Charles v Federal Commissioner of Taxation [1954] HCA 16; (1954) 90 CLR 598 (23 April 1954)

HIGH COURT OF AUSTRALIA

CHARLES v. FEDERAL COMMISSIONER OF TAXATION [1954] HCA 16; (1954) 90 CLR 598

Income Tax

High Court of Australia
Dixon C.J.(1), Kitto(1) and Taylor(1) JJ.

CATCHWORDS

Income Tax - Assessable income - Trust - Realization of capital investments of trust - Profits - Shares - Issue of new shares - Sale of "rights" - Proceeds - "Profits of a business" - "Profit-making undertaking or scheme" - Profits arising - Income or capital - Income Tax Assessment Act 1936-1948 (No. 27 of 1936 - No. 44 of 1948), s. 26 (a).

HEARING

Sydney, 1953, September 7-9; 1954, April 23. 23:4:1954
APPEAL.

DECISION

April 23, 1954.
THE COURT delivered the following written judgment:-
The appellant was assessed to income tax and social services contribution derived during the year ended 30th June 1949. An objection to the assessment was disallowed by a deputy commissioner and subsequently by a Board of Review. From the Board's decision an appeal was brought to this Court and was referred by Webb J. to the Full Court. It is that appeal which is now before us. (at p604)

2. The appeal concerns an amount of 390 pounds, portion of a sum of 830 pounds which the appellant received in the relevant year as a certificate holder in what is known as the Second Provident Unit Trust. 440 pounds of that sum consisted of the appellant's share of dividends and interest received on capital investments of the Trust, and it was treated both by the appellant and by the commissioner as retaining in the hands of the appellant its original character of income from property. The balance, the 390 pounds now in question, came partly from profits which had been made on realizations of capital investments of the Trust, and partly from the proceeds of sale of "rights" in respect of new share issues which had arisen in respect of shares held as capital investments of the Trust. Both parties to the appeal attached significance to the distinction between the two amounts in respect of source, the appellant contending that the 390 pounds was in his hands a receipt of a capital nature and not liable to be included in the computation of his assessable income, and the commissioner contending that the 390 pounds was profits of a business, or (alternatively) profits arising from the carrying on or carrying out of a profit-making undertaking or scheme within the meaning of s. 26(a) of the Income Tax Assessment Act, and accordingly possessed from the beginning, and continued to have when it reached the hands of the appellant, the character of income from personal exertion. (at p605)

3. The Trust was governed by a declaration of trust executed on 13th November 1939 between a company named Unit Trusts Ltd. (therein called the managers) of the one part and Queensland Trustees Ltd. (therein called the trustees) of the other part. It was expressed to apply to a trust fund consisting of 1,350 shares in thirteen companies which the managers had caused or were to cause to be transferred to the trustees, and such further securities as the managers might thereafter vest in the trustees in accordance with elaborate provisions which limited investments of the trust to the shares or debentures of specified companies and securities authorized for the investment of trust funds. (at p605)

4. The beneficial interest in the trust fund was originally divided into 1,700 units (cl. 6), but it was provided that this number might increase as additions should be made to the investments comprising the trust fund (cl. 7). The managers, who were entitled initially to the whole beneficial interest in the trust fund, were empowered to nominate any person including themselves to receive a certificate or certificates as the holder of units, and the trustees were required thereupon to issue to such person a registered certificate (cl. 8), specifying the number of units to which it related and bearing a distinctive number or letter (cl. 9). The trustees were to retain the trust fund in trust for the certificate holders and, subject thereto, in trust for the managers or as they might direct (cl. 2 (A)), and were to recognize the certificate holders or their executors or administrators as the only persons having any right or interest in the units in respect of which they should be registered (cl. 21). Every holder of a registered certificate was to be entitled to transfer the units or any of the units held by him by an instrument in writing (cl. 20). The managers were to be at all times entitled to the benefit of any unit except during such periods as there should be some other person registered as the holder of the unit or entitled to be so registered under certain provisions of the deed (cl. 10). (at p606)

5. A holder of 3,000 units or any exact multiple of 3,000 units was given a right to exchange his units for cash and securities, or securities only, forming a proportionate part of the trust fund (cl. 14(A)); and any certificate holder might at any time surrender his units for cash (cl. 14(D)). (at p606)

6. The Trust was to determine on 15th January 1955 unless previously determined under provisions operating in certain specified events (cl. 7); and upon its determination the trust fund was to be distributed in specie or cash amongst the certificate holders in proportion to their respective unit-holdings (cl. 18). (at p606)

