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High Court of Australia |
HANCOCK v. FEDERAL COMMISSIONER OF TAXATION [1961] HCA 90; (1961) 108 CLR 258
Income Tax (Cth)
High Court of Australia
Fullagar J.(1)
Dixon C.J.(2), Kitto(3), Menzies(4) and Windeyer(5) JJ.
CATCHWORDS
Income Tax (Cth) - Arrangement having purpose or effect of avoiding liability under the Act - Effect of avoidance - Sale of shares in private company by two groups of vendors to share-dealing company - Declaration of dividend to withdraw accumulated profits - Resale of shares to one of the groups - Ultimate purchasers' desire to own all the shares in the company - Assessable income of the ultimate purchasers - Income Tax Assessment Act 1936-1949 (Cth), s. 260.
HEARING
Perth, 1959, July 8, 9; September 4. 4:9:1959DECISION
1959, September 4.2. This is an appeal by a taxpayer against an amended assessment of income tax. The relevant year of income is the year ended 30th June 1949. The taxpayer returned his income from property of that year as 2,694 pounds, and tax was originally assessed on that amount (together with certain income from personal exertion) by an assessment, notice of which was given on 27th March 1950. The effect of the amended assessment, notice of which was given on 6th November 1953, was to increase the taxpayer's income from property by 17,759 pounds. The notice of amended assessment also, under s. 226 of the Income Tax Assessment Act, charged the taxpayer with "additional tax", amounting to 6,503 pounds, on the ground that he had omitted assessable income from his return. At the hearing before me counsel for the Commissioner conceded that the amended assessment could not be justified otherwise than by the application of s. 260 of the Assessment Act, which avoids, as against the Commissioner, certain classes of "contracts, agreements and arrangements". The case arises out of certain transactions in which the taxpayer and two companies, named respectively Mulga Downs Pty. Ltd. and Rowdell Pty. Ltd., were concerned. It is desirable to state the facts in some detail. (at p260)
3. Mulga Downs was incorporated in Western Australia in 1919. It was at all material times the owner of a very large property in the northern part of Western Australia, on which it has carried on a generally prosperous pastoral business. It was a private company within the meaning of the Assessment Act. In 1949 its issued capital consisted of 18,945 fully paid ordinary shares of 1 pound. These shares (apart from one share, which may be ignored) were held, and had for a long time been held, by members of two families - the Lefroy family and the Hancock family. The Lefroy family held a substantial majority of the shares, seven members holding between them a total of 11,209 shares. The remaining shares (a total of 7,735 shares) were held, as to 6,730 shares by Mr. George Hancock (the taxpayer), as to 5 shares by Mrs. L. Y. M. Hancock, and as to 1,000 shares by Mr. Langley Hancock, who is a son of the taxpayer. The five shares owned by Mrs. L. Y. M. Hancock did not enter into the transactions about to be mentioned, and when I speak of the Hancock shares, I shall be referring only to those of Mr. George Hancock and Mr. Langley Hancock. Up to about 1936 the taxpayer resided on the station and was manager of the company's business, and from 1936 to 1949 he was actively associated with the management. It is said - and I see no reason to doubt it - that he had long entertained a hope or ambition that the Hancock family should own the whole of the shares, or at least a controlling interest, in the company. (at p260)
4. Rowdell was incorporated in Western Australia in 1926. All the shares in this company have at all material times been held by Mr. H. K. Watson and his wife, Mr. Watson having a controlling interest. Mr. Watson, who played a prominent part in the transactions now in question, is a chartered accountant and taxation consultant practising in Perth. Rowdell's memorandum of association was not put in evidence, but it has in fact carried on a business of trading in stocks and shares. It possessed, therefore, the virtue - a virtue relevant in the present case - of being prima facie entitled, for the purpose of arriving at its taxable income of any year, to deduct from dividends or other assessable income received by it any loss incurred on a purchase or sale of shares. (at p261)
