Federal Commissioner of Taxation v Miller Anderson Ltd [1946] HCA 2; (1946) 73 CLR 341 (4 April 1946)

Federal Commissioner of Taxation Appellant; and Miller Anderson Limited Respondent.

These are two cases stated in appeals by the Federal Commissioner of Taxation against decisions of a Board of Review in relation to assessments of the respondent company under the War-time (Company) Tax Assessment Act. One assessment relates to an accounting period ended 31st January 1941, the relevant Acts in the case of this assessment being the War-time (Company) Tax Act 1940 and the War-time (Company) Tax Assessment Act 1940. The other assessment relates to an accounting period ended 31st January 1942, and in this case the relevant Acts are the War-time (Company) Tax Act 1940-1941 and the War-time (Company) Tax Assessment Act 1940-1941. The questions which arise upon the cases stated depend upon the interpretation and application of s. 24 of the Assessment Act, which has not been amended since its original enactment.

The procedure of appeal from an assessment to a Board of Review and from a Board of Review to the High Court is introduced by s. 34 of the Assessment Act, which applies the provisions of the Income Tax Assessment Act 1936-1941 relating to these matters.

War-time (company) tax is imposed upon the amount by which the taxable profit derived by any company during the relevant accounting period exceeds the percentage standard (s. 13). "Taxable profit" is defined in s. 3 of the Act. The percentage standard where the accounting period is a period of twelve months (as in the present case) is an amount equal to the statutory percentage of the capital employed or deemed to be employed during the accounting period (s. 19). The statutory percentage under the 1940 Act was 8 per cent, but was reduced to 5 per cent by the amending Assessment Act of 1941.

The greater the amount of the capital employed in any accounting period the higher the percentage standard, and the higher the percentage standard the smaller the amount of difference between the percentage standard and the taxable profit, and, therefore, the lower the tax. The company contends that in each assessment the Commissioner has wrongly calculated the capital employed during each accounting period, because he has deducted from the amount which the company claims to be correct an amount of loss incurred prior to 1st February 1935. The same question arises upon each case stated, and, following the course of argument, I propose to examine it in relation to the second assessment, i.e., for the accounting period ending 31st January 1942.

The amount to be included in the capital under par. (a) of s. 24 (1) is not in dispute. It is the amount of the paid up capital less an amount of £1,243, representing depreciated value of assets deducted under par. (i) of s. 24 (1). Thus it is agreed that under (a) the amount to be included in the capital employed in the accounting period is £183,757.

Certain profits were placed by the company to the credit of reserve accounts. There are three reserve accounts—income tax, stock, and bad debts, amounting to £17,792, which amount it is also agreed should be included in the capital employed. Deductions were made by the Commissioner in respect of a proportion of dividends declared during the accounting period and not paid until after the commencement of the period. As to this matter there is also no dispute.

Controversy arises with respect to the meaning and application of the following words appearing in par. (b) of s. 24 (1)—"accumulated profits ... including amounts standing to the credit of the Profit and Loss Account at the commencement of the accounting period."

The company's year ended on 31st January. The company made profits for the years 1928, 1929 and 1930 (that is, the years ending on 31st January in each case) and, after provision had been made for taxation, depreciation, bad debts and payment of dividends, there was £820 to the credit of profit and loss account at the end of the accounting period ending 31st January 1930. In the five following years the results of trading were as follows:—

As at 31st January 1935 the debit balance in what was called the "Profit and Loss Appropriation Account" was £13,107.

At this time there were arrears of dividends on preference shares amounting to £28,800, and ordinary shares had not received a dividend since 1929.

On 15th May 1935 an agreement was made and duly confirmed by which the rights of the preference shareholders were altered. Arrears of dividend were reduced in amount and payment on account of arrears was postponed until after 1st February 1938. The preference dividend rate was reduced and it was agreed that profits should be applied in the first place to satisfying preference shareholders upon the reduced basis of the agreement.

Another agreement varying the rights of shareholders was made on 7th September 1938. It provided for the distribution of future profits as between preference and ordinary shareholders, and, as to profits not distributed, for their retention, use or application, at the absolute discretion of the directors in "reducing the amount standing to the debit of Profit and Loss Account on 31st January 1935, in making further payments on account of the arrears of preference dividend on that day or in writing off depreciation" or such profits "might be retained and carried forward in the profit and loss account." In fact the power of applying profits to the reduction of the standing debit has not been exercised and the "Profit and Loss Appropriation Account on 31st January 1935" still shows the same debit of £13,107.

After 31st January 1935 the company made profits, and these were "carried to a separate profit and loss appropriation account in the liabilities column of the company's balance sheets." This account was entitled "Profit and Loss Appropriation Account from 1st February 1935" (par. 11 of case). Thereafter the company had two sets of entries in its accounts, each described as "Profit and Loss Appropriation Account." The older account was called "Profit and Loss Appropriation Account to 31st January 1935" and at all times (with one exception) it has since shown merely a debit of £13,107 1s. 10d.

The exception appears in the company's private ledger in a balance sheet as at 31st January 1936. In that ledger the following entries appear:—

But the published balance sheet issued to shareholders with the notice of the annual meeting held on 20th March 1936 contained the following entries:—

The new account is called "Profit and Loss Appropriation Account from 1st February 1935." This account, made up from the liabilities column of the balance sheet (where alone the relevant entries appear), shows a credit balance in each year up to the latest accounting period, an application of part of the profit in paying dividends, and a credit balance as at 31st January 1941 of £20,548.

The company claims that this amount of £20,548 represents accumulated profits which should be included in the "capital employed" by virtue of the words "accumulated profits" in s. 24 (1) (b), and that no deduction should be made on account of the outstanding debit of £13,107 recorded in the older account. That debit balance, it is contended, should be regarded as a loss of capital. The statements of account show that there was nothing to meet the loss except capital assets. Section 24 (1) (a) entitles the company to have all the capital which has been paid up in money included in the calculation of "capital employed," even though the capital has been lost. Similarly, it is argued, no attention should be paid to the debit of £13,107.