7. The deed contained no power to traffic in securities. Indeed it provided that except for purposes of the deed the trustees should not sell any of the investments until the determination of the trust (cl. 5). But in addition to conferring on the trustees a power to sell investments in order to give effect to certain provisions directed to ensuring that the uncalled liability in respect of any of the investments could be met (cl. 4(C)), the deed gave a wide power to vary investments. It provided (cl. 3(A)) that if, in the opinion of the managers, it should at any time or times become in the interests of the certificate holders desirable to realize any investments for the time being comprised in the trust fund, or advantageous to reduce the amount of any particular investment in order to increase the amount or amounts of others, the managers might request the trustees to give their consent (which they might give or withhold as they should in their sole discretion think proper) to the sale of the whole or part of such particular investments and re-investment of the net proceeds of sale in the purchase of securities designated by the managers and approved by the trustees. If the trustees should give their consent they were to act accordingly. Moreover, in respect of, inter alia, any rights in respect of new share issues the deed provided that the trustees with the consent of the managers might exercise such rights or sell them (cl. 13(C)). (at p606)

8. The trustees were to receive all moneys rights and property which should be paid or distributed in respect of the investments by way of dividend, bonus or otherwise (cl. 12); and they were to make half-yearly distributions to the certificate holders in proportion to their respective numbers of units (cl. 13(A)). The fund to be distributed on each occasion was called "the cash produce" which should have arisen in respect of the trust fund during the preceding half year. This expression was defined (by cl. 13(B)), to include, first, all cash received or to be received by the trustees by way of dividend, bonus income appropriation, dividend equalization, or otherwise in respect of the trust fund, where in the opinion of the trustees the same should represent income; secondly, all cash received in respect of any sale of, inter alia, any rights, which the managers with the consent of the trustees might decide to sell and the proceeds of which they should decide to treat as cash produce; and thirdly, at the discretion of the managers, any profits realized, less any losses sustained, on the sale of any of the securities. The provisions in respect of the half-yearly distributions were subject to a power in the managers with the consent of the trustees to retain intact or to invest the proceeds of any capital distributions (cl. 13(A)), and they were also subject to provisions for treating cash produce accruing late in a half-year as if it had accrued in the next following half-year (cl. 13(D)). (at p607)

9. It was provided (cl. 27(A)) that the trustees should not be entitled to any remuneration out of the trust funds in respect of their services under the deed, but that the managers should pay them by way of remuneration such sums as might be agreed upon from time to time, and if not agreed upon, reasonable sums. It is evident that in order to meet this liability and any other expenses of their management, and to remunerate themselves for promoting and managing the trust, the managers had to look to the proceeds of sale of units. Consequently the prices they charged were somewhat in excess of the value which would be attributed to the units by the process of adding together the respective market values of the trust investments and dividing the total by the number of units. In a brochure issued by way of advertisement, the excess was described as a service charge and was stated to amount to seven and one-half per cent on the current stock exchange price of the securities adjusted to cover dividends received, stamp duties, transfer fees and brokerage. (at p607)

10. In the relevant year, the appellant participated in half-yearly distributions of "cash produce". The amounts distributed included moneys belonging to each of the three classes comprised in the definition: dividends, proceeds of sale of rights, and profits realized on sales of securities. The question presents itself at once whether the case is distinguishable in any material respect from a case in which moneys of the same descriptions are distributed amongst beneficiaries by the trustees of a will or settlement, to whose hands the moneys have come in consequence of the exercise of usual powers to invest and to vary investments, and to whom the trust instrument gives a discretionary power to make such distributions. The assumption is that in the handling of the investments the trustees of the will or settlement are not carrying on a business. In such a case the character of the moneys in the hands of the trustees is clear: dividends are income, whether the companies concerned have paid them out of income profits or out of capital profits: Inland Revenue Commissioners v. Reid's Trustees (1949) AC 361 ; proceeds of sale of rights are accretions to capital, on the reasoning of Inland Revenue Commissioners v. Blott (1921) 2 AC 171 ; and profits realized on sales of securities are necessarily capital. And in such a case the position of a beneficiary in respect of income tax upon the moneys distributed is equally clear. In so far as dividends are concerned, the case falls within s. 101 of the Income Tax Assessment Act, with the result that the beneficiary is deemed to be presently entitled to the amount paid to him out of the dividends as income of the trust estate, and as a consequence that amount is either included in his assessable income by force of s. 97 or taxed as a separate assessable income in the hands of the trustees by force of s. 98, according as the beneficiary is or is not free from legal disability; see the discussion of this group of sections in Federal Commissioner of Taxation v. Belford [1952] HCA 73; (1953) 88 CLR 589 . In so far as the proceeds of sale of rights and the profits realized on sales of securities are concerned, however, neither general principle nor statutory provision requires that such capital moneys of the trust should be treated as assessable income of the beneficiaries when distributed to them. Is there any such distinction between a case of that kind and the present that a different conclusion should here be reached? (at p608)