5. The accounting period of Mulga Downs was the year ending 30th April. Its balance sheet for the year ended 30th April 1948 showed it to be in a strong position. Its assets included land and improvements, plant and machinery, and live stock, taken in at a total sum of 37,838 pounds, which evidently represented a considerable undervaluation. The balance sheet also showed considerable "liquid" assets, consisting of Commonwealth bonds of a face value of 7,500 pounds, an advance by George Hancock of 5,000 pounds, and a credit balance of about 3,000 pounds with Dalgety & Co., which was in effect the company's banker. In February 1949 the holding of Commonwealth bonds had been increased by 10,000 pounds to 17,500 pounds, and the credit balance with Dalgety had been increased to about 5,400 pounds. On the liabilities side appeared a reserve of 4,161 pounds, a sum of 16,666 pounds at credit of profit and loss appropriation account, and a sum of 11,081 pounds at credit of profit and loss account. The profits of the year ended 30th April 1949 were about 24,000 pounds. (at p261)
6. With regard to income tax, the position of the company and its shareholders was not made precisely clear to me. It is obvious, however, that, if the whole of the company's accumulated and current profits had been distributed to the shareholders in February 1949, very considerable sums would have become payable by the shareholders by way of income tax. For the rest, it is sufficient, I think, to quote the following extract from the evidence of Mr. Watson. He said: - "In respect of Div. 7 the position at 30th April was this: The tax liabilities at 30th April were roughly 3,600 pounds ordinary tax which had still not been paid in respect of the year ended 30th June 1948. The ordinary income tax prospectively due on profits earned for the year ending 30th April 1949 was 6,900 pounds. Profits for that year were 24,000 pounds. 6,900 pounds was the normal tax, and that, in round figures, left this position: That if the company did not by the 31st October distribute 14,000 pounds or thereabouts it would have been liable for a Div. 7 tax of 7,000 pounds or thereabouts, so that at 30th April I would say that Div. 7 tax of 7,000 pounds was the total liability of the company under that division". (at p261)
7. Whatever view may have been taken by them of their income tax position, it was not by the taxpayer or any other shareholder in Mulga Downs that the transactions now in question were initiated. The first approach was made to Mr. Langley Hancock by Mr. Watson on behalf of his company, Rowdell. That company, as has been seen, had been formed more than twenty years earlier and its turnover appears to have been extensive. About the time with which we are concerned it had had some transactions whereby the shares of private companies which had substantial undistributed profits were bought, and subsequently, after dividends had been declared and paid to it, either the shares were disposed of or the company was wound up. The following passages are taken from the cross-examination of Mr. Watson: - "Q. Is it not a fact that round about that time you, on behalf of Rowdell, were keeping your eyes open for companies where shareholders might find it advantageous to receive a capital sum for their shares? A. At that time I had made it quite clear around Perth that I was interested in any private company that was up for sale. I communicated with the two trustee companies and indicated that if they had any shares for sale I would be interested. Q. My question is directed more to companies where the shareholders were in the difficulty I have mentioned. That the current profits which were going to attract considerable income tax liability were undistributed, and were you not keeping your eyes open? A. I was, yes. Q. And it was your practice to make an approach on the basis of, 'I can do a deal with you of buying shares at a figure which represents its present value with regard to the profits which would be free of tax in your hands and I can dispose of the shares to somebody else'? A. No. My general approach was that I was prepared to have a look at any company's balance sheet and buy the shares on the the basis of net assets value less 10%. Q. Yes, but in the case of the companies which had large current profits, or an accumulation of profits which were not freely available to the shareholders except on the penalty of taxation, was not your approach this: 'Here is a way you can get money as a capital sum free of income tax and I can turn an honest penny for myself'? A. My approach was if you sell them to Rowdell you sell them as a capital asset. Q. Yes, and you would point out that in substance, therefore, they would get the benefit either by the current profits or the accumulated profits, whichever it was, without the liability to pay income tax on the figure? A. I think I made it pretty clear in my letter to Hancock of 15th February - Q. I am not so much concerned with Hancock as to getting your general business practice at this time and show in a general way your approach to the shareholders included pointing