Shelley v Federal Commissioner of Taxation [1929] HCA 31; (1929) 43 CLR 208 (4 November 1929)

I have had the advantage of reading the reasons about to be published by my brother Dixon, and agree with him in thinking that the constitution of the Distributors' Commercial Co. Ltd. is lacking in distinctive features essential to the constitution of a "co-operative" company properly so called. I agree also that clause 137 of the articles of association is not sufficient to render the Company "co-operative." Indeed, it seems to me that in its present form that clause amounts to a negation of the co-operative principle. It is not necessary in this case to decide whether a company formed for the sole purpose of benefiting middlemen, who are neither producers nor consumers, and whose benefit is only attainable at the expense of either the producer or the consumer, can properly be classified as a "co-operative" company, and I desire to reserve my opinion on this question.

The appellant is a merchant and importer, and is taxable in respect of his business income. As to the amount of his actual gross income from his business, there is no question. But he claims to have that income reduced by a sum of £971 3s. 9d., received from the Distributors' Commercial Company Ltd.

The claim is rested on the provision in sec. 4 of the Income Tax Assessment Act that in that Act "income" does not include "any rebate received by a member of a co-operative company based on his purchases from that company, where the Commissioner is satisfied that ninety per centum of its sales is made to its own members." I shall assume for present purposes that the sum in question answers the description in that provision.

It is plain that wherever the word "income" is found in the Act, it must, in the absence of a contrary intention appearing, be read so as to exclude the sum of £971 3s. 9d. Consequently, that sum does not form part of the taxpayer's gross income, although in the absence of that provision it might be included by virtue of sec. 16 (b). If, therefore, the Commissioner had proceeded to add it to the gross proceeds of the business, which do not include it, and would remain the same even if the rebate had never been received, the taxpayer could rightfully have insisted on its excision. But could he also have insisted, as he is doing here, not only on its absence from the gross income side of the computation, but also on its addition to the deductions from the rectified gross income? To do so would require some provision in the Act allowing it. "Taxable income"—which, of course, excludes this rebate—"means the amount of income remaining after all deductions allowed by this Act have been made." The deductions allowed by the Act include losses and outgoings actually incurred in producing income. When a rebate is made to a purchaser of goods based on his purchase, it means that his purchase price is by so much the less. To support the claim, therefore, the deduction of the rebate from the nominal price must be excused, or its deduction from the gross income allowed, by some express provision. No such provision exists. It comes to this, that the provision relied on is irrelevant, because the Commissioner is not seeking to tax it; and there is no other provision enabling the taxpayer to ignore it in arriving at his actual cost of purchases, nor can one see why there should be.

The notice of objections and the case stated treat the sum of £971 3s. 9d. as entire in relevant characteristics and legal result. Sec. 39 of the Act makes the assessment prima facie evidence that the amount and all the particulars of the assessment are correct, and there is nothing to show the contrary in respect of time. The case may therefore be determined on this point alone. Still, as co-operative companies are considered by the Legislature sufficiently important to receive special attention, I think I ought to express my opinion on this part also.

It is true that sub-sec. 1A of sec. 20 says that the definition of "co-operative company" is "for the purposes of the last preceding sub-section." But it does not say for that sub-section only. It is therefore open as a matter of construction of the Act as a whole to see whether any other meaning is intended in sec. 4. It is highly improbable that Parliament intended by "co-operative company" two different kinds of company. It is still more improbable that the "rebates based on purchases by shareholders from the Company" in sub-sec. 1 meant anything different from "rebate received by a member of a co-operative company based on his purchases from that company" in sec. 4. Again, the language in sec. 20 as to commodities and animals is so strikingly like that in sec. 4 that I cannot doubt they were fashioned in the same mould of thought and were meant to be worked together. But, adopting that view, I cannot find in the rules of the Company any limitation of the number of shares which may be held by or by and on behalf of any one member, or which prohibits the quotation of the shares at the Stock Exchange.

For this reason also I think the first question should be answered in the negative, and the second in the affirmative.