Alternatively, the company contends that the amount of £20,548 is an amount standing to the credit of the profit and loss account at the commencement of the accounting period, namely on 31st January 1941, and that therefore it should be included in the "capital employed" by virtue of the express words of s. 24 (1) (b).

The Commissioner contends, on the other hand, that the amount of £20,548 does not represent accumulated profits because there has been no accumulation of this amount, inasmuch as it has not been set aside in any way from the general assets of the company. Further, it is contended for the Commissioner that the true amount standing to the credit of the profit and loss account is not £20,548, but that sum less £13,107. The section, it is said, refers to a true statement of accounts, and a true statement of the profit and loss account would show a credit balance, not of £20,548, but of £7,441.

The Board of Review by a majority decided in favour of the view submitted on behalf of the company.

Some guidance in interpreting the provisions of s. 24 (1) can be obtained from decisions of this Court upon somewhat similar provisions in other statutes. In Meares v. Acting Federal Commissioner of Taxation[1], the Court held that a true profit and loss account, strictly so called, was limited to the dealings of a stated period. It was also said, however, that companies frequently transferred balances from the profit and loss account for one year to the same account for the following year, and that if that were done such action might well be thought to be "inconsistent with an intention to treat the amount so dealt with as an accumulated fund." Thus this decision suggests that an amount carried forward in a profit and loss account should be regarded as not "accumulated."

But other views have been expressed in the Court as to the meaning of "accumulated profits." In Forrest v. Federal Commissioner of Taxation[2], the Court considered a provision in the Income Tax Assessment Act 1915-1916 referring to "undistributed income accumulated prior to 1st July 1914," with a proviso that amounts "carried forward by a company to the credit of the profit and loss account shall not be deemed to be accumulated income." The company in question revalued its assets, with the result that the value of assets was increased over their previously shown book values by an amount of £100,000. The company, treating this sum as representing a profit the existence of which had not previously been recognized, applied the amount for the purpose of enabling shareholders to pay for debenture stock issued by the company. The question was whether a shareholder was liable to income tax in respect of the debenture stock issued to him, or whether, on the other hand, he escaped tax because the debenture stock represented profits accumulated before 1st July 1914. It was held that the increase in value was undistributed income so accumulated. In the judgment of the Court this was said: "Considering the object of the proviso [that is, to exempt a shareholder from certain tax liability], we see no reason for attributing to the expression undistributed income accumulated any meaning other than income which had not been in fact distributed and had in fact accrued to the Company before 1st July 1914"[3]. It will be observed that the "income" in question had not been separated from the other assets of the company by being placed in a reserve fund or otherwise. It had been received, and still existed. Those facts were regarded as sufficient to show that it had been "accumulated." It may further be noted that it was thought necessary by the legislature to make a provision expressly excluding from "accumulated income" amounts "carried forward" by a company to the credit of profit and loss account.

In Hooper & Harrison Ltd. (in Liquidation) v. Federal Commissioner of Taxation[4], one of the sections under consideration was s. 17 (1) of the War-time (Profits) Tax Assessment Act 1917-1918, which provided that:—"The amount of the capital of a business shall be taken to be the amount of its capital paid up by the owner in money or in kind, together with all accumulated trading profits invested in the business, with the addition or subtraction of balances brought forward from previous years to the credit or debit respectively of profit and loss account." This section, providing for the ascertainment of "the amount of the capital of a business," performs in relation to the Act in which it appeared the same function as s. 24 in the present Act. Knox C.J., Higgins and Gavan Duffy JJ. decided the case upon the meaning of the word "invested" (See[5]), and not upon the meaning of the word "accumulated." (The word "invested" is not used in s. 24 (1) of the present Act.) Isaacs and Rich JJ., however, did examine the meaning of the word "accumulated" and were of opinion[6] that the true import of the term "accumulated profits" was "that they are profits which the Company has appropriated to some reserve account, whether that account be of a capital nature or not. Accumulation in that connection does not mean the mere existence of profits, even over a lengthened period, however they are employed; but it connotes the affirmative gathering of these profits, or such as may be selected, into a measured or measurable heap and allocated to a named reserve fund, whatever its nature may be." This view of the meaning of "accumulation" (differing from that expressed in the decision in Forrest's Case[7]) would exclude from accumulated profits a sum which existed only as a credit balance carried forward from one year to another in a profit and loss account, and not placed to any reserve. It is, I think, clear that the legislature had this possible view of the nature of accumulated profits in mind when it expressly provided in the present Act that an amount standing to the credit of a profit and loss account at the commencement of an accounting period should be included in the capital of the company. The words "accumulated profits" appearing at the beginning of par. (b) of s. 24 (1) might not have been effective to bring in such amounts.

In Stodart v. Deputy Federal Commissioner of Taxation[8], the Court had to deal with a section in the Income Tax Assessment Act 1922-1927. This section corresponded to the section which was the subject of decision in Forrest's Case[9]. It excluded from income sums received by a shareholder out of "undistributed income accumulated prior to 1st July 1914," but varied the terms of the earlier section by including the following provision:—"For the purpose of this proviso, amounts carried forward by a company in its profit and loss account, appropriation account, revenue and expenses account, or any other account similar to any of the foregoing accounts shall not be deemed to be accumulated income." The company in which the taxpayer was a shareholder showed in its public accounts only the actual profit in respect of a yearly period, not bringing forward any balances from preceding years. (In so doing it presented a profit and loss account in the sense held to be strictly proper and accurate in Meares' Case[10].) The company had in its ledger a profit and loss account in which balances were carried forward from year to year. It was unanimously held by the court that the amount so brought forward was accumulated income. Knox C.J. simply said: "The sum ... represented trading profits earned by the Company in two preceding years and not distributed or otherwise dealt with, and, in my opinion, is properly described as accumulated income of the Company"[11]. Isaacs J. in this case held that he was bound by Forrest's Case[12] to come to the same conclusion. In so doing he adopted and applied the view which he had rejected in Hooper's Case[13]. There was an equal division of opinion in the Court as to whether the words "carried forward by a company in its profit and loss account" referred to the public accounts of the company, or to its books of account, which were not public.