11. At first sight it may seem that a person who invests in units under a trust deed such as that which is here in question does so with a view to obtaining the half-yearly distributions for which the deed provides, just as he might have bought shares in an investment company with a view to deriving half-yearly dividends from them; and that the periodical distributions received should be regarded as income in the one case just as they would be in the other. Some such view, indeed, would appear to be suggested by the brochure which the managers issued, for the amount to be received by a unit holder in a half-yearly distribution is spoken of throughout that document as income of the unit. But the view is untenable, for a unit held under this trust deed is fundamentally different from a share in a company. A share confers upon the holder no legal or equitable interest in the assets of the company; it is a separate piece of property; and if a portion of the company's assets is distributed among the shareholders the question whether it comes to them as income or as capital depends upon whether the corpus of their property (their shares) remains intact despite the distribution: Inland Revenue Commissioners v. Reid's Trustees (1949) AC, at p 373 . But a unit under the trust deed before us confers a proprietary interest in all the property which for the time being is subject to the trust of the deed: Baker v. Archer-Shee [1927] UKHL 1; (1927) AC 844 ; so that the question whether moneys distributed to unit holders under the trust form part of their income or of their capital must be answered by considering the character of those moneys in the hands of the trustees before the distribution is made. (at p609)

12. A more difficult question, however, is whether it is not true to say of the entire amount of each half-yearly distribution that as a whole, without any distinction being drawn amongst its ingredients, it should be put into the category of income as being the fruit of the carrying out of a plan or scheme, devised by the managers, carried out by the managers and the trustees in co-operation, and joined in by the certificate holders, for the purpose of yielding regular periodical returns to the certificate holders upon their invested capital. This was not exactly the view taken by the commissioner when he made the assessment; he was content to treat that portion of the distributed fund which came from dividends received by the trustees as the income of the certificate holders derived from property; and it was only that portion which came from the proceeds of sale of rights and from profits on realizations of investments that he took to be the certificate holders' income from personal exertion as having arisen from the carrying out of a profit-making scheme. In order to support one or other of these views, counsel for the commissioner devoted a great deal of attention to the history of the dealings in securities and rights which actually took place in the course of the administration of the trust. The evidence established that these dealings were considerable; they occurred frequently and produced substantial profits. Indeed, most sales of securities were made at prices in excess of cost. Moreover, all the profits thus made, less such losses as were sustained, were paid out to the certificate holders in the half-yearly distributions, the managers exercising the discretion given them by cl. 13(B) to include all these profits (less losses) in the "cash produce". This was a course of action which obviously had been contemplated from the beginning; and if the proper conclusion from the evidence were that the managers and the trustees co-operated in pursuing a systematic course of buying and selling securities for the purpose of producing profits and thereby swelling the half-yearly amounts of "cash produce" available for distribution to certificate holders, the commissioner's opinion that such profits should be treated as assessable income of the certificate holders when paid over to them would be clearly correct. But the evidence of the only witness in the case, Mr. T.R. Groom the managing director of Unit Trusts Ltd. was that at no time were securities acquired for the express purpose of re-sale at a profit, and that sales were normally made when the managers anticipated a fall in the value of shares. The purpose (he explained in effect) was to preserve for the fund any increase in value which had occurred and which it seemed likely would otherwise be lost. He said (p. 115) that the general policy of the managers was to hold the securities as investments, and that their "standard idea" in buying was to buy the best available securities and to hold them unless there appeared to be some very good reason for selling. The factors they had before them in buying, he said (p. 114), were security, realizability, yield and possibility of capital appreciation, in that order. They had said something similar in a report for the half-year ended 15th December 1946: ". . . it is not the policy of the managers to buy securities with a view to their resale at a profit . . ." Now, Mr. Groom's evidence on these points was accepted by the Board of Review who saw him as a witness, and on this evidence the majority of the Board made findings which a member, Mr. Bock, expressed in these words (p. 14): "The over-riding consideration in the changing of investment was to ensure security of capital, which, in the manager's view, included not only the purchase cost to them but also any advance in the market price which may have taken place after the date of purchase. From the witness's evidence I think it must fairly be said that during the relevant period the managers kept themselves closely informed of market trends and wherever they were of the opinion that securities were likely to fall in market value, parcels of shares were sold to avoid a reduction in value of each unit in the trust which would be consequent upon a decline in market value of the shares held". We would not be justified in taking a different view, and the case therefore cannot be treated as one in which beneficiaries receive from trustees profits made by the sale of property acquired for the purpose of profitmaking by sale. (at p610)