The taxpayer complains that his taxable income derived during the twelve months ending 30th June 1926 has been assessed for the succeeding financial year at an amount too large by the sum of £944 12s. 6d. This sum is the balance of an amount which he received on 24th March 1926 from a company of which he was a member, called formerly "Distributors' Co-operative Company Limited" but now "Distributors' Commercial Company Limited." The amount which he so received was composed of two sums.

The first, a comparatively small sum, was calculated upon the purchase price of goods supplied to him by or through the Company during the twelve months ending 31st December 1924. The second, the larger sum, was calculated upon the purchase price of goods, supplied to him during the twelve months ending 31st December 1925. The taxpayer contends that these sums should be excluded in the ascertainment of his taxable income because of par. (c) of the definition of in sec. 4 of the Income Tax Assessment Act 1922-1927. That paragraph provides: "Income ... does not include (c) any rebate received by a member of a co-operative company based on his purchases from that company where the Commissioner is satisfied that ninety per centum of its sales is made to its own members." The Commissioner was in fact satisfied that ninety per cent of the Company's sales were made to its own members, but he denies that it was a co-operative company. He further maintains that even if the Company were co-operative, the taxable, income should not be reduced by these sums. He says that par. (c) of the definition of "income" does no more than forbid the inclusion of rebates from a co-operative company in the assessable income as revenue; that properly understood the sums in question are not receipts or revenue, but mere reductions or diminutions of the amounts which otherwise the taxpayer would expend in acquiring his goods. Sec. 23 (1) provides that "in calculating the taxable income of a taxpayer the total assessable income derived by the taxpayer ... shall be taken as a basis, and from it there shall be deducted (a) all ... outgoings ... including ... expenses actually incurred in gaining or producing the assessable income." The Commissioner concedes that when he is satisfied that ninety per cent of the sales of a co-operative company are made to its own members, rebates received by a member based on his purchases from that company are not to be included in the member's total assessable income, but he contends that if these purchases are made in the way of trade or business, and the sums laid out in them are therefore to be deducted as outgoings or expenses incurred in gaining the assessable income, then it is not the gross amount charged in the first instance which is to be deducted from the assessable income but the net amount actually expended, arrived at by diminishing the gross amounts by the rebates. It is to be observed that this argument leaves little or no operation to par. (c). For if a rebate, based upon purchases, is a mere reduction of expenditure, it could not be a receipt or constitute revenue, whether the expenditure was made in order to produce income, or for some other reason. It would thus be needless to provide that income should not include such rebates.

It is further to be remarked that the contention does not give a consistent application to the provisions of sec. 23 (1) (a) upon which it depends. It is based upon the view that sec. 23 (1) (a) prescribes the method of ascertaining the profits of a business. This view was expressed by Higgins J. in Webster v. Deputy Federal Commissioner of Taxation[1] as follows:—"To determine the profits of the business is not—I say it with all respect—the first step to be taken. Under the definition in sec. 4 of income from personal exertion, the first step is to ascertain the proceeds—the gross proceeds—of the business carried on by the taxpayer. These proceeds (including all the moneys realized from the sale of trading stock or wool) become the assessable income; from the assessable income have to be deducted (inter alia) all losses and outgoings (not being in the nature of losses and outgoings of capital) (sec. 23 (1) (a)). What remains after the deductions is the taxable income (sec. 4; sec. 23)." But this view necessitates a comparison between the sum of actual gross receipts and the sum of actual gross expenditure incurred in gaining income. The taxpayer actually expended the full purchase price of the goods, and actually received the sums said to be rebates. But instead of applying sec. 23 (1) (a) by first getting the total gross revenue, the assessable income which (but for par. (c) of the definition of "income") would include the rebates received and then ascertaining the total "outgoings" or "expenses" which would include the full price paid over for the goods, this full price is first diminished by deducting the rebate, and not until it is so diminished is it included in the outgoings.