Another case which was mentioned in argument was Sharp, Stevenson & Hare Pty. Ltd. v. Federal Commissioner of Taxation[14]. But this case is an authority with respect to the meaning of the word "invested" and not with respect to the meaning of either "accumulated" or "carried forward."

The result of the decisions mentioned is that profits may be "accumulated," even if they are not placed to a reserve fund, but that no definite guidance has been afforded by the Court as to the meaning of the words "carried forward in a profit and loss account."

A profit and loss account strictly so called relates only to receipts and expenditure during a definite period; a profit and loss appropriation account is an account showing disposition of profit or method of dealing with a loss: Meares Case[15]. Section 24 refers to a profit and loss account. But it has not been contended on behalf of the company that the "Profit and Loss Appropriation Account from 1st February 1935" is not a profit and loss account within the meaning of s. 24. Such a contention would prevent the company from relying upon the words "amounts standing to the credit of the Profit and Loss Account at the commencement of the accounting period," and would make it necessary for the company to rely only upon the words "accumulated profits." The cases cited show that a balance of profits may be held to be "accumulated" though they merely exist and have not been placed to a reserve fund. But "accumulation" plainly refers to the past and not to a current period. Thus accumulated profits must refer to a continuous account, and the words of the section show that the account is a loss as well as a profit account. Thus, if the matter is to be decided on the words "accumulated profits," it should be held that the loss of £13,107 must be deducted from the amount of £20,548. It is only this balance of £7,441 which can be regarded as accumulated profits.

The company contends, however, that the amount of £20,548 should be taken into account in full as an amount standing to the credit of its profit and loss account at the commencement of the accounting period, i.e., at 1st February 1941, without deduction of the amount of £13,107.

In s. 24 (1) of the Assessment Act the legislature, in addition to including "accumulated profits," has expressly included money standing to the credit of a profit and loss account at the commencement of an accounting period. This provision excludes any argument that such an amount is not to be calculated in capital employed for the reason that it is not "accumulated." Further, this provision also seeks to avoid the difficulties which arose from the use of the words "carried forward" by substituting the words "standing to the credit." The words "carried forward" almost inevitably raise an argument as to whether the reference is not merely to the bookkeeping of the company; the words "standing to the credit" are perhaps stronger to exclude this argument and to require an ascertainment of the amount which actually stands to the credit of the account, whatever may be the form in which the books of the company are kept.

The company has elected to draw a line across its accounts at 1st February 1935, and, by separating its life into two periods, has shown a loss of £13,107 in the first period, and what is called an accumulated profit of £20,548 in the second period. There were quite good reasons for doing this arising out of the necessity for making some arrangement with the preferential shareholders. That arrangement involved special provisions as to the application of profits earned during a period after the making of the arrangement. But though such an arrangement limited the power of the company in respect of the disposition of its profits, it did not affect the amount of profits nor could it, in my opinion, affect the application of taxation legislation. If the company, for purposes of its business, could separate its accounts at 1st February 1935 and thus affect its liability to tax, it could equally well separate them at any other time and so could, without any real change in its true financial position, radically affect its tax liability. It could put all the profits into one account and all the losses into another account, and then claim that the profits so shown were amounts standing to the credit of a profit and loss account within the meaning of s. 24, so that they should be added to the capital employed by the company.

I am of opinion that it is not open to the company to do this, not because such a course would disappoint the revenue authorities, but because the terms of s. 24 (1) (b) show that the legislature intended that the profit and loss account referred to in the section should be a continuous account, and not a series of separate accounts relating to separate years or to selected groups of years. The words "standing to the credit of the profit and loss account at the commencement of the accounting period" show that the profit and loss account referred to is not an account of the strict character referred to in Meares' Case[16], that is, an account limited to the transactions of a single period, with no balance brought forward from preceding years. A profit and loss account of such a character cannot have any amount standing to its credit at the commencement of an accounting period. Thus the profit and loss account which the section contemplates is a profit and loss account which does bring forward balances at the beginning of each year. The account, therefore, must be continuous and, being an account of losses as well as of profits, must bring forward debit balances as well as credit balances. The difficulties revealed in the cases as to the meaning of "carried forward" are avoided by the use of the words "standing to credit at the commencement of the accounting period." The only question to be asked is whether the amount in question really stands to the credit of the profit and loss account at the relevant time. I use the word "really" because the section does not say "shown as standing to the credit" &c. The words which are used mean "actually standing to credit upon a true statement in a continuous account."

The result is that, in my opinion, the two profit and loss accounts of the company must be regarded as a single account. The company cannot at will divide its profit and loss account into two or more profit and loss (or profit or loss) accounts and elect to ignore one or more for the purpose of s. 24. Thus, in my opinion, the debit balance of £13,107 must be carried forward, with the result that the credit balance of £20,548 is reduced to £7,441.

Argument was addressed to the Court as to whether the company was entitled to declare dividends before replacing the loss of £13,107 (Lee v. Neuchatel Asphalte Co.[17]; Ammonia Soda Co. Ltd. v. Chamberlain[18]). But this question does not appear to me to have any relevance to the first question in the cases before the Court.

Question No. 1 in the case relating to the accounting period ending on 31st January 1942 is:—"Whether upon the true construction of s. 24 of the War-time (Company) Tax Assessment Act 1940-1942 the sum of £13,107 1s. 10d. standing to the debit of Profit and Loss Appropriation Account to 31st January 1935 in the books of the respondent company on 1st February 1941 should have been taken into account in computing the capital of the company employed in the accounting period which ended on 31st January 1942 for the purposes of such section." In my opinion this question should be answered: Yes.

The amount standing to the credit of the profit and loss account should therefore be stated as £7,441, and not as £20,548, and the amount of accumulated profits at the commencement of the accounting period is therefore £25,233, the total of the reserve fund (£17,792) and £7,441.