13. The view adopted by the Board of Review appears to have been that the amounts distributed to certificate holders ought not to be dissected and treated as partly income and partly capital according as the components of the fund of "cash produce" were derived as income or as capital by the trustees, but should be treated as distributive shares of a blended fund, provided for by the trust deed as the source from which investors in the trust fund should receive regular periodical returns, and possessing as a whole the income character of its principal ingredient, namely dividends and interest. But the fact that half-yearly distributions were prescribed by the trust deed, and that the moneys to be distributed were given by the deed a collective title, cannot suffice to change the character of those moneys. It is true that in the advertising matter which the managers used to promote sales of units - and thereby to obtain the seven and one-half per cent "service charge" which provided them with their remuneration for launching and carrying out the scheme - the language used was calculated to divert the attention of prospective investors from the fact that distributions would include capital moneys as well as income; and it could hardly fail to lead them, when weighing the relative advantages of investment in Trust units and investment in shares by purchase on the stock exchange, to think of the total sums likely to be received in half-yearly distributions under the Trust as comparable with the dividends likely to be derived from shares. But to obscure the facts is not to alter them. We are considering here moneys which fall into the distributable fund because they are the proceeds of sale of rights or profits realized on the sale of capital assets of the trust not acquired for the purpose of sale at a profit. The title of the participants to have those moneys included in the distribution depends, therefore, upon the very facts which give them their capital nature. The case is not like that of an annuity payable out of a capital fund, for the very conception of an annuity imparts its own character to the payments made, notwithstanding the character of the fund resorted to for the payment. Here, it is as capital moneys of two particular descriptions that the sums in question find their way, via the distributable fund, into the hands of the certificate holders. (at p611)

14. It remains to consider one argument upon which counsel for the commissioner relied. They contended, in effect, that even if the position be accepted that the course pursued in the administration of the Trust cannot properly be described as the carrying on of a business of stock-jobbing, still it amounted to a business of making profits of various kinds for the certificate holders, and that the selling of rights, and the buying of securities and re-selling them at prices in excess of cost, were part and parcel of the sum of activities by which those profits were made. In such a situation, counsel submitted, cases such as Punjab Co-operative Bank Ltd., Amritsar v. Commissioner of Income Tax, Lahore (1940) AC 1055 and Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation [1946] HCA 60; (1946) 73 CLR 604 show that the whole of the profits realized, even though some part of them would otherwise be of a capital nature, are to be regarded as income. To accept this argument, however, would be to ignore the evidence already mentioned, which is inconsistent with the notion that the activities of the managers, or of the managers and the trustees together, were different in kind from those in which trustees normally engage who hold a portfolio of shares with power to vary investments from time to time as they consider the interests of the beneficiaries require. According to that evidence, the moneys in question arose, not (as in the cases cited) from transactions forming incidents in the conduct of a business or a profit-making scheme, but from transactions effected in the course of performing a fiduciary duty to preserve for beneficiaries as far as practicable the assets comprising the trust fund and any increments in the value of those assets which might appear from time to time to be in jeopardy. The case therefore differs fundamentally from the cases relied upon by counsel for the commissioner. (at p612)

15. It will be observed that the conclusion depends wholly upon the acceptance of the evidence given by Mr. Groom as to the purposes which animated the managers in acquiring shares and in deciding to hold or sell shares and to exercise or sell rights. This evidence we cannot but accept, since it was accepted by the Board before which it was given. In this Court the witness was not called, the written depositions alone being before us. (at p612)

16. The appeal should be allowed, the decision of the Board of Review should be set aside, and the assessment should be reduced by the exclusion of the moneys in dispute from the appellant's assessable income. (at p612)

ORDER

Appeal from decision of the Board of Review allowed with costs. Order that the assessment be varied by reducing the taxable income by 390 pounds and that the tax be recalculated accordingly.