But apart from these considerations this contention of the Commissioner is misconceived. For, upon the facts of this case, it does not operate to support the assessment. The rebates in question were not allowances made in respect of the price of the goods bought or paid for in the twelve months in which the income under assessment was derived, but in respect of purchases made in two consecutive periods of twelve months the last of which ended in the middle of this year of income. Thus the sums in dispute are not discounts or reductions of expenditure which otherwise would be allowed in full as a deduction in the year of income. It is true that there is a period of six months common to the year of income and to the last year for which the rebate was paid. It may therefore be that some part of the last rebate was in fact attributable to purchases made or paid for within the year of income, but the special case does not state that this is so. On the contrary it deals with rebates as entire sums. It follows that if Distributors' Commercial Co. Ltd. is a co-operative company within the meaning of par. (c) of the definition of "income," the two sums which compose the amount of £945 17s. 6d. ought not to be included in the assessment. The question whether it is a co-operative company must therefore be considered.

This does not depend upon the artificial definition of co-operative company introduced into sec. 20 as sub-sec. 1A by the Income Tax Assessment Act 1925 (No. 28 of 1925). That definition is confined in its application to sec. 20 (1), and can only be of indirect assistance in determining the connotation of the expression used in the definition of in sec. 4. To discover that connotation is no easy matter. The word "company" is defined to include all bodies or associations corporate or unincorporate. But what attributes must such a body or association possess in order to answer the description "co-operative"? "Co-operation" is defined by the Oxford New English Dictionary to mean, when used in political economy, "the combination of a number of persons, or of a community, for purposes of economic production or distribution, so as to save, for the benefit of the whole body of producers or customers, that which otherwise becomes the profit of the individual capitalist." But it appears from a survey of the long history of the "Co-operative Movement," and a perusal of some of the works which describe the many applications of its principles, that the means by which this general purpose is worked out vary almost without limit. Indeed, the opening statement of the supplementary article on Co-operation in the 12th edition of the Encyclopædia Britannica does not go too far in saying that the term covers a large number of forms of economic organization which have little resemblance except that of name. The author (Mr. Leonard Woolf) simply resorts to classification. "Co-operative organizations may," he says, "be conveniently classified under four main heads:—Consumers Co-operation, Industrial Producers Co-operation, Co-operative Credit and Banking, Agricultural Co-operation." This or some similar classification is generally adopted, but usually without much attempt to discern and define the common characteristics which the word "co-operation" is intended to express. The late Mr. Aneurin Williams, who contributed the article upon Co-operation to the 11th edition of the Encyclopædia Britannica, was alive to the lack of a clear conception of what the term "co-operative" exactly connotes when thus used, and he made some endeavour to supply the want. In effect, he considered that there must be a voluntary association or working together for the production or distribution of wealth, but so that the shares of those concerned were not determined by competition (i.e., a struggle and the relative ability of each to secure a large share) and so that all concerned had an opportunity to share in the ultimate control. But he found it necessary to add:—"We speak of co-operative societies for agriculture, for manufacturing, for retail, or wholesale distribution, for building or house-owning, for raising capital and so forth; while the great Friendly Societies though a part of co-operation as a theory of life, are not part of the co-operative movement. The line is somewhat hard to draw, and consequently is drawn somewhat arbitrarily. Thus while a society for building, or for the collective ownership of houses, is counted a co-operative society, a building society (as we ordinarily understand the term), though it be purely mutual in its basis, is not so counted in Great Britain, but is in the United States." This attempted analysis leaves out of account an element which some writers, who perhaps discuss co-operation rather as a means of social, economic or industrial amelioration, describe as essential to the conception. This element is the free or unrestricted admission to membership of the co-operative association. Thus Mr. C. R. Fay in his Co-operation at Home and Abroad (2nd ed., 1920, pp. 4-5) says:—"The ultimate criterion is this: are the members prepared to admit to the benefits of their society on proportionately equal terms all those who, being of suitable character, are commercially as weak as or weaker than themselves? If so, the society is co-operative. We have, therefore, as our final definition of the co-operative society: An association for the purposes of joint trading, originating among the weak and conducted always in an unselfish spirit, on such terms that all who are prepared to assume the duties of membership share in its rewards in proportion to the degree in which they make use of their association. Any narrower definition runs the risk of excluding much that claims, and is recognized, to be co-operative." (See, too, Webb, Consumers' Co-operative Movement, at p. 9.) The capacity of such an association to enlarge its membership is almost necessarily inconsistent with a distribution of dividend upon share capital, and with the existence of a fixed capital divided into shares. To multiply shares would tend to reduce dividends, if what the rules of the co-operative union describe as "the fund commonly called profit," was distributed as a dividend upon share capital. But additional members could not be admitted indefinitely without indefinite multiplication of shares.