out to them the advantage of selling and receiving a sum which would be a capital sum and which would include the benefit of profits without incurring income tax? A. I made my approach exactly as I have told you. Q. Did you not point out to the shareholder the advantage of receiving from you a capital sum, and the amount would be distributed to the shareholder? A. No, I left it to the shareholder to draw his own conclusions. In my letter to Hancock I made it quite clear that it was a sale of a capital asset. Q. You say that at no time you made that approach? A. No, I would not say that. Q. Whether you say it expressly in those words or not, that was what was to be understood - that was the advantage to the shareholder? A. Yes, it was obvious. Q. The advantage you were offering him was a tax free sum? A. Yes. Q. As opposed to having to pay income tax alternatively on profits as such? A. That would be so." (at p263)
8. Mr. Watson and Mr. Langley Hancock were on friendly terms, but there was no business or professional relation between them. About the end of 1948, or very early in 1949, they met on some social occasion, and Mr. Watson, who then thought that Mulga Downs was owned entirely by the Hancock family, asked whether they would be prepared to sell all the shares. Mr. Hancock explained that the Lefroys owned a majority of the shares, and said that he would be more interested in buying shares in the company than in selling them. At that time, or a little later, Mr. Watson asked for and obtained the last balance sheet of the company and full particulars with regard to the station - stock records, rainfall records, and so on. (at p263)
9. The next step was taken when Rowdell on 15th February 1949 wrote to Langley Hancock a letter which I think should be set out practically in full. It reads: - "If your family would still be interested in acquiring the whole of the issued shares in Mulga Downs Pty. Ltd., or if you desire to get right out of Mulga Downs at a good profit, here are some deals for which our Company would be pleased to negotiate with your family and the Lefroys. We would be prepared to buy all the shares held by G. Hancock and L. G. Hancock and the Lefroy Group in Mulga Downs Pty. Ltd. for up to 20,000 pounds and up to 3,000 pounds and up to 40,000 pounds respectively - i.e. a total of 63,000 pounds for the issued capital of some 18,900 shares of 1 pound each. A sale at these figures would give the Lefroys and the Hancocks a substantial capital profit on which income tax would not be chargeable. We would not be particularly interested in buying only the shares of the Lefroy group or of your group. We would much prefer to buy the total issued capital of the Company, except for say, 10 shares. . . .We may as well also tell you quite frankly that if our Company succeeded in so purchasing all the issued shares in Mulga Downs Pty. Ltd. our Company would - after having first taken and retained no more and no less than 50,000 pounds out of Mulga Downs Pty. Ltd. by way of dividends during the month of May next - then be willing to sell all the issued shares in Mulga Downs Pty. Ltd. to any buyer/s - the Hancocks or the Lefroys or the Butchers or anyone else, for 21,000 pounds. We would - if you so desired it - be prepared to give the Hancock family the first right of refusing our offer to sell all the shares at that figure of 21,000 pounds; if, in this connexion, you wanted a formal option we would be quite prepared to give it to you if and when we are ever in a position to do so. If our offers to purchase and re-sell appeal to you it would probably be as well for your father to sound out the Lefroys and - before we approach them - see whether they are willing to sell their shares for the price of 40,000 pounds indicated above. That is really an excessive price. It is certainly a price which you could not afford to pay them. If the Company were wound up they would not net anything like that amount after paying income tax on the surplus over 1 pound per share. The nature of our offer direct to the Lefroys - i.e. whether it will simply be an offer to buy their shares for 40,000 pounds or whether we will also offer them a first opportunity of repurchasing all the shares or some of them - will be determined largely by your attitude towards our offer as above. We will not approach them until we hear from you. We would like you to give serious thought to this offer of ours as it would enable the Hancocks in due course to acquire all the issued capital of Mulga Downs without any cash outlay at all over and above their present resources. Indeed, at the conclusion of all the purchases and sales the Hancock's cash position would be about 2,000 pounds better off than it is today. With Mulga Downs milked of most of its resources and accumulated and current profits by our dividends of 50,000 pounds the shares therein would, of course, then be worth very much less than they are today - but future prospects seem pretty bright. Alternatively, if you are not interested in the opportunity of re-purchase, our prime offer to buy your shares for 23,000 pounds would give you a handsome non-taxable profit. . . . We would require to buy the shares not later than April or May and to offer them for re-sale during the last fortnight in June". (at p264)
