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High Court of Australia |
H C of A
10 May 1926
Starke J.
Owen Dixon K.C. and Russell Martin, for the appellant.
Sir Edward Mitchell K.C. and Herring, for the respondent.
May 10
Starke J. delivered the following written judgment:—
Penfold's Wines Ltd. took over an established business from a company of the same name, and during the first year of its trading, ending 30th June 1921, it made a profit of £68,591, which was carried to a Development Reserve Account. At an extraordinary general meeting of the company held on 6th December 1921, a resolution was carried that a dividend of one shilling and fourpence and four-fifths of a penny per share, amounting to the sum of £42,000, be declared from the profits earned during the year ended 30th June 1921, and that it be paid out of the moneys which were placed to the credit of development reserve, and that in lieu of payment of cash, shares to the full value of such dividend be issued to the shareholders entitled to the dividend in accordance with their respective rights thereto. The resolution was confirmed on 22nd December 1922. This resolution was acted upon, and proper entries made in the books of the company. The sum of £42,000 was carried to a Bonus Shares Distribution Account, and thence to Capital Account, and ultimately share certificates were issued to shareholders in accordance with the resolution and appropriate entries made in the Share Register. The genuineness of the transaction was not in any wise challenged, and I see no reason to suspect it, though it is uncertain when the entries in the various accounts were made, and some, at least, appear to have been made after the year 1922. Pursuant to the resolution of the company, 20,608 shares were issued or allotted to the appellant Hyland during the financial year 1921-1922, and the Commissioner has included the face value of those shares, namely, the sum of £20,678—it should be £20,608—in his assessable income for the financial year 1922-1923. It is from the inclusion of this sum in the assessment that an appeal has been brought to this Court.
The liability of the taxpayer depends upon a proper interpretation of the Income Tax Assessment Act 1922, sec. 16 (b) (i.) and (ii.). James v. Federal Commissioner of Taxation[1] has not settled the question, for since that decision the law has been altered. By sec. 16 (b) (ii.) it is provided that the assessable income of a person shall include the face value of shares distributed by a company to its members or shareholders in consequence of the capitalization of the whole or any part of the assessable income of the company which it is liable to include in its return for the purposes of its current assessment. A phrase such as "capitalization of income," or of "profits," must be understood in the sense in which it is used in business. Thus Palmer (Company Precedents, Part I., 12th ed., pp. 1012-1013), writing upon the capitalization of profits, says:—"Cases very commonly occur in which it is desired to capitalize undivided profits. If the issued shares are only in part paid up, the capitalization can be effected by declaring a bonus out of the undivided profits and making a call payable at the same date. But more commonly what is desired is to issue paid-up bonus shares to the members and at the same time to carry from reserve to capital account a corresponding amount. ... In order ... to compass what is desired, it is necessary to declare a bonus or dividend payable out of reserve ... so that each member may have an individual right, and then this indebtedness of the company for the bonus or dividend can be satisfied by the issue of paid-up shares." (Cf. Bouch v. Sproule[2] .) The latter method is that substantially adopted by the company and its shareholders in the present case: the transaction did not liberate and was not intended to liberate the accumulated profits of the company to the shareholders—it added to or increased the company's capital. That, in my opinion, is a capitalization of income within the meaning of the section.
But what is the "current assessment" of a company within the meaning of sec. 16 (b) (ii.) of the 1922 Act? In the present case the profits were actually made in the financial year 1920-1921; they were capitalized, and shares allotted to the shareholders of the company in the financial year 1921-1922, and the taxpayer is assessed for the financial year 1922-1923. These profits were part of the total assessable income of the company, which it was liable, under the income tax law then in force, to return, for the purpose of its assessment to income tax, for the financial year 1921-1922. The company was not liable to return these profits for the purpose of its assessment for the financial year 1922-1923: they were not income upon which the assessment of the company for that year could be based. The Commissioner contends that the "current assessment" referred to in the section is the assessment of a company current in the financial year in which the shares are distributed, namely, in this case, in the year 1921-1922. I am unable to assent to this view. Income tax is payable in respect of each financial year, based upon the income received during the twelve months preceding the year for which tax is payable (Act, sec. 13). Now, sec. 16 is ancillary to sec. 13. The income which can be included pursuant to sec. 16 must be income received for the twelve months preceding the financial year for which the tax is payable. Sec. 16 (b) (ii.) no doubt treats the distribution of shares by a company to its members as income received by those members. So far, then, it would seem that the taxpayer's income for 1922-1923 might include the full value of shares received in 1921-1922. But sec. 16 (b) (ii.) is more specific: the shares must represent assessable income which has been capitalized and which the company is liable to include in its return for the purposes of its current assessment. Those words suggest a period for the assessment identical with that for which the member of the company is also assessed. And that view is supported, I think, by the scheme of secs. 20 and 21. A company is allowed to deduct from its total assessable income for the financial year in respect of which it is being assessed, so much of that income as is distributed to its shareholders. The income must be derived by the company and distributed to its shareholders in the same period. And what the company deducts the shareholder adds to his assessable income. The provisions of secs. 20 (4) and 21 fall into line with this scheme. But it cannot be said, in the present case, that the profits capitalized and distributed in the form of shares formed part of the company's assessable income for 1922-1923, which is the period in respect of which the taxpayer is assessed. Consequently, the provisions of sec. 16 (b) (ii.) do not warrant the inclusion of the face value of the 20,608 shares in the taxpayer's assessment.
