James v Federal Commissioner of Taxation [1924] HCA 34; (1924) 34 CLR 404 (13 August 1924)

In my opinion the facts and figures stated in the special case show clearly that £72,798, representing profits of the company, was, as stated in the resolution of the directors at their meeting of 10th February 1921, appropriated as "a bonus" to be distributed among shareholders; a portion of that sum, proportionate to the number of shares held by each shareholder on 26th January 1921, being subsequently credited to him in the books of the company in part payment of his liability on the shares allotted to him, in pursuance of the resolution to allot shares in accordance with the agreement of 10th February 1921 annexed to the special case. The sum of £3,168 so credited to the appellant answers the description of "profits" or a "bonus" credited to a shareholder of the company, and is therefore, by sec. 14 (b) of the Income Tax Assessment Act 1915-1918, included in the appellant's income for the purposes of that Act.

In my opinion the question submitted should be answered "In respect of the said sum of £3,168."

By art. 123 of the articles of association of the Australian Portland Cement Co. Pty. Ltd. it is provided: "The Board may declare and pay dividends in cash in shares or in specie or otherwise out of the net profits of the company." Art. 124 is in these terms: "Subject to any priorities that may be given upon the issue of any shares the profits of the company available in the judgment of the Board for distribution shall be distributed as dividend among the members in accordance with the amounts paid or credited as paid on the shares held by them respectively." In order to give effect to extraordinary resolutions of shareholders passed on 5th November 1920, the Board of Directors resolved that £72,798 undivided profits be distributed as a bonus amongst the shareholders in proportion to the shares held by them respectively; and that 145,596 shares of the value of £1 each paid up to 10s. per share "be in accordance with the said resolution distributed amongst such shareholders in proportion to the said shares held by them respectively in satisfaction of the said bonus and that ... Paul Lovenorn Munster be and he is hereby authorized on behalf of the shareholders upon the register ... to enter into an agreement with the company providing for the allotment to such shareholders ... of their due proportion of the said shares credited as paid up to 10s. and in satisfaction of the said bonus" &c. The agreement was accordingly entered into as annexed to the case stated. The shares were issued and accepted. The extraordinary resolutions of 5th November 1920 are recited in the agreement, and express the desire of the company "to capitalize the undivided profits." and that "the amount to be capitalized as aforesaid be distributed as a bonus" &c., and that the directors be authorized to distribute "such number of unissued shares of £1 each paid up to 10s. as shall be equivalent ... to the amount to be capitalized in satisfaction of the said bonus." The shares after allotment were entered in the share register of the company; and the appellant's shares, 6,336 in number, were credited as paid up to the amount of £3,168. The other books of the company by appropriate entries treated the sum of £72,798 profits as capitalized.

The Commissioner claims, and the appellant denies, that the sum of £3,168 is "income" of the appellant by virtue of sec. 14 (b) of the Income Tax Assessment Act 1915-1918.

The appellant contends that the case is governed by the decision of the House of Lords in Blott's Case[1]. I am very clear that it is not. The decisive factor is different in each case. In Blott's Case the law, as I understand, made the shareholder liable for the profits of the company only so far as he was a person "receiving or entitled unto the same"—that is, in the form otherwise than as capital.

