Federal Commissioner of Taxation v Standard Trust Ltd [1933] HCA 19; (1933) 49 CLR 609 (24 April 1933)

The Federal Commissioner of Taxation Appellant; and The Standard Trust Limited Respondent.

This is an appeal from the judgment of Cussen A.C.J. allowing an appeal from an assessment for Federal income tax for the financial year 1928-1929, based on income derived in the calendar year ended 31st December 1927. By the order appealed from, his Honor set aside the assessment and remitted it to the Commissioner for reconsideration. The appellant company, which was formerly called the Melbourne Trust Ltd., when it was constituted in 1903, acquired from three other companies a mass of assets in consideration of debenture stock and shares. The primary purpose of the company was to dispose of these assets to advantage, and it was held that in doing so it was carrying on business as a trading company and that "the surplus realized by it by selling the assets at enhanced prices is a surplus which is taxable as profit" (Commissioner of Taxes v. Melbourne Trust Ltd.[1]). The reports of this case[2] provide a full statement of the circumstances affecting the formation of the company and its method of operations until 1909. The assessment appealed from in the present proceedings assesses the company upon a net income of £92,008 derived from sources in Australia during the twelve months ended 31st December 1927. This figure is ascertained by a dissection of a sum of £150,000 which, pursuant to alterations of the articles of association, adopted during the year, the directors appropriated substantially in equal proportions to a capital reserve fund and a general reserve fund. The assessment proceeds upon the view that the appropriation amounted to an unequivocal acknowledgment that the sum appropriated was profit and to a detachment of the sum from the general funds of the company so that it should be considered income derived during the year in which this was done. The ultimate conclusion of the judgment appealed from is that the amount so dealt with by the company, in so far as it comprised assessable income, was derived, not during the year ended 31st December 1927, but during a period which did not extend into that year. It is not disputed that the sum included in the assessment was, before the opening of the year 1927, contained in the funds of the company and that the operations of the company which brought it into its hands were performed before that date and had caused its receipt. The contention of the Commissioner is that the sum had not the clear characteristics of income until it was, so to speak, severed from the receipts or funds of the company and diverted from them in a manner which impliedly acknowledged that it was income. The sum of £92,008 represents the proportion obtained from Australian sources of amounts credited to the company's realization reserve account. This account contained a record of the results of the company's dealings with the assets acquired at its inception in consideration of shares and debenture stock. The entire basis of the assertion that the sum in question standing at the credit of that account bore an equivocal character until it was appropriated, as income only could be, is a supposed analogy which the Commissioner has found between the condition of the company and its financial operations in 1927 and that of 1909, dealt with in the Privy Council (Commissioner of Taxes v. Melbourne Trust Ltd.[3]). At that date the company had not realized by the disposal of its original assets a sufficient amount to cover the value at which they were acquired or the value at which they were taken into the account. Its debenture stock had not been paid off and, by an article of association, the company was prohibited from paying any dividend out of such realizations until the debenture stock was redeemed. The proceeds of realization were accordingly carried to a realization account, and, so far as concerned the question whether the contents of the account constituted profit or a fund available for dividend, it was necessarily true that the account might properly be considered a suspense account. Until enough was recovered by the realization of the assets to cover the amount treated as expended in their acquisition there could be no logical certainty that any sum at its credit represented profit on the entire transaction. Until the debenture stock was paid off none of the moneys contained in the account was available for dividend. The Privy Council had before them this state of affairs obtaining in 1909. The facts, however, showed that by 15th October 1909 the whole of the debenture stock had been paid off and that out of the moneys to the credit of the realization account the directors resolved to distribute 6d. a share as a bonus to the members of the company and further proposed a distribution of new debenture stock to the shareholders, paid up out of the same source. Their Lordships, whose opinion was delivered by Lord Dunedin, after holding that the initial figure at which the original assets were taken into the company's account represented real value and should be adopted said:—"But it is possible that other investments on realization may show loss instead of profit; and it is obvious that it is in the totality of the transactions that the question of profit comes to be fixed. Their Lordships are, however, of opinion that the company may well be held bound by its own actions. In distributing a bonus of 6d. per share it affirmed that to that extent at least there was profit realized. In the same way in making a distribution of debenture stock on and after August 10, 1910, they may be held to have distributed profit. ... As regards the question of when a profit is earned their Lordships' view is that a profit can be said to be earned when it is dealt with as a profit. In ordinary cases this synchronizes with the realization of the sums which swell the assets of the person or company, and which entering the account (whether on the creditor or debtor side will depend on the particular account in view) go to bring out the balance which is deemed profit. But for the reasons already given their Lordships think that in a case like this the company are entitled to hold at least a part of their realizations in suspense—as indeed they have done in their accounts—and that it is only when finally the same is given to the shareholders that the final impress of profit is, so to speak, stamped upon it, and that therefore, for the purposes of the Act, that is the time at which it is earned"[4]. Among the declarations made by their Lordships was the following:—"Declare that as regards the bonus of 6d. per share referred to in par. 7 of the directors' report of April 9, 1910, there is evidence sufficient to show that this is taxable as profit so far as it was earned in or derived from Victoria; and that pari ratione the distribution of debenture stock to shareholders calculated as justified by the state of the realization reserve account should be properly held to be taxable as profit according to the pecuniary value thereof"[5]. Now, to my mind, it is obvious that the whole foundation of these observations and of their Lordships' decision upon this point is the condition of the company's affairs at that time when the result of the "totality of the transactions" was not known, although it is upon that totality that "the question of profit comes to be fixed." If in these circumstances a corporation exercising a trade in carrying out such transactions chooses to detach from the moneys so far recovered a sum which it forthwith treats as profit it avows that by the exercise of trade it has, when it does so, earned that profit. But when it has become clear that a profit has been earned on the "totality of the transactions" and it continues to trade with the assets remaining in its hands quite different considerations arise. It needs no exercise of judgment on the part of the directors, no determination to appropriate funds, and no distribution, to establish the character of the moneys derived. The ascertainment of their character depends upon nothing but the construction of the correct account. In the present case Cussen A.C.J. has made a close examination of the company's condition and of its accounts, and, to my mind, has shown conclusively that the realization account was not considered and could not be considered a suspense account in any relevant sense, that a clear profit had arisen on "the totality of the transactions," and that the moneys out of which £92,008 came were accumulations in the hands of the company which bore no equivocal character. I cannot agree with the contention on the part of the Commissioner that, because large sums had already been distributed to the shareholders, and because losses might have been incurred in dealings by the company with other assets, or deficiencies in the book values of such original assets as might be considered still in the company's hands at any relevant date might appear on realization, therefore the contents of the realization account must be still considered as held in suspense awaiting determination whether they represented profits or not. This argument departs from the issue. In every trading concern valuations may be falsified by the event, and net profits ascertained on the trading account at a particular date may be lost in subsequent operations. The issue is, whether, apart from severance or detachment from the company's funds, it could be said that in the disposal of the items of a mass of assets a profit had been made. Once the expenditure in acquiring the entire mass has been recovered the particular difficulty, in my judgment, vanishes. I entirely agree with the judgment of Cussen A.C.J. and think the appeal should be dismissed.