The Commissioner did not, as I understood the argument, rely upon sec. 16 (b) (i.) and the decision in James's Case[3] for in sec. 16 there is a proviso that "nothing in this section shall render liable to taxation the value of shares issued by a company to its members or shareholders in consequence of the capitalization of any other of its profits." It was rightly conceded, I think, that this proviso excluded from the assessable income of a taxpayer profits credited or paid to him as a shareholder as part of a capitalization scheme other than the profits covered by sec. 16 (b) (ii.).
Declare that the taxpayer was not assessable to income tax for the financial year 1922-1923 in respect of the sum of £20,678, as the face value of shares distributed to him by Penfold's Wines Ltd. Direct that the assessment be amended in accordance with this declaration and that the amount of tax paid by reason of the inclusion of the sum of £20,678 in the said assessment be refunded. Liberty to apply. Order the Commissioner to pay the costs of appeal.
From that decision the Federal Commissioner of Taxation now appealed to the Full Court.
Appeal allowed. Declare that the respondent was assessable in the financial year 1922-1923 in respect of the sum of £20,608 as the face value of shares distributed to him by Penfold's Wines Pty. Ltd. in the preceding financial year. Respondent to pay costs of appeal from Commissioner of Taxation and of this appeal.
Solicitor for the appellant, Gordon H. Castle, Crown Solicitor for the Commonwealth.
Solicitors for the respondent, Blake & Riggall.
H C of A
16 June 1926
Knox C.J., Isaacs, Higgins, Gavan Duffy and Rich JJ.
Owen Dixon K.C. and Russell Martin, for the appellant.
Sir Edward Mitchell K.C. and Herring, for the respondent.
May 10
Starke J. delivered the following written judgment:—
Penfold's Wines Ltd. took over an established business from a company of the same name, and during the first year of its trading, ending 30th June 1921, it made a profit of £68,591, which was carried to a Development Reserve Account. At an extraordinary general meeting of the company held on 6th December 1921, a resolution was carried that a dividend of one shilling and fourpence and four-fifths of a penny per share, amounting to the sum of £42,000, be declared from the profits earned during the year ended 30th June 1921, and that it be paid out of the moneys which were placed to the credit of development reserve, and that in lieu of payment of cash, shares to the full value of such dividend be issued to the shareholders entitled to the dividend in accordance with their respective rights thereto. The resolution was confirmed on 22nd December 1922. This resolution was acted upon, and proper entries made in the books of the company. The sum of £42,000 was carried to a Bonus Shares Distribution Account, and thence to Capital Account, and ultimately share certificates were issued to shareholders in accordance with the resolution and appropriate entries made in the Share Register. The genuineness of the transaction was not in any wise challenged, and I see no reason to suspect it, though it is uncertain when the entries in the various accounts were made, and some, at least, appear to have been made after the year 1922. Pursuant to the resolution of the company, 20,608 shares were issued or allotted to the appellant Hyland during the financial year 1921-1922, and the Commissioner has included the face value of those shares, namely, the sum of £20,678—it should be £20,608—in his assessable income for the financial year 1922-1923. It is from the inclusion of this sum in the assessment that an appeal has been brought to this Court.