In this case the law, sec. 14 (b), declares arbitrarily that "The income of any person shall include ... (b) dividends, interest, profits, or bonus credited or paid to any depositor, member, shareholder," &c., with an exception now immaterial. The word "credited" is all-important. In Webb v. Federal Commissioner of Taxation[2] I said:—"The employment of all these terms marks the anxiety of the Legislature that, in whatever form profits of a company are credited or paid to the members, &c., credited or paid shall be regarded as the recipient's income for the purpose of taxation. Whether it becomes taxable income depends on circumstances stated in the Act. As to the words credited or paid, the conclusion of Lord Herschell's judgment in Bouch v. Sproule3(1887) 12 App. Cas. 385, at p. 399. was: Upon the whole, then, I am of opinion that the company did not pay, or intend to pay, any sum as dividend, but intended to and did appropriate the undivided profits dealt with as an increase of the capital stock in the concern. Lord Watson says4(1887) 12 App. Cas., at p. 403.: It was equally within the power of the company to capitalize these sums by issuing new shares against them to its members in proportion to their several interests. He says 5 (1887) 12 App. Cas., at p. 404. that the money should not be paid to the shareholder, but should simply, by means of an entry in the company's books, be imputed in payment of the call of £7 10s. upon each new share. The Legislature, as it appears to me, has by the word credited sought to reach cases where, through a member or shareholder who has not been paid the dividend or bonus, there has been credit in the company's books imputed to the share he holds. This may or may not be satisfied under the Federal Income Tax Assessment Act by such a transaction as took place in Blott's Case1(1921) 2 A.C. 171. or Bouch v. Sproule2(1887) 12 App. Cas. 385.. I am not aware whether any attention was directed to the word credited in either the Swan Brewery Case3(1914) A.C. 231. or Blott's Case, and I leave that entirely open for consideration should the question arise. But, at all events, profits credited or paid are, as it seems to me, pointed to profits which have in some way been made a debt by the company to the shareholder, &c. In the case of a shareholder, that would be by a dividend or bonus—or even by interest used in the sense of distribution of profits. But the declaration of a dividend creates a debt (In re Severn and Wye and Severn Bridge Railway Co.4(1896) 1 Ch. 559, at p. 564.). Where there is no debt, or debit, the word credit or the word pay, in relation to profits, is meaningless, for there is nothing calling for payment and there is no balance to be struck." I adhere to that opinion, and it becomes directly necessary here.

In Blott's Case[10] the House of Lords solved the question essentially in this way:—The majority held that what was "received" in fact was nothing but shares, that the shares in the circumstances were, on the doctrine of Bouch v. Sproule[11], capital as against all the world including the Crown for taxing purposes, and that the intermediate operations, whereby the profits divided were appropriated by the company to satisfy the liability on the shares, did not amount in fact or in law to payment, to a receipt by the shareholder of the profits themselves. I may refer to the following passages from the judgment of Viscount Haldane:—"He neither paid nor received any cash"[12]. "It is quite another question whether these profits as such ever reached the respondent and the other shareholders as income"[13]. "But if, acting within its powers, it disposes of these profits by converting them into capital instead of paying them over to the shareholders, that, as I conceive it, is conclusive as against all the outside world, including the Crown, and the form of the benefit which the shareholder receives from the money in the hands of the company is one which is for determination by the company alone"[14]. "Apply them" (profits) "in paying up the capital sums which shareholders electing to take up unissued shares would otherwise have to contribute. If this is done the money so applied is capital and never becomes profits in the hands of the shareholder at all"[15]. So per Viscount Finlay (quoting Rowlatt J.):—Part of the profits "liberated to him in the sense that the company parts with it, and he takes it"[16]. "I am asked to decide whether there was a payment of this bonus upon the strength of what I consider bare machinery"[17]. "They did not pay over the accumulated profits to the shareholders to enable them to pay up the new shares. They issued the new shares as fully paid up as representing the increase of capital which resulted from the detention by the company of the money which might otherwise have been paid as dividend"[18]. Viscount Cave[19] said: "The resolution did not give to any shareholder a right to sue for the dividend in cash, his only right being to have an allotment of fully paid shares in the capital of the company." Lord Dunedin, one of the minority, founded himself on Trevor v. Whitworth[20], which indeeed Lord Haldane[21] also relied on, and which is unquestioned. Shares must be paid for, and not by the company's money. Payment had been "imputed." His Lordship proceeded to conclude that therefore the shareholder in law paid in the capital, and therefore he must in law be taken to have received the money from the company. Lord Sumner[22] adhered strongly to the position that the declaration of "bonus" and the mode of satisfying it were legally distinct, and[23] held that the share had to be paid for by the allottee, and therefore, in accord with Lord Dunedin, that the company's debt had been in contemplation of law discharged by payment. The pivotal consideration in His Lordship's judgment is, as I venture to think, found in the sentence: "When debt for dividend is set off against debt for calls and the account is squared, the equivalent of payment of a dividend takes place"[24]. And see p. 221, last line but three, "there was a payment here."

