South Brisbane Gas & Light Co Ltd v Hughes [1917] HCA 37; (1917) 23 CLR 396 (11 August 1917)

The South Brisbane Gas and Light Company Limited Appellants; and Joseph Hughes (Commissioner of Income Tax for Queensland) Respondent.

The facts of this case are set out in a special case stated by the learned District Court Judge, acting as a Court of Review, for the opinion of the Supreme Court. The balance-sheets and the other material documents are appended to the special case and incorporated in it. The material statutory provisions are cited in the judgment of the Supreme Court now under appeal.

The first proviso to sub-sec. IV. of sec. 7 of the Income Tax Act of 1902, as amended by sec. 5 of the Act of 1904, appended to the provision that the tax on the incomes of all companies should be one shilling in the pound the requirement "that the income subject to the tax of every company having its head office or chief place of business in Queensland shall be assessed at not less than the amount of the dividends declared by such company during the year in respect of which the assessment is made." Is, then, this issue of debentures "a dividend declared" by the Company during the year in respect of which the assessment was made?

The assessment was made in 1915 on the basis of the income of 1914. The word "dividend" as used in this body of Acts is, with certain exceptions not material to this case, defined as "all sums of money paid, allocated, distributed, or credited by a company to or amongst its shareholders as such, by whatever name called." If the debenture issue was dividend within this definition it was clearly declared by the Company in their balance-sheet describing the operations up to 31st December 1914, and is therefore the proper subject of income tax.

The process adopted by the Company was as follows:—Their balance-sheet of 30th June 1914 debited them with £100,000 of capital, and other sums, including profit and loss £11,549, making up £208,745. Against this they credited property and assets in the shape of plant, land, buildings and Company's undertaking valued at £179,386, and other credits, bringing their total on that side to the same sum of £208,745. Between this balance-sheet and that of the next half-year, namely, in November 1914, they had a revaluation made showing a very large increase in the value of their assets. In the balance-sheet of 31st December 1914 they debited themselves with share capital paid up £100,000, interminable debenture-stock (being the issue in question) £100,000, and reserve funds £44,125, and also with other items, including profit and loss account £10,745, bringing the debit side to £309,900. Against this they credited themselves by way of property and assets with plant, land, buildings, and Company's undertaking, value £293,096, and other items, bringing the total on that side to £309,900. The main factor was the increased valuation of plant, land, buildings and Company's undertaking by £113,710.

The debenture issue was the consequence of a scheme embodying proposals of the directors adopted at an extraordinary general meeting of shareholders on 14th December 1914, by which debenture-stock to the amount of £100,000 was issued to shareholders free of cost to them. It clearly represented an equivalent amount of the revalued assets. This debenture-stock had a face value of 10s. for every share held by the member. It was to bear interest from 30th June 1917 at 5 per cent. per annum, which might be increased up to 10 per cent. according to profits. The stock was redeemable by the Company at face value from time to time proportionately to the shares held, or the whole might be so redeemed at any time. In the event of a winding-up the stockholder was to receive from the Company the full face value of his stock in priority to shareholders. The debentures and the names of the holders, with the amount of the stock held by each, and the date of entry, were to be registered in the books of the Company, and the stock was transferable.

I do not discuss the question whether the scheme which was carried out was strictly warranted by law. The shareholders do not appear to have raised the question, and could scarcely do so on this assessment appeal.

Before the Court of Review the chairman of directors said in evidence that certificates were issued to shareholders to the amount of £100,000, that the stock book, pp. 7 and 8, contained a typical entry in the register of stockholders relative to the issue of stock, and that the shareholder to whom this stock had been issued sold and transferred it on the date shown. (This entry showed that H. M. A. of Mars Street, Wilston, had on 22nd December 1914 by certificate No. 7 acquired stock to the amount of £305, and had on 2nd September 1915 disposed of stock to the amount of £205 by transfer No. 33, and to the amount of £100 by transfer No. 34.) He further said that the revaluation was rendered necessary because of the greatly increased cost of material, labour, &c., and that the Company allocated the increase to the year 1914.