A further question arises, however, as to the application of the provision in s. 24 (1) (b) that "accumulated profits" are to be "averaged over the accounting period." In my opinion this provision for averaging applies to all the accumulated profits to which the provision relates, that is to say, in the present case it includes not only the reserve funds mentioned, but also the amount of £7,441 standing to the credit of the profit and loss account at the commencement of the accounting period.

On 31st March 1941, that is, after 59 days of the accounting period had elapsed, the company declared a dividend of £10,075. The company did not draw upon the reserve funds, and the dividend was in fact paid out of other moneys, namely out of the whole or part of the amount of £20,548, which represented profits earned since 1935. The company was entitled to do this without replacing the accrued loss of £13,107: See Lee v. Neuchatel Asphalte Co.[19]. The question is as to the proper method of averaging the accumulated profits under the section. If the whole of the £7,441 is regarded as having been absorbed by the payment of the dividend, the company would be regarded as having the use of £7,441 (part of £25,233) for only 59 days of the year, and the proper addition to make to the reserve fund (£17,792) under the section would be 59/365 of £7,441, that is, £1,203.

This was the view taken by the chairman of the Board and it was in effect accepted on both sides upon the hearing of the appeal. Subsequently, upon the invitation of the Court, counsel made submissions with respect to another possible method of applying the averaging provision of the section. The parties also agreed upon a further fact as to the declaration of the dividend which they desired the Court to take into consideration. This fact is that the company resolved in general meeting to adopt a recommendation of the directors that the dividend be paid out of a sum of £14,528, being the profits of the preceding year. According to the other possible method of applying the averaging provision the dividend would be regarded as paid either out of the whole credit balance of £20,548, or alternatively out of the amount of £14,528, and only a ratable proportion of the dividend would be treated as paid out of the amount of £7,441. There is, I think, much to be said in support of this view. But, though not without doubt, I have come to the conclusion that the former view is to be preferred. Section 24 adopts a special artificial method of determining the "capital employed" for the purposes of the Act. It is the part of that capital, determined in accordance with par. (b) of the section, that is to be averaged. The reference to averaging supposes that that part of such capital may be increased or diminished during an accounting period. Increases during the year are to be added to that capital and on the same principle decreases during the year should be charged against that capital, in each case in respect of the period during which the increase or decrease was effective in relation to the amount of that capital available for use by the company. The object of s. 24 is to ascertain how much capital is to be taken for the purposes of the Act as being used in the business of the company. Only the amount calculated in accordance with this section is regarded by the Act as being available for disposition by the company. Where, as in this case, part of the capital is made up of accumulated profits as ascertained under par. (b) of the section, expenditure chargeable against accumulated profits should, I think, be regarded as chargeable against the accumulated profits which are recognized by the Act as part of the statutory artificial "capital employed," and not against another fund which the section excludes from recognition as accumulated profits within the meaning of the Act. Thus the proper addition to make to the reserve fund (£17,792) is, in my opinion, the above-mentioned sum of £1,203.

The second question in the case, which suggests various methods of averaging, should be answered by stating that the method set out in par. 2 (c) of the question is correct.

A corresponding order should be made in the other case—No. 9 of 1943. The costs of the cases should be costs in the appeal and the cases should be remitted to Dixon J.

Cases stated pursuant to the War-time (Company) Tax Assessment Act 1940, the Income Tax Assessment Act 1936-1941, and the Judiciary Act 1903-1940.

The main question is whether a sum of £13,107 in round figures standing to the debit of "Profit and Loss Appropriation Account to 31st January 1935" in the books of the company on 1st February 1940 and on 1st February 1941 respectively, should be taken into account in computing the capital of the company employed in the accounting periods which ended on 31st January 1941 and 1942 respectively.

That depends upon the construction of s. 24 of the War-time (Company) Tax Assessment Act 1940-1941.

"The Profit and Loss Appropriation Account to 31st January 1935" in the books of the company shows a debit balance of £13,107 in round figures, which was not carried forward into the profit and loss appropriation accounts of succeeding years. But a new profit and loss appropriation account described as "Profit and Loss Appropriation Account from 1st February 1935" was opened, which at 31st January 1941 showed a credit balance of £20,548 in round figures. These two separate profit and loss appropriation accounts were rendered necessary in order to carry out an agreement between preference and ordinary shareholders, providing that profits from 1st February 1935 were to be used in a particular way.

The Commissioner claims that the amount of £13,107 carried forward and at debit of the "Profit and Loss Appropriation Account to 31st January 1935" should be deducted from the sum of £20,548 standing to credit of "Profit and Loss Appropriation Account from 1st February 1935" in ascertaining the capital employed by the company in the accounting period of twelve months which ended on 31st January 1942.

The War-time (Company) Tax Assessment Act 1940, s. 24, provides "the capital employed in any accounting period shall, for the purposes of this Act, be ascertained by adding the following amounts, namely:— ... (b) accumulated profits, averaged over the accounting period, including amounts standing to the credit of the Profit and Loss Account at the commencement of the accounting period but not including any profit of the accounting period."

Accumulated profits are simply profits that are amassed or collected and not distributed, including, as the Act prescribes, amounts standing to the credit of the profit and loss account of the company.