Those who regard co-operation from a business point of view find that the thing which distinguishes it from all other forms of organization for trading or production, is that the surplus remaining after the capital invested has been rewarded by a fixed percentage and all expenses have been met, is distributed or allocated among the members in proportion to their dealings. Thus in the Co-operative Wholesale Societies' Bank, the surplus, which remains after a period of business, is appropriated to increase interest upon deposits, and to reduce the charge for overdrafts. (Webb, Consumers' Co-operative Movement, p. 99). In Ireland the provision usually made by the co-operative agricultural and dairying societies is, or was, (1) that the surplus arising from general business should be appropriated first in payment of a fixed percentage on share capital, next in a subvention to reserve, and then in a distribution of the balance among members in proportion to their sales through, and purchases from the society; (2) that the surplus arising from the dairying business, after providing for a fixed percentage on share capital should be appropriated in paying to employees an additional remuneration of a specified percentage on wages, and in distributing the balance amongst those who supplied milk, cream or other produce to the society, in proportion to the value of their supplies. (See Industrial Co-operation, 3rd ed., p. 153, by Catherine Webb). In consumers' co-operation, although an equal division of profits is recognized (see Walker. Political Economy, sec. 433), a division according to the value of purchases is required by what is called "the Consumers' Theory of Co-operation." "This," says Mr. Aneurin Williams in his Co-partnership and Profit Sharing, at p. 215, "is, that all profit is due to the consumer, that, in fact, the value of everything is caused by him, seeing that if there were no consumers desiring to purchase, even the rarest thing, and the thing produced with the most labour and capital would be valueless. If the consumer, says this theory, be charged 7d. for what costs the producer 6½d. to produce—including cost of materials, wages, and all necessary expenses—then he is overcharged a ½d., and he has a claim to have that ½d. returned to him. If the ½d. is retained by the producer it is a profit on the price for which he sells the article, and profit on price is the forbidden fruit in the eyes of this school. They claim that a society which pays out its so-called profits to its customers as a dividend on their purchases, does not really make any profit; it merely retains, temporarily, a balance belonging to the consumer and ultimately returned to him."

The British Legislature took account of these features in co-operation, and by the Industrial and Provident Societies Acts 1852, 1862 and 1876 (now consolidated in that of 1893) provision was made for the incorporation and regulation of societies with limited liability but without a specified nominal capital and therefore capable of admitting an indefinite number of members. A limit was placed upon the number of shares which one person might hold. In partial recognition of the theory of profit, or absence of profit, held by co-operators, it was provided that a registered society should not be chargeable under Sched. C of the Income Tax Acts (profits arising from interest, annuities, dividends and shares of annuities payable out of any public revenue) or Sched. D (balance of profits or gains from trade, vocation, &c.) unless it sells to persons not members thereof, and the number of shares of the society is limited either by its rules or its practice. (See sec. 24 of the Industrial and Provident Societies Act 1893 (56 & 57 Vict. c. 39) and sec. 39 (4) and 7th Sched. of the Income Tax Act 1918 (8 & 9 Geo. V. c. 40)). The profits or surpluses of such societies were, however, subjected to excess profit duty (see Finance Act (No. 2) 1915, 4th Sched., Part. I., cl. 10, and Finance Act 1917, sec. 26 (8)). And corporation profit tax was imposed upon any profit not paid out by way of bonus, discount, or dividend on purchases. (See sec. 53 (2) (h) of Finance Act 1920 (10 & 11 Geo. V. c. 18); see too Webb, Consumers' Co-operative Movement, pp. 259 et seq. and 263 (n).)