10. To put it shortly, Rowdell by this letter proposes to buy the Lefroy shares for 40,000 pounds and the Hancock shares for 23,000 pounds. slightlyA higher value per share (about 3 pounds 11s. 0d.) is placed on the former than on the latter (about 2 pounds 18s. 0d.). Rowdell announces its intention, if the offer is accepted and it thus acquires complete control of Mulga Downs, of causing that company to declare and pay to it dividends amounting to 50,000 pounds. After this "milking" operation - to use what Mr. Burt described as the "bucolic metaphor" of the letter - it will be willing to sell all the shares acquired by it for 21,000 pounds. It will sell them to any buyer, but, if the Hancocks so desire, it will give them an option, and the Hancocks are obviously very likely so to desire. The transaction, if fully carried out, will not involve the outlay of any money or the payment of any income tax by either the Lefroys or the Hancocks, and it will leave the Hancocks owning all the shares in Mulga Downs. It is true that those shares will have a considerably lower asset backing than they had before, but the station assets will be intact and the prospects of the station business are "bright". As for Rowdell, the dividends to be received by it will be assessable income in its hands, but it is contemplated that the "loss" represented by the difference between the price paid by it for the shares and the price received by it from the Hancocks will be an "allowable deduction". (at p265)
11. On receipt of the letter of 15th February Mr. Langley Hancock communicated the contents to his father and to Mr. R. A. Long, a chartered accountant practising in Perth, who acted for Mulga Downs and also for both the Lefroys and the Hancocks. On 3rd March 1949 Mr. Long wrote to all the Lefroy shareholders, conveying and explaining the proposal which had been made, and by an exchange of letters on 14th April between Rowdell and Mr. Long a contract was concluded for the sale by the Lefroy group to Rowdell of their shares in Mulga Downs for 40,000 pounds payable in exchange for signed transfers on or before 31st May 1949. No formal contract of sale was executed between Rowdell and the Lefroys, but settlement was in fact effected on 30th April 1949, when Mr. Watson on behalf of Rowdell handed to Mr. Long on behalf of the Lefroys a bank cheque for 40,000 pounds in exchange for signed transfers of the Lefroy shares to Rowdell. At this point the Lefroy shareholders drop, so to speak, out of the picture : they have simply sold their shares to Rowdell for a cash price of 40,000 pounds. (at p265)
12. So far as the Hancocks are concerned, although doubtless an understanding had been reached, the evidence does not disclose any concluded contract for the sale of their shares to Rowdell until 30th April, when a formal contract between the Hancocks and Rowdell was executed, and the Hancock shares, as well as the Lefroy shares, were transferred to Rowdell. In the meantime, on 23rd April, Rowdell had bought the 17,500 pounds Commonwealth bonds, which were owned by Mulga Downs, for 17,300 pounds, giving therefor a promissory note for that amount payable on 27th May "fixed". Then on 28th April Rowdell sold 17,000 pounds of these bonds for 16,786 pounds, which sum was paid into its current account with the Union Bank. This was done in order to finance in part the purchase of the Lefroy shares by Rowdell. The rest of the necessary money for that purchase was obtained by the declaration and immediate payment on 30th April of a dividend of 3,500 pounds from profits earned by Mulga Downs in the year ended 30th April 1948 and a dividend of 21,500 pounds from profits earned by Mulga Downs in the year ended 30th April 1949 (a total of 25,000 pounds). Payment of these dividends was financed by overdraft on the current account of Mulga Downs with Dalgety & Co. The bank account of Rowdell was, in effect, overdrawn for the few hours which elapsed between the issue of the bank cheque for 40,000 pounds and the payment into the account of the cheques for the two dividends. (at p266)