A profit and loss account is, as Griffith C.J. said in Meares v. Acting Federal Commissioner of Taxation[20], "an account showing the transactions of the business adventure during a given period," but as a matter of book-keeping, the account may be kept as a continuous account bringing forward the amounts of profit or loss, the result of operations extending over a number of successive periods. It is not the form of the company's accounts that determines its accumulated profits, but the true result of its operations. To say that the accumulated profits of the company at the commencement of the accounting period in this case were £20,548 because that amount stood as at 31st January 1941 at credit of the "Profit and Loss Appropriation Account from 1st February 1935," although the company had incurred a loss of £13,107 by the end of the balancing period in 1935, which was carried forward in a special "Profit and Loss Appropriation Account to 31st January 1935" for certain business purposes of the company, requires demonstration both as a matter of fact and of law. It was said that the sum of £13,107 was capital that had been lost and should not therefore be taken into account in ascertaining the accumulated profits of the company. But the argument is untenable, for no part of that sum was written off capital or otherwise, but was carried forward in a special account as a trading loss. And the contention that the Act itself prescribes that the sum of £20,548 standing to credit of the company in its "Profit and Loss Appropriation Account from 1st February 1935" must be treated as capital employed by the company in the relevant period, is equally untenable. The Act contemplates the ascertainment of profits that have been accumulated over an indefinite period and does not preclude the ascertainment of that amount by means of a continuous account of operations extending over any number of successive years. The cases of Hooper & Harrison Ltd. (in Liquidation) v. Federal Commissioner of Taxation[21], Sharp, Stevenson & Hare Pty. Ltd. v. Federal Commissioner of Taxation[22], Stodart v. Deputy Federal Commissioner of Taxation[23], and some other cases were referred to upon the argument of this case, but were decided under other Acts in different language and do not conflict, I think, with anything that has been said. Indeed, the present section appears to have been enacted in its present form to meet some of those decisions or the opinions expressed in them.

The subsidiary questions raised by question 2 do not require elaboration, for the questions and the answers to them explain themselves.

The balance sheets and profit and loss accounts of the company from 1st January 1935 disclose a credit balance as at 31st January 1940 of £6,020 after dividend distributions, including a dividend of £2,400 on preference shares for half-year to 31st July 1940. But if the sum of £13,107 were debited against this sum the accounts would disclose a debit balance of £7,087. Now the accounts of the company for the year which ended on 31st January 1941 disclose a profit of £14,528 or, taking into account the debit of £7,087, a credit balance of £7,441 or the accumulated profits of the company which in truth were amassed in the year which ended on 31st January 1941. The directors recommended and the company in general meeting resolved that various dividends amounting to £10,075 be payable on 31st March 1941 out of the profits of the year ended on 31st January 1941. Those profits, as already stated, were £14,528, but that excludes the debit balance of £7,087 which would have appeared in a continuous account of profit and loss the result of operations over a number of successive years. The profits in hand were short by £2,634 of the amount required to meet the dividends, but it is clear, in these circumstances, that the sum of £7,441, so far as it would go, was necessarily used in meeting the dividend for the year ended 31st January 1941. The sum of £7,441 is averaged over the accounting period as explained in question 2 (c) (ii).

The case stated in relation to the assessment for the accounting period of twelve months which ended 31st January 1941 involves the same considerations, but the figures are not identical.

The questions in both cases should be answered as follows:—(1) Yes; (2) (a) and (b) No; (2) (c) (i) and (ii) Yes.

The facts and issues in this rather complicated case are explained with great clearness and completeness in the valuable opinion given in the Board of Review by the chairman (Mr. Gibson), with whose conclusions I find myself in substantial agreement. In view of his explanation, it is enough to state the chief question we have to decide in general terms. It concerns the method of ascertaining, for the purpose of s. 24 (1) (b) of the War-time (Company) Tax Assessment Act 1940-1941, a company's accumulated profits including amounts standing to the credit of the profit and loss account at the commencement of the accounting period. The question is whether a company may exclude a past accrued loss which it has carried to, or carries in, a distinct account and bring into the computation of what, for the moment, I may call its undistributed profits, only the gains and losses of subsequent accounting periods. The contrary view is that it must bring into account the consecutive results of its trading over its history, that is, except in so far as it has effectually written off or otherwise disposed of any specific accrued loss, as for instance by reduction of capital.

The respondent company incurred losses which, taking into account a possibly unjustifiable distribution of dividend, amounted as at 31st January 1935 to £13,107. This, in consequence of arrangements between the company and its preference and ordinary shareholders, was segregated and placed to an account called "Profit and Loss Appropriation Account to 31st January 1935." As at the end of the next accounting period a new account was opened and called "Profit and Loss Appropriation Account from 1st February 1935." After the deduction of dividends, the relevant result of the company's operations from that date to 31st January 1941, the commencement of the second of the two accounting periods with which we are concerned, as appearing from the balance sheet, has been a credit to the last-mentioned account of £20,548 and the making of provisions which we may call reserves amounting to £17,792. In the balance sheet on the debit side was shown "Profit and Loss Appropriation Account from 1st February 1935 £20,548," and, on the credit side, "Profit and Loss Appropriation Account to 31st January 1935 £13,107." If the two profit and loss appropriation accounts had not been separated as at 31st January 1935 and instead there had been a continuous account, the amount at its credit would have been £7,441. No one denies that the reserves, amounting to £17,792, constitute accumulated profits within the meaning of par. (b) of s. 24. But the important issue is whether, for the purposes of the paragraph, what I may call its undistributed profits should, as the company claims, be considered as £20,548 or as £7,441. The claim of the company is maintained both by general reasoning and upon the precise structure of the paragraph. As to the latter, it will be noticed that the general words "accumulated profits" are followed, after the direction for averaging the amount over the accounting period, by the specific inclusion of amounts standing to the credit of the profit and loss account at the opening of the relevant accounting period. Can the respondent bring the balance at credit of the "Profit and Loss Appropriation Account from 1st February 1935" within the latter words? That is to say, can the company say that balance is specially provided for and falls outside the operation of the general descriptive expression "accumulated profits"? Or to state the question more generally, are unreserved or floating profits accruing before the opening of the accounting period governed by the words "accumulated profits" or by the special inclusion of amounts standing to the credit of the profit and loss account at the commencement of the period? These questions arise because, as is obvious, the descriptive character of the general words "accumulated profits" provides a justification for going behind the form of the accounts adopted by the company and independently ascertaining what, so to speak, is the net result of the company's profits, losses and distributions, and such a justification would not exist if the question depended exclusively on what was found standing to the credit of the profit and loss account. Like expressions, such as "income accumulated," "accumulated trading profits invested in the business," "amounts carried forward to the credit of profit and loss account," have been used in pari materia in prior legislation and they have been considered and discussed in this Court in Meares v. Acting Federal Commissioner of Taxation[24]; Forrest v. Federal Commissioner of Taxation[25]; Hooper & Harrison Ltd. (in Liquidation) v. Federal Commissioner of Taxation[26]; Sharp, Stevenson & Hare Pty. Ltd. v. Federal Commissioner of Taxation[27]; Stodart v. Deputy Federal Commissioner of Taxation[28], decisions which, as the chairman's analysis and comparison have shown, do not provide a consistent guidance in the meaning and application of the phrases. Indeed, I repeat what I said in Resch v. Federal Commissioner of Taxation[29] concerning Forrest's Case[30], namely, that how far that case is consistent with Hooper & Harrison Ltd. (in Liquidation) v. Federal Commissioner of Taxation[31] and Sharp, Stevenson & Hare Pty. Ltd. v. Federal Commissioner of Taxation[32] may be doubted.