The various forms of co-operation described above were all known in Australia and many of them were practised (see "Co-operation in Australia," contributed to the Commonwealth Year Book No. 17 (1924), at pp. 581 et seqq., by Mr. H. Heaton, lecturer in economics, University of Adelaide). But it was not until the Income Tax Assessment Act 1918 that any special provision was made in the Federal income tax law in respect of co-operative companies. That Act inserted in the definition of "income" a provision that it should include "(b) in the case of a co-operative company or society—all sums received from members in payment for commodities supplied or animals or land sold to them or received in respect of commodities animals or land sold by the company or society whether on its own account or on account of its members." This provision is necessarily confined, on the one hand, to what may in spite of the mention of land be called "consumers' or consumptive co-operation," and on the other, to co-operation for the disposal of vendible things. But in spite of the restriction in the application of the term co-operation which this involves, it remains possible to contend that a company is not co-operative (1) if its membership is limited; (2) if its control is not vested in members equally, or according to dealings, but according to investment or subscriptions of capital; (3) if its constitution does not require the division of "the fund commonly called profit" among the members who deal with it in proportion to their dealings; or (4) if its purpose or primary purpose is not to serve the "consumer" or the user as such, or the "producer" as such, as the case might be. Possibly the enactment was necessary only by way of precaution and did not in fact alter the law. For it might be supposed that the sums derived by such co-operative companies from transactions would fall within Last v. London Assurance Corporation[2] rather than within the New York Life Insurance Co. v. Styles[3] and Jones v. South-West Lancashire Coal Owners' Association[4]. But, however this may be, it was followed by the enactment in the Income Tax Assessment Act 1921 of the provision that income should not include "(c) any rebate received by a member of a co-operative company based on his purchases from that company where the company is one which usually sells goods only to its own members." This was enacted probably because it was thought to be the logical consequence of par. (b). But it extends only to co-operation for the supply of goods, commonly called consumers' or consumptive co-operation. When in the Act of 1922 the provision was re-enacted in its present form, it was still confined in effect to this form of co-operation, although ten per cent of the society's sales may now be made to non-members and although sales of land may perhaps be included now that the word "goods" is dropped.

It is evident that the meaning of co-operative company in par. (c) can be no wider than in par. (b) and the contentions open as to the requirements of the term in the one case are open in the other. But whatever characteristics may be required in order to bring a company within that expression, it seems reasonably clear that the company must possess them by virtue of its constitution. It is not enough that a company may in fact conduct a series of transactions or a business upon principles which justify the title "co-operative." The company itself must be a union for "co-operation." To render the company co-operative by its constitution it is at least necessary that the contract inter socios shall be "co-operative."

Distributors Commercial Co. Ltd. was incorporated in 1916 under the Companies Act 1899 of New South Wales by the name Distributors Co-operative Co. Ltd. Its members were and are merchants. Amongst the objects of its memorandum were the following: "(9) To carry on the business of a co-operative store and general supply society in all its branches and to transact all kinds of agency business; (11) to promote economical buying on the co-operative principle; (15) to control, conduct and organize the trade of the members of the Company and promote their mutual benefit; (16) to disseminate trading intelligence amongst the members of the Company and mitigate bad debts." But its objects were 62 in number, and enabled the Company to do almost anything, and to do it on ordinary commercial or capitalist principles. The Company was limited by shares, and its nominal capital is £100,000 divided into 1,000 shares of £100 each. The transfer of shares is restricted to persons approved by an extraordinary resolution of the Company. No limit is placed upon the number of shares a member may hold.

It is not easy to interpret the articles which relate to the votes of members (69-75), but probably their effect with sec. 248 of the Companies Act 1899 N.S.W. is to give to each member one vote, whether upon a poll or otherwise, irrespective of his shareholding. Arts. 137, 138 and 149 are as follows:—"(137) Subject to the provisions as to reserve fund and to any extraordinary resolution of the Company with respect to the same the profits of the Company which it shall from time to time determine to divide shall be divisible amongst the members by way of dividend at a rate not to exceed 8 per cent per annum on the share capital paid up from time to time and any balance remaining over after such payment of such dividend shall be divided between the members for the time being as a bonus in proportion to the amount of their purchases respectively from or through the agency of the Company as determined by the Company in general meeting." "(138) Subject to the foregoing clause the Company in general meeting may declare a dividend or bonus to be paid to the members according to their rights and interests in the profits and may fix the time of payment." "(149) If the Company shall be wound up the surplus assets shall subject to the rights of the holders of the shares issued upon special conditions be distributed amongst the members of the Company in the first place in paying to them the amount of capital paid up on their respective shares and in the second place in paying to them a cumulative dividend of 8 per cent per annum upon the amounts paid up on their shares respectively calculated from the date of registration of the Company but less all sums theretofore paid to such members by way of dividend and in the third place any surplus then remaining shall be distributed amongst the members of the Company in proportion to the amount of their purchases respectively from or through the agency of the Company during the twenty-four calendar months next before the winding up of the Company."