13. The formal contract for the sale of their shares by the Hancocks to Rowdell, which, as has been said, was executed on 30th April, provided that the purchase price should be 23,500 pounds, of which 2,500 pounds was to be paid on the execution of the contract, and the balance of 21,000 poun on or before 30th June 1949. (It does not appear when or how the increase of the price from 23,000 pounds to 23,500 pounds was first agreed upon.) The "deposit" of 2,500 pounds was paid on 30th April in exchange for the transfers of the Hancock shares. The position then was that Rowdell owed 21,000 pounds, the balance of the purchase price of their shares, to the Hancocks, and there was an understanding (perhaps a contract) that Rowdell would, after "milking" Mulga Downs of a further 25,000 pounds, sell the whole of the shares in that company to the Hancocks for 21,000 pounds. (at p266)
14. The next relevant events occurred on 27th May 1949. On that date an extraordinary general meeting of the shareholders in Mulga Downs passed a special resolution effecting certain alterations in the company's articles. I do not attach any importance to these. On the same day the thirtieth annual general meeting of shareholders was held, at which the following resolutions were passed : "1. That the dividends of 3,500 pounds and 21,500 pounds paid by the Directors on the 30th April 1949 be and hereby are ratified sanctioned and confirmed. 2. That out of the profits for the year ended 30th April 1949 there be and hereby is declared a further dividend of 2,500 pounds and that such dividend be forthwith paid to the registered members of the Company as at this date according to their respective rights and interests. 3. That having regard to the amount of the undivided profits of 15,780 pounds still standing to the credit of P. & L. Appropriation Accounts and to the estimated profits for the year ending 30th April 1950, represented by the wool clip now about to be shorn, the Directors be and hereby are authorized and requested forthwith to declare an interim dividend of 22,500 pounds for the current financial year ending 30th April 1950." Also on the same day a meeting of the directors of Mulga Downs was held, at which the "interim" dividend of 22,500 pounds, which had been authorized by the general meeting, was declared and made payable forthwith. Finally, on the same day the promissory note for 17,300 pounds given by Rowdell to Mulga Downs for the price of the Commonwealth bonds was honoured by cheque drawn on Rowdell's bank account and paid into the bank account of Mulga Downs. The payment of the dividends declared and paid on 27th May was financed, as had been the dividends declared and paid on 30th April, by overdraft on the current account of Mulga Downs with Dalgety & Co. (at p267)
15. The whole transaction originally contemplated was completed on 3rd June 1949 by delivery of share transfers and an exchange of cheques. Rowdell paid to Mr. George Hancock the balance (21,000 pounds) of the purchase money payable by it under the contract of 30th April for the Hancock shares, and transferred those shares, together with what had been the Lefroy shares, to George Hancock, Langley Hancock and certain nominees of George Hancock, receiving cheques drawn on Dalgety & Co. and totalling 21,000 pounds. The nominees were members of the Hancock family. In respect of the nominations gift duty was paid. The result of what was done on 3rd June was that all the shares (18,945) in Mulga Downs (with the exception of one share held by Mr. Long) were held by Mr. George Hancock and members of his family. (at p267)
16. Rowdell's receipts and payments, which have been narrated above, are
tabulated (the exact figures being given) in Exhibit E,
which is as follows :
1949 Payments Receipts28 Proceeds of sale of Bonds (Face
Pounds Pounds April
Value 17,000 pounds) purchased frompurchase price for 11,210 shares in
Mulga Downs Pty. Ltd. 16,786 17 6
" 30 Bank Cheque for Lefroys - full
Mulga Downs Pty. Ltd. 40,000 0 0Rowdell's general revenue 6,968 7 4
" 30 Cheque to G. & L. G. Hancock -
Deposit on purchase of 7,728 shares
in Mulga Downs Pty. Ltd. 2,500 0 0
" 30 Dividend Cheques from Mulga
Downs Pty. Ltd. on 18,938 shares 24,990 14 11
May 27 Dividend Cheques from Mulga
Downs Pty. Ltd. on 18,938 shares 24,990 14 11
" 27 Paid to Mulga Downs Pty. Ltd.
(P/N met) in payment for Bonds
(face value 17,500 pounds) purchased in
April 17,300 0 0
59,800 0 0
" 27 Cash Balance - being part of
66,768 7 4 66,768 7 4
RECONCILIATION AS AT 27TH MAY, 1949
Dividends received from Mulga Downs 49,981 9 10
Bank Cheque for Lefroys 40,000 0 0
Paid to Hancocks 2,500 0 0 42,500 0 0
Cash Balance as above 6,968 7 4
Cost of Bonds (Face Value 500 pounds) unsold at
27th May 1949 (and still unsold at
30th June 1949) 17,300 pounds 0 0
16,786 17 6 513 2 6 7,481 9 10
PARTICULARS OF CHEQUES EXCHANGED ON 3RD JUNE, 1949.
