that part of the objection decision, no error was made by the Commissioner.

99 As we have observed already with regard to the argument that regard should have been given to the terms of s 160ZLA as it stood before repeal, nothing in the terms or scope of operation of s 160ZLA negates the foregoing construction of s 160ZK(5)(b).

100 The appeal must be allowed, the objection decision of the Commissioner set aside and the matter remitted to the Commissioner for determination in accordance with these reasons.

101 With regard to the matter of costs, the effect of the orders proposed is that the appellant should have succeeded below in obtaining an order that the objection decision be set aside. Notwithstanding that the amended assessment to be issued in due course will not allow the whole of the losses claimed by the appellant, the appellant succeeded in obtaining the orders sought and should have the costs below in addition to the costs of the appeal.

I certify that the preceding one hundred and one (101) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Court.

Associate:

Dated: 9 March 2004

Counsel for the Appellant:	B J Shaw QC, M M Gordon
Solicitors for the Appellant:	Maddocks
Counsel for the Respondent:	A H Slater QC, R L Hamilton
Solicitor for the Respondent:	Australian Government Solicitor
Date of Hearing:	22 August 2003
Date of Judgment:	9 March 2004