I think that, perhaps, there has been a tendency to give both too much fixity of meaning and too much precision to expressions of the kind in question and that the purpose of the provision in which they occur and the principle upon which it proceeds will throw more light on their exact application. Broadly speaking, the legislature may be taken to be alive to the distinction between the two courses that a company may follow with reference to profits which have accrued but which it does not desire immediately to distribute or withdraw from its business. The directors may in some way earmark the profit or part of it as a reserve or provision for a special purpose and thus distinguish it by placing it in an accounting category so that to withdraw it and make it available for distribution would require a new and affirmative decision. On the other hand, they may carry it forward in the company's accounts in such a way that, subject to the increment or diminution the trading of the next period or later periods may bring, it still awaits the decision of the directors to distribute it, to earmark it as a reserve, or otherwise to dispose of it. If the latter course is followed the profit will, according to the usual practice, stand as a credit to an appropriation account. But, although a profit and loss account should be confined to the transactions of a single accounting period, sometimes the profit of the previous period is carried to the actual profit and loss account itself of the subsequent period. But in either case it may be said to be carried forward on account of profit and loss. It may sometimes be uncertain whether and how far it is the intention of a legislative provision dealing with the profits retained in a business to demand some decision or indication on the part of a company to segregate or earmark the profits. It may be a question of interpretation whether it demands so formal a course or regards it as enough for the company to ascertain the profits and in its accounts to identify them as belonging to an accounting period. When expressions like "accumulation" and "amounts carried forward to the credit of profit and loss" are used in such a legislative provision, it may be important to extract from the expressions an intention precisely to distinguish reservation or earmarking for a purpose or separation, on the one hand, from, on the other hand, carrying forward an account of profit and loss. Further, under the latter head, it may be found that a second distinction is made, namely, between crediting profits to an appropriation account and the less usual and unorthodox course of carrying them down to the next profit and loss account.

In Meares' Case[33] and Stodart's Case[34], the second distinction was drawn and the fact that it was credited to the appropriate account was considered enough to satisfy the purpose of that legislation in preserving the separate identity and chronological source of the profit. In Forrest's Case[35] and Stodart's Case[36], it was thought that none of these things was demanded by the particular provision and that, if a profit existed before the requisite time and remained, it was to be considered to have been accumulated; whereas, in Hooper & Harrison's Case[37], Isaacs and Rich JJ. regarded "reservation" in some form as necessary and, I think, it may be said that the judgments in Sharp, Stevenson & Hare Pty. Ltd.[38] tend in the same direction, more particularly those of the minority.

Now the object of the provision contained in par. (b) of s. 24 (1) appears to me to be to authorize the inclusion in the capital amount on which the percentage standard is calculated of all shareholders funds employed in the business at or over the relevant time, that is to say, funds put to employment in the business and not withdrawn. This view is borne out by the general plan of the section and the nature of the other paragraphs as well as by the care shown to see that the funds mentioned in pars. (b) and (c) are averaged over the accounting period. When the legislature expressly included amounts standing to the credit of the profit and loss account at the commencement of the accounting period, I think that it meant exactly what it said and was referring to the distinction already drawn by this Court in the cases mentioned between the two ways in which profit is carried forward on account of profit and loss; viz., the orthodox crediting of an appropriation account and the loose practice of carrying down a profit into the next profit and loss account or showing it in connection therewith. It means that the line is not to be drawn at a profit and loss appropriation account so as to include nothing which had not at least gone into such an account and that there was to be no exclusion of an ascertained profit on the ground that it had been transmitted into the account of the next period to share with the net receipts of that period the burdens and chances to which the further transactions would expose it. I agree with the chairman—"that the inclusive words were inserted in order that companies should not be penalized for dealing" in this manner "with the unappropriated balances of their profit and loss account." More than that is not covered, I think, by the reference to amounts standing to the credit of the profit and loss account. The expression "accumulated profits" comprises all else down to and including balances to the credit of the profit and loss appropriation account.