The Melbourne Trust Ltd. was incorporated in England in the year 1903, and in 1927 changed its name to The Standard Trust Ltd. It was formed to take over, nurse, develop and realize the assets of three other companies, and for other purposes. The Commissioner of Taxes for the State of Victoria assessed the company to income tax in respect of the year 1910, and the Judicial Committee held in 1914 that the surplus realized by the company over the purchase price paid for the assets sold, after making all just deductions, was profit taxable as income in the following year (Commissioner of Taxes v. Melbourne Trust Ltd.[6]). The Federal Commissioner of Taxation has now assessed the company under the Federal Income Tax Assessment Act for the financial year 1928-1929 in respect of a sum of £92,008, based, as he asserts, upon the taxable income of the company derived directly or indirectly from sources in Australia during the year 1927, its accounting period (Income Tax Assessment Acts 1922-1928, 1922-1930, sec. 13). The sum of £92,008 is part of a sum of £150,000 standing to the credit of the company's "reserve account" in 1927, and which in that year the directors, in accordance with its articles of association, divided, and transferred to "capital reserve fund" and "general reserve." The parties, in view of the decision of the Judicial Committee, have not contested that the sum of £92,008, or the greater part of it, is assessable income, but the question is whether that sum is assessable income for the year in respect of which it was assessed, namely, the financial year 1928-1929. The determination of that question involves an examination of the reserve accounts of the company and how they were built up.