Cheques (drawn by George Hancock on
Dalgety & Co. Ltd.) received by Rowdell
from the Hancocks - for purchase, on
3rd June, of 18,938 shares in Mulga
Downs Pty. Ltd. 21,000 0 0
Cheque (Drawn by Rowdell on Union Bank)
given by Rowdell to the Hancocks -
balance due under contract dated 30th
April, 1949 21,000 0 0 (at p268)
17. I have before me balance sheets of Mulga Downs for the years ended 30th
April 1948, 1949 and 1950, but, in the absence of explanation,
I have not been
able fully to understand them. The precise effect of the operations of Rowdell
does not appear to be revealed by
any comparison of them. In a very rough and
approximate way the effect of those operations is shown by Exhibit D, which
contains
the figures on which Mr. Watson based his original proposal of 15th
February 1949. It is clear, I think, that, for the purposes of
this case the
dividends of 50,000 pounds must be regarded as having been paid out of profits
of Mulga Downs. (at p268)
18. Although the facts may be thought to be less complicated than either those in Bell's Case (1953) 87 CLR 548 or those in Newton's Case [1958] UKPCHCA 1; (1957) 96 CLR 577 ; (1958) AC 450 ; (1958) 98 CLR 1 , I have felt considerable difficulty over this case. The solution, however, begins, I think, to become apparent when one realizes that there were really two distinct transactions involved - the one between Rowdell and the Lefroys, and the other between Rowdell and the Hancocks. The two were, of course, interdependent both in the sense that Rowdell would not have bought either group of shares without buying the other, and also in the sense that one object of the operations as a whole was to place the Lefroy shares in the hands of the Hancocks. But the fact remains that there were two distinct transactions. A contract between Rowdell and the Lefroys was made and performed, and a contract between Rowdell and the Hancocks was made and performed, but there was, so far as the evidence goes, no contract or agreement or arrangement between the Lefroys and the Hancocks. It will not be misleading to speak from now onwards of a "contract" between Rowdell and the Hancocks, although on the evidence only one half of the transaction between them was actually the subject of an antecedent binding contract. (at p269)
19. The contract between Rowdell and the Lefroys was concluded by the letter of 14th April from Rowdell to Mr. Long, and that contract was completely performed on 30th April, when the Lefroys (those members of that family who were directors having in the meantime resigned from the board) transferred their shares to Rowdell and received the bank cheque for 40,000 pounds. So far as the Lefroys were concerned, that was the end of the whole matter. The sum of 40,000 pounds had in fact been obtained by Rowdell, as to about 17,000 pounds, by the sale of Commonwealth Bonds, which it had bought from Mulga Downs, and for which it did not have to pay until 27th May, and, as to the balance, by the declaration and immediate payment to it of a dividend out of the profits of Mulga Downs. But, so far as I can see, it was a matter of complete indifference to the Lefroys how or where Rowdell obtained the 40,000 pounds to pay for their shares. (at p269)
20. The contract between Rowdell and the Hancocks was made and partly performed on 30th April, and was completely performed on 3rd June. On 30th April the formal document of that date was executed. On that date also the required deposit of 2,500 pounds was paid by Rowdell to the Hancocks, and the Hancocks transferred their shares to Rowdell. As to this payment of 2,500 pounds, Rowdell, after paying the Lefroys their 40,000 pounds, still had in hand some 2,000 pounds, being the balance of the dividends and the proceeds of the sale of the bonds. For the balance of 500 pounds it presumably drew on its own resources. It still held, of course, 500 pounds of the 17,500 pounds Commonwealth bonds which it had brought from Mulga Downs and not yet paid for. (at p269)
21. The formal contract of 30th April provided only for the sale of the Hancock shares to Rowdell. It did not provide for the re-purchase of those shares or the purchase of the Lefroy shares by the Hancocks from Rowdell. Obviously, however, it was understood throughout that Rowdell, after the "milking" operation, would sell all the shares to the Hancocks for 21,000 pounds in accordance with the terms of that letter. After 30th April Rowdell had to find some 17,500 pounds to pay Mulga Downs for the Commonwealth Bonds and 21,000 pounds to pay the Hancocks the balance of the price of their shares. Also it had to provide for some profit or reward for itself. The 21,000 pounds, however, could be set off against the 21,000 pounds which the Hancocks were to pay to Rowdell for the whole of the shares. This was the position when the dividends of 25,000 pounds were declared and paid to Rowdell on 27th May. On the same date Rowdell honoured its promissory note and paid 17,500 pounds to Mulga Downs. Then on 3rd June the whole business was completed by the transfer of all the shares by Rowdell to the Hancocks and the exchange of the two cheques for 21,000 pounds. Rowdell's profit was roughly the difference between the 25,000 pounds and the 17,500 pounds. This sum would be subject to income tax, but the tax payable would not be anything like the tax which would have been payable on a distribution of the available profits of Mulga Downs among the original shareholders. (at p270)