I am, therefore, of opinion that the question whether the amount to be taken into account under par. (b) is £20,548 or £7,441 depends upon the meaning of those words and not upon the application of the words—"standing to the credit of the Profit and Loss account at the commencement of the accounting period," which are material only as part of the context in which the expression "accumulated profits" is to be interpreted. The argument that, under that expression, the accrued losses of the period up to 31st January 1935 should be excluded from consideration depends in some aspects upon the general purpose and policy disclosed by s. 24 and, in others, upon the principles governing the dealings of companies with their profits, principles which s. 24 may be taken to presuppose. In some degree, too, it claims support from the word "accumulated" on the footing that the word connotes or suggests some decision or course of action or of accounting on the part of the company. It is pointed out that, though s. 24 (1) speaks of "capital employed," it is clear from par. (a) that the chief element is the capital which the shareholders have in the past contributed to the company, not what at the opening of the accounting period may be found still to be represented by the assets. The same policy is discernible in par. (c). It follows that, although share capital is not represented by assets, it forms part of the capital fund on which the percentage standard is calculated, and that, it is said, is because the purpose is to allow a standard of war-time profit commensurate with what shareholders have committed to the enterprise, whether it has been lost or not. In the same way, it is contended, par. (b) ought to be understood with respect to profits which the shareholders might have had but which it was decided to leave at risk in the enterprise. It is not, according to the argument, a question of what on a balance of gains and losses over an extended period of time, over a period, perhaps, from the establishment of the company, ought to be treated as the net accretion to its funds over and above share capital. The question, it is claimed, is rather what sums, annually ascertained as detachable profits which the shareholders might have taken out by way of dividend but preferred to leave at risk in the business, are shown by the accounts to remain. Are they not, it is asked, notionally as much contributions by the shareholders to the funds employed as premiums on the issue of shares or as paid up capital itself? When the loss of £13,107 was ascertained, what else could it mean but a loss of money subscribed as share capital? On what are now established principles of company law, why, it is asked, should subsequent profits be treated as replacing this loss? So far from appropriating subsequent profits to the purpose, a line was drawn, the loss was carried or suspended, and subsequent profits were treated as available for provisions in the nature of reserves and for dividend. The case is represented as one in which past losses are left unreplaced deliberately by a definite decision, while the company, in accordance with law, dealt with the net proceeds of subsequent trading by distributing profits, reserving them, or carrying them over on account of profit and loss as the wisdom of its directors and members might dictate. In other words, the law allowed the company to appropriate the profits as it thought fit and instead of dividing them or wiping out the loss with them, it decided to retain them as profits and that, it is said, amounts to "accumulating" them. Notwithstanding the closely reasoned argument of counsel for the respondent company, I think that the foregoing contention should not be accepted. In the first place, I reject the view that by "accumulated profits" par. (b) means to establish a test depending in any way on accountancy, or on the positive course the company may take in appropriating the profits it retains. For whatever purpose the like expressions may be used elsewhere, I think that those contained in par. (b) were intended to cover the profit actually ascertained and retained for employment in the business. They are intended as a descriptive category implying, no doubt, the ascertainment and retention of profit, but not otherwise depending on the accounting or on the volition of the company.

In the next place, it must be true that as part of the working capital of the company's business the subsequent profits did in fact replace the past losses. There was no reduction of share capital. The subsequent profits necessarily made up once more the fund which would answer share capital. Perhaps it is true that they were never placed beyond the power of the directors to divide them and, in that sense, they never came fully to "represent" share capital. But, except for the arrangement with shareholders which justified the division of the appropriation accounts as at 31st January 1935, there was nothing in the dealings with the profits or the assets of the company to segregate out, or to provide for, the loss, except by the actual use of the subsequent profits. When the placing of the respective balances of the two appropriation accounts, the debit of the one and the credit of the other, on opposite sides of the balance sheet is considered, it will be seen as an express acknowledgment of their necessary relation and as falling just short of an amalgamation of the two accounts by using the later to answer the earlier.

In my opinion the reality is that up to 31st January 1941 the company never accumulated more than £7,441 of profits and that sum, together with the addition of the reserves of £17,792, is the amount upon which the calculation under s. 24 (1) (b) should be based.

There is, however, a question arising under the words "averaged over the accounting period" contained in par. (b). For, on 31st March 1941, that is, within the accounting period, the company declared dividends amounting to £10,075. In addition, an interim dividend amounting to £2,400 was paid on preference shares on 10th October 1941. It does not appear, however, from what source it was paid or to what profits the payment has been attributed. It may amount to a distribution of the profits of the then current accounting period, that ending on 31st January 1942. If so, the distribution would not affect the period under consideration. I think, therefore, that we should ignore it and confine ourselves to the dividends amounting to £10,075 declared as on 31st March 1941.

The declaration of these dividends involved a reduction or diminution by £10,075 of the accumulated profits fifty-nine days after the opening of the accounting period. The question is how should this diminution of accumulated profits be averaged over the accounting period?

In the first place, it is clear that none of it was in fact or in law paid out of reserves. The reserves as such were continued without increase or diminution throughout the accounting period. If it be proper to regard them separately, they require no "averaging." The chairman of the Board so regarded them and put them out of consideration in applying the averaging provision, on the ground that it was not necessary to average the reserves as their amount remained unchanged throughout the year. This position the Commissioner accepted on the hearing of the appeals before us and we need not consider its correctness.

The sum of £20,548, which the company's accounts showed as its balance of unreserved accumulated profits as at 31st January 1941, included a sum of £14,528, the profits of the year ending upon that date. It appears that, in proposing to the shareholders the declaration of the dividends amounting to £10,075, the directors recommended that they should be payable out of the profits of the year just closed, viz., out of the £14,528, and, as the shareholders resolved that the dividends as recommended by the directors be declared, we may assume that the source of the distribution of £10,075 was the £14,528 parcel of the £20,548. These sums of profit are recognized by company law as existing, notwithstanding that prior losses have not been recouped, and as being available as a source of dividend. But, for the purpose of the War-time (Company) Tax Assessment Act upon the foregoing interpretation of that Act, the only accumulation of profit recognized is £7,441. That sum may be considered to be contained within the £20,548 recognized under company law and perhaps it may be treated as altogether comprised within the £14,528, the profits last to be earned, forming part of the £20,548. It is clear that, after 31st March 1941, the amount declared as dividends ceased to be profits held by the company. In applying the direction to average the accumulated profits over the accounting period, should we throw the whole of the dividends so declared against the £7,441 with the consequence that we must treat no part of that sum as in the possession of the company for more than fifty-nine days of the accounting period and must then regard it as having been exhausted by contributing to the payment of £10,075? Or, on the other hand, should we treat the dividend as payable ratably out of each and every £1 of the £14,528, so that only so much in the £1 of the dividend should be considered attributable to the £7,441, treating the latter sum of course as forming part of the £14,528? Before the Board this question does not appear to have been raised and the chairman regarded the whole of the sum of £7,441 as distributed, or appropriated for distribution, as at the end of fifty-nine days in part payment of the dividends amounting to £10,075. He, therefore, considered that the sum of £7,441 should be averaged as follows, viz.59× £7,441 = £1,203.365

The opposing view is based on an application of the rule that where sums such as dividends are paid out of an aggregate sum without differentiation, they must be taken to have been paid ratably out of every part of it (Resch v. Federal Commissioner of Taxation[39]). If this principle be applied the dividends amounting to £10,075 would be taken as paid out of a total sum of £14,528 without differentiation and, of every £1 of the latter sum, the dividends must be considered to have taken£10,075£14,528. On the footing that the accumulated profits recognized by s. 24 (1) (b), viz. £7,441, form a part of the £14,528, the dividends would be taken to have been paid out of the £7,441 only to the extent of£10,075£14,528, that is £5,160.