The realization reserve account spoken of in this report consisted of the net surplus on realizations and the profit arising from the purchase of the debenture stock. In the balance-sheet as at 31st December 1910, realization reserve account disappears, and a new account appears, "Reserve account." To it are credited the balance on revaluation above mentioned, £41,970 13s. 4d., further surpluses on realization, and profits on purchase of debenture stock from the dividend equalization account, making a total of £47,998. In the next balance-sheet, 31st December 1911, and in all future balance-sheets, to and inclusive of that as at 31st December 1926, the account appears as reserve account, and to its credit are placed surpluses on realization, profits on purchase of debenture stock, appropriations from profit and loss, premiums on shares issued, war loan interest, and against it have been debited losses on realizations and discount and brokerage expenses of debenture stock issue. On 31st December 1925, and on 31st December 1926, the reserve account stood in credit £150,000. But was that sum a realized profit before the end of 1926, as the company now asserts, and so definitely ascertained that it could be treated as income earned or derived by the company at or before that time? It is a question of fact, upon which the actions of the company may well throw light.

It will be remembered that, before the end of 1909, the company had paid off its original debenture-stock issue of £392,485, and had distributed to the shareholders 6d. per share in cash and 3s. 4d. per share in debenture stock or cash in lieu thereof. As to this, the Judicial Committee observed that in distributing a bonus of 6d. per share the company affirmed that to that extent at least there was a profit realized. In the same way, in making a distribution of debenture stock on and after 10th August 1910, they may be held to have distributed profit. It may be open to doubt whether their Lordships would have reached the latter conclusion if they had known, as they did not, that the distribution of 3s. 4d. per share in debenture stock was based largely upon a revaluation of assets and not upon profits actually realized and placed to the credit of the realization reserve. The debenture stock issued about August 1910 was redeemed as the realization of the assets taken over proceeded. The balance-sheets give the history of the matter:—

Before 31st December 1914, the whole of the 4 per cent debenture stock issued about August 1910 had been redeemed (see directors' report submitted to a meeting on 29th April 1915).

It thus appears that, by the end of 1926, practically the whole of the assets acquired by the company had been realized, and that the company had redeemed the debenture stock originally issued as part of the purchase price (£392,495) and had distributed in cash 6d. per share in May 1910 (£34,166), and the sum of 3s. 4d. per share (£246,559) resolved upon about August of 1910, either by payments in cash or redemption of debenture stock then issued, and still held £50,000 7 per cent cumulative preference shares received on account of Strathdarr, or the proceeds thereof, and unrealized assets valued at £14,496; in addition, there was the sum of £150,000 in reserve account as already mentioned.

Despite these outstanding facts, the Commissioner insists that the sum of £150,000, or the part thereof derived from Australian sources, can and should be treated as taxable income of the company derived directly or indirectly by it during the year 1927. The argument depends upon the reasons assigned by the Judicial Committee for their advice in the Melbourne Trust Case[7]:—"It is obvious that it is in the totality of the transactions that the question of profit comes to be fixed. Their Lordships are, however, of opinion that the company may well be held bound by its own actions. In distributing a bonus of 6d. per share it affirmed that to that extent at least there was profit realized. In the same way in making a distribution of debenture stock on and after August 10, 1910, they may be held to have distributed profit. ... As regards the question of when a profit is earned their Lordships' view is that a profit can be said to be earned when it is dealt with as a profit. In ordinary cases this synchronizes with the realization of the sums which swell the assets of the person or company, and which entering the account (whether on the creditor or debtor side will depend on the particular account in view) go to bring out the balance which is deemed profit. But for the reasons already given their Lordships think that in a case like this the company are entitled to hold at least a part of their realizations in suspense—as indeed they have done in their accounts—and that it is only when finally the same is given to the shareholders that the final impress of profit is, so to speak, stamped upon it, and that therefore, for the purposes of the Act, that is the time at which it is earned."