The reason given by the chairman for the revaluation is not very intelligible in view of the fact that the directors had described the debenture issue as "the best method of giving to shareholders the full benefit of the extra profits which the Company will undoubtedly make."

A form of "certificate for debenture-stock," as handed to stockholders is annexed to the special case, by which the Company "binds itself to pay to the registered holder for the time being hereof the principal sum (named) and until payment thereof to pay interest thereon or on so much thereof as shall from time to time remain unpaid at the times after the rate and in the manner provided by the resolution."

It is clear that the Company acknowledged itself the debtor of the debenture-holder in a sum of money specified. It matters not that this debt, a present debt, was only payable in the future and was to run until the Company chose to discharge it. Being transferable, it necessarily had a value in the market, as a security the price of which depended upon the success of the Company. But it had behind it a very large sum in the shape of realized profits of the Company, which held against its capital a sum nearly three times as great in plant, land, buildings and value of undertaking alone. The excess of this sum over capital must represent profits gained by the Company. During the argument I am afraid I was rather insistent in putting to Mr. Feez the view that each debenture certificate acknowledged that a "sum of money" was "credited" to a shareholder, and that therefore it came within the definition of a dividend as contained in the 1906 amendment of sec. 3 of the Principal Act. I cannot hold that a dividend is not declared unless the cash out of which it is to come actually exists in the hands of the company. That would be to ignore the notorious fact that large sums of profits, invested, as large sums constantly are, either in the company's business or in other concerns, are constantly and rightly made applicable to the purpose of distribution to shareholders. Such reinvestments themselves return large profits, which in their turn may either be distributed at once or again invested until the time comes at last for the realization of such investments for the benefit of shareholders. It is true that they may be kept intact all this time at the option of the members, or of the directors with their sanction express or implied. But it does not follow that when a distribution representing a part of these accretions, just as these debentures do, is made to shareholders, that operation is to escape income tax if it amounts to a distribution of profits under some other name, whether payable at once or at some future date. It is no answer to say that this is the creation of a debt and cannot therefore be a declaration of a dividend. There is no declaration of a dividend without the creation of a debt.

The views which I suggested during the argument are put, of course in a much clearer and more forcible form, by Lord Shand in the case of City of Glasgow Bank v. McKinnon[1]. I have been referred to that case by my brother Isaacs, who is about to quote fully from his Lordship's judgment, but I am sure he will not think I unduly anticipate him by mentioning two short passages. The first runs thus:—"It is clear that it is not necessary that there must be cash realized, and in the coffers of the bank, received expressly on account of interest or profits, in order to justify the payment of a dividend. To enforce such a rule would be to run counter to ordinary and reasonable usage in the case of mercantile companies." Again: "The profits may, and must often to a great extent, be represented by obligations of debtors, often secured, and by direct securities over property. They are not the less profits fairly realized and divisible because they exist in that form and have not been received in cash."

Here was a valuation exceeding the amount of the Company's capital by so great a sum that a great deal more than the £100,000 denoted by the debentures was available for the shareholders if they chose to authorize the directors to deal with it either by way of cash distribution or in the way adopted. It is to my mind, as in each case a "sum of money credited," a dividend within the definition, no less than if so much actual cash had been distributed in place of the allocation or credit, and, if a dividend within the definition, it does not lack the quality of declaration to bring it within the first proviso to sub-sec. IV. already quoted.

I do not propose to make any full analysis of sec. 5 of the Act of 1915. It is enough to say that there is not a tittle in that Act which takes away from the quality of the transaction as it existed under the prior Acts. I agree with the Supreme Court in their view of the meaning of sec. 5 and of its declaration that a transaction such as this, described as it is in sub-sec. X. (b), is to be regarded as having from the first enactment of the definition and of the proviso constituted a declaration and distribution of dividends.