It appears to me that the point of divergence between the majority and the minority in that case is found in this consideration:—Both agreed that the declaration of dividend entitled the shareholder to his proportion of the profits in some way. Both agreed that he was entitled to have that proportion applied by the company so as to impute payment of his liability in respect of the capital represented by the new shares to be issued. But they differed as to the legal character of that "imputation." The minority considered it as equivalent in law to "payment," that is, an implied cross-payment for two independent debts. The majority considered it, having regard to the doctrine of Bouch v. Sproule[25], as no payment by the company at all of the proportion of profits, but as an authorized operation of another and inconsistent character. That operation was an authorized application by the company of the money to the creation of share capital, by detaining the money in the coffers of the company both in law and in fact, while crediting it, as the law required, to the shareholder in respect of the new shares issued.

Reverting for brevity's sake to my own above-quoted observations in Webb's Case[26], and to the analysis I have just made of Blott's Case[27], it appears to me that, so far from the last-mentioned case supporting the appellant's contention here, it is, in its media concludendi, quite opposed to that contention.

The declaration of the bonus to be satisfied by the issue of bonus shares paid up to 10s. meant, when the ellipsis is filled by the necessary business operations, that, though the cash representing the share of bonus was not to be actually paid over to and received by the shareholder, yet it should be so applied by the company on behalf of him as to be imputed to and credited as payment pro tanto of the liability created by the issue and acceptance of shares. That the declaration of dividend created a debt, there can be no doubt. But it was a debt which from its birth was conditioned to be satisfied, not by payment over, but by a credit in discharge of a liability on shares in a process which the law says is, in the result, the creation of capital. The Australian Act, unlike the English Act, does not always wait till the end of the process: it also sometimes seizes an intermediate operation. This is shown unmistakably by the second proviso to par. (b) of sec. 14 in these words: "Where it is proved to the satisfaction of the Commissioner that an amount standing to the credit of a profit and loss account before the first day of July one thousand nine hundred and fourteen has been appropriated by a company for the purpose of crediting a dividend to the shareholders and the dividend or a part thereof is retained by the company for the purpose of paying for an increase in value or number of shares issued to the shareholders, the shareholders shall not be liable to pay tax on the dividend or part so retained."

It is impossible, in my opinion, consistently with the actual facts, particularly the expression, in the resolutions and the agreement, "credited as paid" and the actual crediting of £3,168 in the share register, and consistently with the reasoning of all the learned Lords in Blott's Case[28], to contend that there have not in this case been "profits" or "bonus" to the amount of £3,168 "credited" to the shareholder. That being so, it is by force of sec. 14 (b) of the Act his "income." He is liable to be assessed in respect of that sum, that is, at 10s. per share, and not in respect of the higher sum of 15s. for which the shares could be sold in the market. If so sold, they would, as Viscount Cave in Blott's Case[29] observes, be realized as a capital asset producing income, and not as income itself. The 15s. per share would not represent a share of profits of the company; it had not in fact so much to give. Therefore, it would not fall within the sub-section. The question should be answered accordingly.

I would add that since this judgment was written the case of In re Speir; Holt v. Speir[30], has come to hand, and strongly confirms the views I had expressed as to the doctrine of Bouch v. Sproule[31] and the effect of Blott's Case[32].

The facts are fully stated in the case, and the question for our consideration is whether the appellant is liable to be assessed to income tax in respect of his proportion of certain accumulated profits of the Australian Portland Cement Co. Pty. Ltd., which that company derived from sources in Australia, and distributed "as a bonus amongst its shareholders," in proportion to the number of shares held by them in the company, by issuing to them certain unissued £1 shares paid up to 10s. "in satisfaction of the said bonus."

The solution of this question depends upon the terms of sec. 14 (b) of the Income Tax Assessment Act 1915-1921, which provides that the income "of any person shall include ... dividends, interest, profits, or bonus credited or paid to any ... shareholder ... of a company which derives income from a source in Australia ..."