Now, the facts in the present case establish that the company never made any return to the Commissioner before or after 1926 setting forth that the sum of £150,000 or any part of it was income or profit of the company. The company, through its taxation expert, informed the Commissioner that the reason why the profits on realization of assets and securities were not included in the Federal income tax return was because the company considered that, in view of the decision of the Judicial Committee in the Melbourne Trust Case[8], profits on the realization of old assets and securities were not liable to taxation until they had been treated by the company as profits available for distribution. But I agree with Cussen A.C.J. that this cannot affect the company's rights. It was a question of law, and a mistake as to the meaning and effect of the reasons of the Judicial Committee would not convert income derived in law and in fact during a preceding year into income derived by the company during the year 1927. The directors, however, in a report submitted to a meeting on 12th April 1927, announced that it was proposed that the articles of association be altered so as to provide that the balance of profits arising from the realization of securities should be applied in writing down investments—that is, its "other investments"—or carried to a capital reserve fund, and not used to pay dividends. The articles were altered accordingly. By the articles as altered the directors were empowered to reserve or set aside out of profits and to carry to reserve or reserves, other than the capital reserve fund, such sums as they thought proper. And they were also authorized to establish a special reserve, to be called the capital reserve fund. Into this fund capital appreciation realized on sales was to be carried, including any sums then standing to the credit of any reserve in the books of the company and which in the opinion of the directors represented appreciations realized on the sale of investments by the company. Before 31st December 1927, the directors, in accordance with the altered articles of association, divided the reserve fund, which at the beginning of the year stood at £150,000, into capital reserve fund £75,290 2s. 11d., and general reserve £74,709 17s. 1d. (which, with a sum transferred from revenue, brought the latter to £75,000). The balance-sheet at 31st December 1927 records the transaction as follows:— Liabilities. Assets. General reserve £75,000 Investments at or under cost (less capital reserve fund) £1,039,804.

In my opinion, it is quite impossible on these facts to conclude that the company thus affirmed, or that in fact, the sum of £150,000 remained, until 1927, in suspense awaiting the final result of the realization before the profit on the totality of the transactions was ascertained. Everything points to the conclusion that it was, long before that time, a reserve of ascertained profits available for application by the company in any manner allowed by its memorandum and articles of association. A company does not escape taxation because it leaves profits in, or carries them to, reserve account. The passage relied upon in the Melbourne Trust Case[9] deals with the company at a time when realization had not proceeded far, when the result of the totality of the transactions could not be predicated. In such circumstances, their Lordships declined to treat all receipts from realizations and carried to reserve as ascertained profits; they must remain in suspense until the company affirmed by its acts how much represented profit, or, as I think, until the fact could be otherwise established. And in my opinion it is clearly established in the present case that the sum of £150,000 in the reserve account was a realized and ascertained profit of the company before the end of the year 1926, and consequently not assessable to income tax for the financial year 1928-1929.

The appeal is simply against an assessment for that year, and we have no authority to determine, nor would it be desirable to express any opinion upon, the years in which the sum of £150,000 is assessable, or the amount assessable in any particular year. All that is or can be decided is that an assessment for the financial year 1928-1929 is wrong, and that the appeal from the decision of Cussen A.C.J. should be dismissed.

This is an appeal from the decision of the Supreme Court of Victoria (Cussen A.C.J.) which held that the appellant Commissioner had wrongly assessed the respondent company for the financial year 1928-1929 in respect of income derived by the company during the year ending December 31st, 1927.

The respondent company is identical with the Melbourne Trust Ltd., which in 1914 was held by the Privy Council to have been so constituted and to have so carried on its affairs

The Commissioner included an amount of £92,143 as part of the income derived by the company from its realization business during 1927. The sole question upon the present appeal is whether this sum of money should be regarded as attributable to the activities conducted by the company within Australia during the year in question.