In my opinion the Supreme Court answered the questions raised in the special case correctly, and the appeal to this Court must therefore be dismissed with costs.

The claim made by the Commissioner for income tax in this case rests upon the meaning which the first proviso to sub-sec. IV. of sec. 7 of the Act of 1902 had, or which Parliament now declares it had, up to 31st December 1914. If its meaning at that time embraced such a transaction as the one proved here as a declaration of dividend, this appeal should be dismissed, otherwise it should be allowed.

I consider the latest expression of the legislative will in the first place. In the Act of 1915, Parliament, after describing in par. (b) of sub-sec. X. of sec. 7 of that Act the issue of debenture-stock such as that in the present case, says it "shall be and it is hereby declared that the same always has been a declaration of dividends and a distribution of dividends within the meaning of the two last preceding sub-sections."

The Supreme Court has held that those words amount to a legislative interpretation of the old sub-section relied on in the present case.

The arguments against any implied retrospectivity have no place here, because the retrospectivity is express. The only question is how far back does it reach?

The appellants contend that the limit is 1st January 1915, and two considerations are urged in support of that view. The first is that sec. 2 expressly carries the operation of the Act back to that date only, and the next is that the words "the two last preceding sub-sections" limit the declaration to the two sub-sections of the Act of 1915.

As to the first, it should be observed that in the Act of 1902, passed 1st December 1902, it was provided by sec. 39 (2) as follows: "The first period for which assessments shall be made shall commence on the first day of January 1902, and, save as hereinafter provided, all subsequent annual periods shall be reckoned from that date, and to that extent this Act shall have retrospective operation." A similar section appeared in the amending Acts of 1904 (No. 9), of 1906 (No. 11), of 1907 (No. 5).

Sec. 2 of the Act of 1915 is therefore merely a repetition of a section the function of which is to apply as from a given date the whole body of income tax law as last enacted. In other words, the relevant effect of the section in the Act of 1915 is to apply to appropriate cases as from 1st January 1915 the two sub-secs. VIII. and IX. of sec. 7, quite apart from the declaration of retrospectivity. That declaration is not wanted for that purpose. And further, reading it literally, its application for that purpose would be nonsense. The date of the declaration is, of course, the date of the Act—29th December 1915. Up to that date, the two sub-sections of that Act did not exist, and therefore could not have had the declared, or any, meaning. The Legislature, consequently, must either have declared a nullity or an absurdity if they did not mean by the words "the two last preceding sub-sections," the two sub-sections in identical terms, which they were merely transplanting into an improved section 7, along with certain additions, but without any intention of altering these provisions themselves, or of allowing their force and operation to cease for a single moment. Their real intention is clear. Now, as the Privy Council said in Salmon v. Duncombe[2], it is "a very serious matter to hold that when the main object of a Statute is clear, it shall be reduced to a nullity by the draftsman's unskilfulness or ignorance of law. It may be necessary for a Court of Justice to come to such a conclusion, but their Lordships hold that nothing can justify it except necessity or the absolute intractability of the language used." I do not find the words intractable. Having regard to the way in which sec. 7 was dealt with, I entertain no doubt the legislative declaration is sufficiently indicated by the Legislature's words as applicable to the law as existing in the words of the two sub-sections referred to at the moment the Legislature were enacting the Act of 1915. The transparent object of Parliament was to prevent the very contention now raised upon the former Act. This conclusion in itself would be decisive of the case.

But, in the circumstances, I proceed to consider the other branch, namely, whether the transaction would be struck by the sub-section.