According to the contention of the appellant, the distribution of the new shares to the shareholders was "a distribution of capital and not of income," and "the shareholders' interest in the profits of the company did not become their income unless severed from the capital funds of the company and liberated and released to them" (Blott's Case[33]; Webb v. Federal Commissioner of Taxation[34]; Speir's Case[35]). But the force of this contention depends, of course, upon the precise words of the taxing Act. The Act may declare that, for its purposes, the dividend, profit or bonus shall be income (see Swan Brewery Co.'s Case[36]). And if it does so, then the Courts must enforce the law, subject, in the case of the Commonwealth, to the observance of certain constitutional provisions (The Constitution, sec. 55). Now the Act in this case explicitly provides that any profit or bonus credited or paid to any shareholder of a company shall form part of his income for the purposes of that Act. On the cases, it may be established that the profits were not paid or released to the shareholders; but it is clear, we think, that these profits were credited to the shareholders. The agreement of 10th February between the company and the trustee for the shareholders stipulates (1) that the company shall allot and issue to each of the shareholders his proportion of the unissued £1 shares of the company, each credited as paid up to 10s. pursuant to the company's resolution; (2) that the shares shall be credited as paid up to 10s., and (3) that the shares so credited shall be accepted in satisfaction of the said bonus. Such a transaction could not be carried out, in point of fact or of law, unless the profits had been allocated to the shareholders and treated, in account between the company and the shareholders, as at the "credit" of the shareholders. It was suggested, during the argument, that this view of the effect of sec. 14 (b) of the Income Tax Assessment Act results in a contravention of sec. 55 of the Constitution. But the argument is met by the decision of this Court in National Trustees &c. Co. v. Federal Commissioner of Taxation[37]. Blott's Case[38], we should add, was decided under the Finance (1909-1910) Act 1910, which contains no such provision as the Federal Income Tax Assessment Act. And in Webb's Case[39] this Court was of opinion that there was no dividend or bonus credited or paid to the shareholders.

We agree that the amount credited to the shareholders was 10s. per share, and not 15s. per share (the market value).

Sec. 14 of the Income Tax Assessment Act enacts that "the income of any person shall include ... (b) dividends, ... profits, or bonus credited or paid to any depositor, member, shareholder, or debenture-holder of a company." It is incontestable on the facts stated, including the entries in the company's books, that £3,168 were credited to the appellant out of the profits of the company in respect of the 6,336 shares, that is, 10s. a share.

That satisfies the statute and, in my opinion, the answer must be that the appellant is liable to be assessed in respect of that sum.

Question answered: The appellant is liable to be assessed in respect of the sum of £3,168.

Solicitor for the respondent, Gordon H. Castle, Crown Solicitor for the Commonwealth.

[1] (1921) 2 A.C. 171.

[2] (1922) 30 C.L.R., at pp. 478-479.

[3] (1887) 12 App. Cas. 385, at p. 399.

[4] (1887) 12 App. Cas., at p. 403.

[5] (1887) 12 App. Cas., at p. 404.

[6] (1921) 2 A.C. 171.

[7] (1887) 12 App. Cas. 385.

[8] (1914) A.C. 231.

[9] (1896) 1 Ch. 559, at p. 564.

[10] (1921) 2 A.C. 171.

[11] (1887) 12 App. Cas. 385.

[12] (1921) 2 A.C., at p. 179.

[13] (1921) 2 A.C., at p. 180.

[14] (1921) 2 A.C., at pp. 182-183.

[15] (1921) 2 A.C., at p. 184.

[16] (1921) 2 A.C., at p. 194.

[17] (1921) 2 A.C., at p. 195.

[18] (1921) 2 A.C., at p. 196.

[19] (1921) 2 A.C., at p. 200.

[20] (1887) 12 App. Cas. 409.

[21] (1921) 2 A.C., at p. 187.

[22] (1921) 2 A.C., at p. 208.

[23] (1921) 2 A.C., at p. 212.

[24] (1921) 2 A.C. at p. 213.

[25] (1887) 12 App. Cas. 385.

[26] [1922] HCA 27; (1922) 30 C.L.R. 450.

[27] (1921) 2 A.C. 171.

[28] (1921) 2 A.C. 171.

[29] (1921) 2 A.C., at p. 200.

[30] (1924) 1 Ch. 359.

[31] (1887) 12 App. Cas. 385.

[32] (1921) 2 A.C. 171.

[33] (1921) 2 A.C. 171.

[34] [1922] HCA 27; (1922) 30 C.L.R. 450.

[35] (1924) 1 Ch. 359.

[36] (1914) A.C. 231.

[37] [1916] HCA 62; (1916) 22 C.L.R. 367.

[38] (1921) 2 A.C. 171.

[39] [1922] HCA 27; (1922) 30 C.L.R. 450.

High Court of Australia

James v Federal Commissioner of Taxation [1924] HCA 34; (1924) 34 CLR 404 (13 August 1924)

HIGH COURT OF AUSTRALIA