Par. 40 of the admissions of fact and annexure "P" therein referred to show at the very first glance that the sum of £92,143 is a composite or resultant figure representing realization activities spread over many years. Annexure "P" also shows that the sum of £92,143 was, according to the Commissioner's own analysis of the reserve account of the company, referable to profits or income which had been actually realized on or before December 31st, 1925. How is this sum of money capable of being referred to the income year 1927 and treated as income solely derived during that year?

The Commissioner says that the Privy Council decision already referred to is binding and arms him with authority to make this hypothetical or arbitrary allocation of income. That the decision binds us is obvious, the proved facts being identical.

Moreover, it is true that Lord Dunedin in his judgment pointed out that there was ample evidence that the company was a trading company, that the surplus realized by it in selling the assets at enhanced prices was taxable as a profit and that it was "in the totality of the transactions that the question of profit comes to be fixed"[11].

It is argued that these expressions mean that the Commissioner is entitled to treat the year in which the company proceeds to deal with its accumulated profits from realization as the year in which the whole of such profits are earned, although the period of accumulation has extended over many years.

It may be pointed out that the Victorian Act under consideration by the Privy Council in Commissioner of Taxes v. Melbourne Trust Ltd.[13] did not, as do the Commonwealth Acts now before us, provide for a graduated system of taxation with the rate of tax increasing with the increase of income. This distinction would, of course, result in a considerable increase in the amount of tax if it were held that the operations of (say) ten years can be attributed to the activities of the tenth year only.

Assuming for the moment that Lord Dunedin's words have been correctly interpreted by the Commissioner, the question arises whether the company did, during the year 1927, in any relevant sense "deal with" the amount of £92,143 upon the footing of profit. Certainly it did not distribute such sum or any of it to its shareholders. In the report submitted with the balance-sheet and profit and loss account for the year ending December 31st, 1926, the following paragraph appeared:—

During the year 1927, the articles of association having been altered as proposed, there was a division by the company of its then reserve fund into two almost equal sums, one being put into the capital reserve fund, and the other into general reserve; and it is correct to say that, included in the total reserve fund of £150,000 thus divided, there was included the sum of £92,143 which the Commissioner now seeks to bring into charge against the company.

If Lord Dunedin's observations are to be regarded as requiring the attribution of the accumulated profits to the year during which the company dealt with them as such, the only act to which the Commissioner can point as occurring in 1927 is the division of the reserve fund I have just mentioned. In my opinion this act is quite insufficient to warrant any inference that the accumulated profit of £92,413 was derived during the year 1927.

But I do not accept the theory that Lord Dunedin's judgment was ever directed to such a state of affairs as has been proved in the present case. When the matter was before the Privy Council in 1914, the outstanding feature was that the company had distributed to its shareholders a bonus of 6d. per share and had also distributed considerable debenture stock to its shareholders. Each of these distributions of money or money's worth, the company had considered to be warranted by the then state of its realization reserve account. The statement of the history of the company which is now presented to us, and which is necessarily fuller and more accurate, shows clearly that in making these distributions to its shareholders the company was anticipating the coming in of large sums of money and was relying upon the correctness of its valuations of assets not disposed of. Its confidence was justified, but only after four or five years had elapsed.

It seems to me that the gist of Lord Dunedin's finding is contained in the sentence: "As regards the question of when a profit is earned their Lordships' view is that a profit can be said to be earned when it is dealt with as a profit"[14]. The company had itself elected to treat as profits the moneys sought to be charged against it by the Victorian Commissioner, and this course of conduct was deemed sufficient to justify the Commissioner in following the company's example.

In my opinion the decision of the Privy Council is not to be regarded as addressing itself to the very different state of affairs here, where the company, having made profits from its operations during a series of years, has refrained from making any distribution to its shareholders. A very good illustration of the established principle that profits made by a company from a realization business may be treated as income, irrespective of any question of distribution of the profit among shareholders, is provided by the recent decision of the House of Lords in Westminster Bank Ltd. v. Osler[15].