The material facts are that in the balance-sheet issued on 30th June 1914, the value of the Company's plant, buildings and undertaking—that is, their whole business enterprise, except cash, stock and coal account—stood at nearly £180,000. A revaluation was considered necessary and was made, by which the above sum was increased, roughly speaking, to £280,000. The Company allocated the whole increase to the one year 1914, and issued a circular in November of that year in which they offered the shareholders £100,000 worth of debentures, or the same amount in shares. On 14th December a general meeting by resolution adopted the debenture scheme, and debenture certificates to the amount of £100,000 were actually issued to the shareholders, as such, proportionately to their respective share interests. The debentures were registered in the Company's books, each shareholder being entered according to the serial number of his debenture, and the amount of it. The debentures contain an acknowledgment of indebtedness in respect of a specific sum—in fact an aliquot part of the £100,000; they also contain a promise to pay that sum, and until payment to pay interest on that sum or so much as remains unpaid, at the times, after the rate and in manner provided by the resolution. The rate is a minimum rate of 5 per cent., with provision for possible increase; the interest is payable half-yearly after 30th June 1917. The debentures are transferable to any person even though not a shareholder. They are redeemable at face value at any time but pro ratâ. In the event of winding up, they are payable out of surplus assets, but in priority to shareholders.

No express condition is made that the debentures shall not be paid off unless the Company chooses, or otherwise before liquidation. I am not prepared to hold that the view presented on behalf of the Company that a debenture-holder could not otherwise demand payment is correct. I do not decide for or against the view; it is not necessary to do so. But having regard to legal principles, illustrated by the decision of Lord (then Mr. Justice) Parker in In re Tewkesbury Gas Co.[3], subsequently affirmed[4], I leave that for future consideration, should it ever become necessary.

Assuming, however, that the position is as contended, namely, that the principal sum need not be paid until the Company chooses, or otherwise upon liquidation, how does it stand?

It is said the debentures are not money, and that is true. Handing debentures is not the same as paying money (Wood v. Odessa Waterworks Co.[5]). And if the statutory definition of "dividend" in the Income Tax Act were limited to "money paid," the objection would be complete. Nowhere does it appear that money was actually or constructively immediately handed to the shareholders. The facts show that that is what the Company decided to avoid.

The Supreme Court has rested on the word "allocated." I do not say that is wrong; but I prefer the word "credited." The debentures in acknowledging an indebtedness by the Company to the debenture-holder connote that the amount of that indebtedness stands to the credit of the debenture-holder in the accounts of the Company. Mr. Feez said that could not be, because there was no "money" in the Company's hands to be credited; it was only a balance on valuation. But that is not a sound argument. A company may validly declare a dividend of money though for the moment it has not the money in hand or in the form of cash, provided, in substance, when accounts are adjusted as between capital and revenue, the amount proposed to be divided belongs to revenue. I shall cite only three authorities.

One is Lord Cairns L.J. in Hoole v. Great Western Railway Co.[6], where it is said:—"A dividend can only be declared upon the assumption that there is either money in hand to pay it, or that there is money which ought to be brought into the revenue account for the purpose of paying it. If, when the dividend comes to be payable, there is not money in hand sufficient to pay it, what should be done? If the revenue account is entitled to be recouped, the natural and ordinary process would be at once to take steps, by means of the raising of capital, for recouping the revenue account out of the capital account."

The second is the judgment of Selwyn L.J. in In re Mercantile Trading Co. (Stringer's Case)[7], the second half of p. 492.

The third is a few years later, 1882. In City of Glasgow Bank v. Mackinnon[8], a decision of the First Division, Lord Shand put the matter very clearly (part only of the passage I refer to being found in the English Law Reports[9]), and as the Scottish report is less generally accessible than the ordinary reports, I quote his observations somewhat freely. The learned Lord said:—"It is clear that it is not necessary that there must be cash realized, and in the coffers of the bank, received expressly on account of interest or profits, in order to justify the payment of a dividend. To enforce such a rule would be to run counter to ordinary and reasonable usage in the case of mercantile companies. In order to ascertain the profits earned and divisible at any given time, the balance-sheet must contain a fair statement of the liabilities of the company, including its paid-up capital; and, on the other hand, a fair or more properly bonâ fide valuation of assets; the balance, if in favour of the company, being profits. The profits may, and must often to a great extent, be represented by obligations of debtors, often secured, and by direct securities over property. They are not the less profits fairly realized and divisible because they exist in that form and have not been received in cash. If profits have been earned, and are, in the judgment of those in the management of the company, secured, the shareholders of a joint stock company are, in the ordinary case, entitled to have such profits, which may properly be called realized profits, declared and divided, except in so far as they may be otherwise appropriated either by the express terms of the contract, or by the exercise of powers conferred on those charged with the management of the company; and the directors may properly use funds otherwise available to them, and forming part of the floating balances on capital account, in payment of the dividend."