The liability of the taxpayer depends upon a proper interpretation of the Income Tax Assessment Act 1922, sec. 16 (b) (i.) and (ii.). James v. Federal Commissioner of Taxation[4] has not settled the question, for since that decision the law has been altered. By sec. 16 (b) (ii.) it is provided that the assessable income of a person shall include the face value of shares distributed by a company to its members or shareholders in consequence of the capitalization of the whole or any part of the assessable income of the company which it is liable to include in its return for the purposes of its current assessment. A phrase such as "capitalization of income," or of "profits," must be understood in the sense in which it is used in business. Thus Palmer (Company Precedents, Part I., 12th ed., pp. 1012-1013), writing upon the capitalization of profits, says:—"Cases very commonly occur in which it is desired to capitalize undivided profits. If the issued shares are only in part paid up, the capitalization can be effected by declaring a bonus out of the undivided profits and making a call payable at the same date. But more commonly what is desired is to issue paid-up bonus shares to the members and at the same time to carry from reserve to capital account a corresponding amount. ... In order ... to compass what is desired, it is necessary to declare a bonus or dividend payable out of reserve ... so that each member may have an individual right, and then this indebtedness of the company for the bonus or dividend can be satisfied by the issue of paid-up shares." (Cf. Bouch v. Sproule[5] .) The latter method is that substantially adopted by the company and its shareholders in the present case: the transaction did not liberate and was not intended to liberate the accumulated profits of the company to the shareholders—it added to or increased the company's capital. That, in my opinion, is a capitalization of income within the meaning of the section.
But what is the "current assessment" of a company within the meaning of sec. 16 (b) (ii.) of the 1922 Act? In the present case the profits were actually made in the financial year 1920-1921; they were capitalized, and shares allotted to the shareholders of the company in the financial year 1921-1922, and the taxpayer is assessed for the financial year 1922-1923. These profits were part of the total assessable income of the company, which it was liable, under the income tax law then in force, to return, for the purpose of its assessment to income tax, for the financial year 1921-1922. The company was not liable to return these profits for the purpose of its assessment for the financial year 1922-1923: they were not income upon which the assessment of the company for that year could be based. The Commissioner contends that the "current assessment" referred to in the section is the assessment of a company current in the financial year in which the shares are distributed, namely, in this case, in the year 1921-1922. I am unable to assent to this view. Income tax is payable in respect of each financial year, based upon the income received during the twelve months preceding the year for which tax is payable (Act, sec. 13). Now, sec. 16 is ancillary to sec. 13. The income which can be included pursuant to sec. 16 must be income received for the twelve months preceding the financial year for which the tax is payable. Sec. 16 (b) (ii.) no doubt treats the distribution of shares by a company to its members as income received by those members. So far, then, it would seem that the taxpayer's income for 1922-1923 might include the full value of shares received in 1921-1922. But sec. 16 (b) (ii.) is more specific: the shares must represent assessable income which has been capitalized and which the company is liable to include in its return for the purposes of its current assessment. Those words suggest a period for the assessment identical with that for which the member of the company is also assessed. And that view is supported, I think, by the scheme of secs. 20 and 21. A company is allowed to deduct from its total assessable income for the financial year in respect of which it is being assessed, so much of that income as is distributed to its shareholders. The income must be derived by the company and distributed to its shareholders in the same period. And what the company deducts the shareholder adds to his assessable income. The provisions of secs. 20 (4) and 21 fall into line with this scheme. But it cannot be said, in the present case, that the profits capitalized and distributed in the form of shares formed part of the company's assessable income for 1922-1923, which is the period in respect of which the taxpayer is assessed. Consequently, the provisions of sec. 16 (b) (ii.) do not warrant the inclusion of the face value of the 20,608 shares in the taxpayer's assessment.
The Commissioner did not, as I understood the argument, rely upon sec. 16 (b) (i.) and the decision in James's Case[6] for in sec. 16 there is a proviso that "nothing in this section shall render liable to taxation the value of shares issued by a company to its members or shareholders in consequence of the capitalization of any other of its profits." It was rightly conceded, I think, that this proviso excluded from the assessable income of a taxpayer profits credited or paid to him as a shareholder as part of a capitalization scheme other than the profits covered by sec. 16 (b) (ii.).
Declare that the taxpayer was not assessable to income tax for the financial year 1922-1923 in respect of the sum of £20,678, as the face value of shares distributed to him by Penfold's Wines Ltd. Direct that the assessment be amended in accordance with this declaration and that the amount of tax paid by reason of the inclusion of the sum of £20,678 in the said assessment be refunded. Liberty to apply. Order the Commissioner to pay the costs of appeal.
From that decision the Federal Commissioner of Taxation now appealed to the Full Court.
Appeal allowed. Declare that the respondent was assessable in the financial year 1922-1923 in respect of the sum of £20,608 as the face value of shares distributed to him by Penfold's Wines Pty. Ltd. in the preceding financial year. Respondent to pay costs of appeal from Commissioner of Taxation and of this appeal.
Solicitor for the appellant, Gordon H. Castle, Crown Solicitor for the Commonwealth.
Solicitors for the respondent, Blake & Riggall.
1. [1924] HCA 34; (1924) 34 C.L.R. 404.
3. [1924] HCA 34; (1924) 34 C.L.R. 404.
4. [1924] HCA 34; (1924) 34 C.L.R. 404.
6. [1924] HCA 34; (1924) 34 C.L.R. 404.
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