So far as the facts of the present case are concerned, it is clear that, during the year 1926, for all practical purposes the company wound up its realization business, the last receipt being the £100,000 received in 1926 as dividend in the liquidation of the Penang Sugar Co. Ltd. This receipt was mentioned in the report from which I have already quoted. In the circumstances the Privy Council decision does not compel us to hold that the Commissioner was correct in treating the sum of £92,413 as part of the company's income derived during the year 1927, and for the reasons given I think that the judgment of Cussen A.C.J. should be affirmed.

But the Commissioner had some reason for his action in delaying and finally making his assessment referable to 1927. On June 18th, 1926, the company was asked to state why no part of the surpluses arising from the realization of the original assets had been included in its Federal income tax returns for any year. The company's reply, dated June 23rd, 1926, included the following statement:—

I have already pointed out that in my opinion the Privy Council did not lay down the rule suggested. But, not unnaturally, Sir Edward Mitchell relied strongly upon this express statement of the company and urged that it was not unjust to treat the company upon the legal basis suggested. Even upon such assumption, I do not think that any action taken by the company in 1927 satisfies the test stated in the letter. However, the question for our determination must turn upon the ascertained and admitted facts rather than upon any supposed reason or excuse for the company's failure to make adequate returns of income.

So far, I have expressed no opinion as to how the accumulated income should have been allocated amongst the various income years prior to 1927. The matter has not been fully gone into, but it seems to me that, once the final amount of the accumulated profit is established, there should be no great difficulty in going back and distributing it throughout the years prior to December 31st, 1926.

For such purpose it is better that the accounts should not be made up upon the analogy of ordinary profit and loss accounts with the assets valued at the beginning and end of each trading year. I can see no logical difficulty in adopting such method, but it seems to be excluded by a portion of the reasoning of the Privy Council in the case already discussed.

Perhaps that case would authorize the Commissioner in fixing the year 1926 as the main, if not the sole, year of profit. It must be remembered, however, that the £100,000 received by the company during 1926 was received as a dividend in the liquidation of a separate company, which had been brought into existence some years earlier by the respondent.

Interesting questions arise whichever system of division of the profit amongst the years may be finally adopted, and I have no desire to prejudice their full investigation and final solution.

I should not leave the case without the observation that it was practically undisputed before us that the company had become liable to pay taxation to the Commissioner in respect of its accumulated profits from realization, and that it has only succeeded in excluding 1927 as the true income year. It is desirable in the interest both of the Commissioner and the company that an agreement should be reached by them as to the quantum of tax owing, otherwise further proceedings may be necessary to determine it.

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

[1] (1914) A.C., at p. 1010; 18 C.L.R., at p. 421.

[2] [1914] UKPCHCA 5; (1914) A.C. 1001; 18 C.L.R. 413; (1912) 15 C.L.R. 274; (1913) V.L.R. 196.

[3] [1914] UKPCHCA 5; (1914) A.C. 1001; 18 C.L.R. 413.

[4] (1914) A.C., at pp. 1011, 1012; 18 C.L.R., at pp. 421, 422.

[5] (1914) A.C., at p. 1012; 18 C.L.R., at pp. 422, 423.

[6] [1914] UKPCHCA 5; (1914) A.C. 1001; 18 C.L.R. 413.

[7] (1914) A.C., at pp. 1011, 1012; 18 C.L.R., at pp. 421, 422.

[8] [1914] UKPCHCA 5; (1914) A.C. 1001; 18 C.L.R. 413.

[9] [1914] UKPCHCA 5; (1914) A.C. 1001; 18 C.L.R. 413.

[10] (1914) A.C., at p. 1012; 18 C.L.R., at p. 422.

[11] (1914) A.C., at pp. 1010, 1011; 18 C.L.R., at p. 421.

[12] (1914) A.C., at pp. 1011, 1012; 18 C.L.R., at p. 422.

[13] [1914] UKPCHCA 5; (1914) A.C. 1001; 18 C.L.R. 413.

[14] (1914) A.C., at p. 1011; 18 C.L.R., at p. 422.

[15] (1933) A.C. 139.

High Court of Australia

Federal Commissioner of Taxation v Standard Trust Ltd [1933] HCA 19; (1933) 49 CLR 609 (24 April 1933)

HIGH COURT OF AUSTRALIA