Consequently, assuming, as I do, perfect honesty on the part of the Company in making the revaluation, and finding that £100,000 at least was available over and above capital to enable the debentures to that aggregate amount to be handed to the shareholders, then it appears to me there was an allocation or a crediting of money to the shareholders in the form of a present debt payable either presently or in the future. I also can see no objection to it from the point of view of any statutory provision, and, as far as the Articles go, no shareholder has objected. In any case the Income Tax Statute either assumes in such case the legality and regularity of the act done or imposes the tax irrespective of anything but the actual fact.

Then it is said, the debentures are only after all a debt payable in futuro; and creating a "debt" is not the same as declaring a dividend of money. Therein lies a fallacy. Every declaration of dividend until payment creates only a debt, and one which may be barred by the Statute of Limitations—running from the time the dividend is made payable. (See Lindley on Companies, 6th ed., p. 609, and cases there cited, notably In re Severn and Wye and Severn Bridge Railway Co.[10]; and see also Buckley on Companies, 9th ed., p. 649.) In the meantime the money stands to the credit of the shareholder in account with the Company as his debtor. And the debt once validly created is, until barred by the Statute of Limitations, recoverable out of any assets of the Company.

I have dealt with the only substantial objections raised, and am of opinion that the appeal is not well founded, and should be dismissed.

We are not called upon to determine the validity of the transaction to which we are about to refer, but to decide whether, if valid, it renders the appellant Company liable to pay income tax.

In July 1914 the Company revalued the miscellaneous assets which appear in its balance-sheets under the heading of "plant, land, buildings, and Company's undertaking," and found their value to be greater by about £100,000 than the sum at which they had been valued in its then last half-yearly balance-sheet. Thereupon the directors proposed at the option of the shareholders either to issue and distribute among them "free of cost" debenture-stock to the face value of £100,000, or to allot among them shares paid up to 9s. 9d., in the proportion of one new share to every existing share. The shareholders in general meeting adopted the debenture scheme and debenture certificates were issued and distributed accordingly.

In the next half-yearly balance-sheet the Company was debited with the amount of £100,000 in respect of this debenture-stock and credited with the increased value of the "plant, land, buildings, and Company's undertaking." The effect of this transaction, if valid, was that the shareholders became possessed of debenture-stock, and the assets of the Company which belonged to the shareholders subject to the claims of the Company's creditors became liable to satisfy the debenture-holders.

In these circumstances we think that the shareholders were credited with this sum of £100,000 within the meaning of the definition of the word in sec. 3 of the amended Income Tax Act of 1902, and that the Company is liable to pay income tax on that sum under sec. 7 (VIII.) of that Act.

[1] 9 R., 535, at p. 602.

[2] 11 App. Cas., 627, at p. 634.

[3] (1911) 2 Ch., 279.

[4] (1912) 1 Ch., 1.

[5] 42 Ch. D., 636.

[6] L.R. 3 Ch. 262, at pp. 269-270.

[7] L.R. 4 Ch., 475.

[8] 9 R. at p. 602.

[9] 35 Ch. D., at pp. 506 and 507.

[10] (1896) 1 Ch., 559.

High Court of Australia

South Brisbane Gas & Light Co Ltd v Hughes [1917] HCA 37; (1917) 23 CLR 396 (11 August 1917)

HIGH COURT OF AUSTRALIA