On the whole I have come to the conclusion that the principle of ratable attribution ought not to be applied, and that the chairman's method is the correct one. My reason for this conclusion, which I have not reached without some doubt, lies in s. 24 (1) (b) itself. In that section the words "averaged over the accounting period" are attached to the words "accumulated profits." I do not mean by this to exclude the possibility of them governing also the words "standing to the credit of the Profit and Loss Account." That is a question that can be put on one side. But I do mean that the conception of "accumulated profits" seems, by the juxtaposition of the words, to be one that ought to be carried into the process of averaging. If it is right, as for the reasons given, I think it is, to go to the actual accumulation of profits as ascertained from a consideration of the profits made, the losses made and the dividends distributed, I think it is also right to carry the same principle into averaging. This means, in effect, that we ought not to go to company law to find out what sum was consumed in distributing the dividends during the accounting period or, in other words, to determine the source of the dividends. We should continue, in averaging, just as in ascertaining the accumulated profits at the beginning of the accounting period to look to the actual balance of accumulated profits available. This means that we should treat the sum of £7,441 as the accumulated profits at the beginning of the accounting period against which the dividends paid during the accounting period should be primarily thrown. We are averaging the sum of £7,441 in the sense of ascertaining over what period of time that amount was retained as part of the funds of the company, and making an apportionment in accordance with time over the accounting period. I, therefore, think that the view of the chairman is correct, namely, that since 31st March 1941, the amount declared as dividends ceased to be profits held by the company, the accumulated profits not distributed or otherwise dealt with at the beginning of the accounting period amounted to £7,441 and, having been distributed at the end of fifty-nine days, this amount should be averaged as follows:—59= £1,203.365

I, therefore, answer the first question in the case stated in respect of the accounting period ending 31st January 1942, Yes, and the second question, that it should be taken into account to the extent and in the manner described in par. (c) of the question.

In the case stated for the accounting period ending 31st January 1941 the facts are the same, though, of course, the figures differ. The questions are in the same form and the answers should be the same.

Questions in case answered as follows:—(1) Yes; (2) The said sum should be taken into account in the manner stated in par. (c) of question 2. Costs of case costs in the appeal. Case remitted to Dixon J.

[1] [1918] HCA 15; (1918) 24 C.L.R. 369.

[2] [1921] HCA 35; (1921) 29 C.L.R. 441.

[3] [1921] HCA 35; (1921) 29 C.L.R. 441, at p. 447.

[4] [1923] HCA 56; (1923) 33 C.L.R. 458.

[5] (1923) 33 C.L.R., at pp. 469, 489, 490.

[6] (1923) 33 C.L.R., at p. 481.

[7] [1921] HCA 35; (1921) 29 C.L.R. 441.

[8] [1928] HCA 30; (1928) 42 C.L.R. 106.

[9] [1921] HCA 35; (1921) 29 C.L.R. 441.

[10] [1918] HCA 15; (1918) 24 C.L.R. 369.

[11] (1928) 42 C.L.R., at p. 112.

[12] [1921] HCA 35; (1921) 29 C.L.R. 441.

[13] [1923] HCA 56; (1923) 33 C.L.R. 458.

[14] [1927] HCA 10; (1927) 39 C.L.R. 158.

[15] [1918] HCA 15; (1918) 24 C.L.R. 369.

[16] [1918] HCA 15; (1918) 24 C.L.R. 369.

[17] (1889) 41 Ch. D. 1.

[18] (1918) 1 Ch. 266.

[19] (1889) 41 Ch. D. 1.

[20] [1918] HCA 15; (1918) 24 C.L.R. 369, at p. 372.

[21] [1923] HCA 56; (1923) 33 C.L.R. 458.

[22] [1927] HCA 10; (1927) 39 C.L.R. 158.

[23] [1928] HCA 30; (1928) 42 C.L.R. 106.

[24] [1918] HCA 15; (1918) 24 C.L.R. 369.

[25] [1921] HCA 35; (1921) 29 C.L.R. 441.

[26] [1923] HCA 56; (1923) 33 C.L.R. 458.

[27] [1927] HCA 10; (1927) 39 C.L.R. 158.

[28] [1928] HCA 30; (1928) 42 C.L.R. 106.

[29] [1942] HCA 2; (1942) 66 C.L.R. 198, at p. 231.

[30] [1921] HCA 35; (1921) 29 C.L.R. 441.

[31] [1923] HCA 56; (1923) 33 C.L.R. 458, at pp. 480-482.

[32] [1927] HCA 10; (1927) 39 C.L.R. 158, at p. 172.

[33] [1918] HCA 15; (1918) 24 C.L.R. 369.

[34] [1928] HCA 30; (1928) 42 C.L.R. 106.

[35] [1921] HCA 35; (1921) 29 C.L.R. 441.

[36] [1928] HCA 30; (1928) 42 C.L.R. 106.

[37] [1923] HCA 56; (1923) 33 C.L.R. 458.

[38] [1927] HCA 10; (1927) 39 C.L.R. 158.

[39] [1942] HCA 2; (1942) 66 C.L.R. 198, at pp. 230, 231.

High Court of Australia

Federal Commissioner of Taxation v Miller Anderson Ltd [1946] HCA 2; (1946) 73 CLR 341 (4 April 1946)

HIGH COURT OF AUSTRALIA