The Company in fact has acquired and supplied to its members commodities in which they trade. It charged a price calculated by adding to the net cost price charged to it (but without deducting a special discount arranged for with the supplier) the costs of handling, &c., and ½ per cent to cover expenses and dividend of 8 per cent on its capital. The price so obtained was paid to it by its members, and was sufficient to meet the items of expenditure for which it was required. But in fact the Company obtained from its suppliers a special discount, with the result that a balance of profit remained to it and this was divided amongst the members. The special case says:—"The amount so divided was calculated separately in respect of each commodity in the manner hereinafter stated. That part of the amount so divided which was paid to each member in respect of each commodity (other than kerosene) was that part of the special discount allowed to the Company in respect of that commodity which the Company considered was attributable to that part of such commodity which such member had purchased." The distribution is not precisely in conformity with art. 137 because it discriminates among the various classes of commodities bought. The article contemplates a distribution of a lump sum of profit in proportion to all purchases. The principle of division is nevertheless co-operative in its general character. But the Company does not employ this principle of division for the purpose of supplying consumers or users of the commodities. The members whom it supplies are indeed traders, who deal in the commodity for profit. They are employing the co-operative principle to facilitate the very method of distribution which the originators of "The Co-operative Movement" desired to replace. But if by its constitution the Company had other attributes which would entitle it to the description co-operative, this fact might not be enough perhaps to take it outside the description. For instances are given of co-operative societies, one of which has even gone into production for exchange, and another accommodates shopkeepers with the use of its refrigerating store. (Webb, Consumers' Co-operative Movement, pp. 76, 80.) Indeed the Wholesale Co-operative Society which supplies retail societies is said to be no more than "practically" open only to co-operative societies (p. 96). Moreover, the definition in sec. 20 (1A) does not include such a requirement.

Desirable as it might be to formulate a definition of "co-operative company," the conclusion seems to be unavoidable that there is no one characteristic, the presence or absence of which is essential to the description co-operative. It is a term used to describe bodies which differ in character and purpose but possess enough of the features commonly associated with the description to bring them within one of the categories recognized as deserving the title.

But in the case of this Company most of the features are absent which are relied upon, whether alone or in combination, as a justification of the title Co-operative. It does not serve the consumer or user. Its membership is not open to all who may desire its services. Its capital is fixed. There is no limitation upon the number of shares to be held by one person. Its trade is not restricted to its members. It is not concerned with social, economic, industrial, or other amelioration. The facts upon which it depends for the title are that it distributes "the fund commonly called profit" among its members in proportion to their dealings, and that it is controlled by members who vote without reference to share capital. Perhaps these characteristics would be enough if the articles of association bound the Company absolutely to this course of distribution and this method of voting. But art. 137 is expressed to be subject to an extraordinary resolution. It does not prescribe what may be called "co-operative distribution" of profit. It merely requires it unless and until a three-fourths majority of those present at a meeting resolve otherwise pursuant to notice. Having regard to the absence of all other attributes of co-operation, such a provision in the contract inter socios is not enough to render the Company co-operative in its constitution.

For these reasons the first question in the special case should be answered No and the second Yes.

Solicitor for the respondent, W. H. Sharwood, Crown Solicitor for the Commonwealth.

[1] [1926] HCA 52; (1926) 39 C.L.R. 130, at p. 135.

[2] (1885) 10 App. Cas. 438.

[3] (1889) 14 App. Cas. 381.

[4] (1927) A.C. 827.

High Court of Australia

Shelley v Federal Commissioner of Taxation [1929] HCA 31; (1929) 43 CLR 208 (4 November 1929)

HIGH COURT OF AUSTRALIA