22. The first question is whether the transaction which I have described, and the parties to which were Rowdell and the Hancocks and Mulga Downs, constituted or involved, within the meaning of s. 260 of the Assessment Act, a contract agreement or arrangement which had the purpose or effect of avoiding any liability imposed on Mr. George Hancock by the Act. This is ultimately a question of fact, but it depends in no way on the credibility of witnesses. There is no conflict of evidence, and there is no witness whom I disbelieve. It is simply a matter of inference from the nature and result of the transaction itself and from all the surrounding circumstances. Mr. George Hancock did not give evidence before me, but Mr. Langley Hancock did, and I think it very probable that much of what he said could be accepted as true of his father also. I do not think that the transaction, so far as they were concerned, had its direct origin in a conscious desire to have a distribution of the profits of Mulga Downs without paying income tax. Therein the case differs, I think, both from Bell's Case (1953) 87 CLR 548 and from Newton's Case (1957) 96 CLR 577 ; [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 . The transaction originated indeed not with them but with Mr. Watson, acting for Rowdell. I have nevertheless come to the conclusion that there was here such an arrangement as is struck by s. 260. (at p270)
23. The position of Mulga Downs at the beginning of 1949 was analogous to that of the motor companies in Newton's Case [1956] HCA 39; (1957) 96 CLR 577 ; (1958) AC 450 ; (1958) 98 CLR 1 , though it was not nearly so acute, and the amount of tax potentially payable was not nearly so large. An important factor was the desire of the Hancocks to acquire the whole or a large part of the Lefroy shares. They were not financially in a position to buy the whole of those shares at a price which the Lefroys, if they were willing to sell, were likely to demand, but they could obtain all the shares in Mulga Downs - a milked but by no means crippled Mulga Downs - if they could get their share of the available profits of that company without having to pay income tax thereon. When Mr. Watson first approached Mr. Langley Hancock, he was under the impression that the Hancocks owned all the shares in Mulga Downs, and he probably had in mind a plan somewhat similar to that which I envisaged in Newton's Case (1957) 96 CLR, at p 657 , and which I though would clearly fall within s. 260. When he found that the Hancocks were minority shareholders and would prefer to buy shares rather than sell them, he evolved a different plan. It was a very ingenious plan indeed, but it seems to me that (apart from the potential profit to Rowdell itself) one of its purposes, and indeed its most essential feature, was that the Hancocks should have the benefit of a distribution of profits by Mulga Downs without having to pay any income tax by reason of that distribution. It is quite likely that the Hancocks did not fully understand the plan. Mr. Langley Hancock said that he was "bewildered" by the steps taken, and I sympathize with him. But both he and his father must have known that the plan was designed to effect the purpose I have mentioned as a means of their acquiring the Lefroy shares after the "milking" of Mulga Downs. They were present in person at the meetings at which dividends were declared. On these facts it seems to me that I am bound to find that there was an arrangement between the two Hancocks and Rowdell which had for its purpose the avoiding of a liability to tax within the meaning of that expression as determined by Newton's Case (1958) AC, at p 464 ; (1958) 98 CLR, at p 7 . (at p271)
24. There remains the question whether s. 260 can be applied to this case in such a way as to justify the Commissioner's amended assessment. What the Commissioner has done by that amended assessment is to treat Mr. George Hancock as having received so much of the total distribution of 50,000 pounds as is proportionate to his shareholding in Mulga Downs before 30th April 1949. He has done the same thing in the case of Mr. Langley Hancock. (at p271)
25. The general effect to be given to s. 260 is now settled, though difficult cases will doubtless continue to arise under it. I will do no more than quote once again a well known passage from the judgment of Rich, Dixon and Evatt JJ. in Clarke v. Federal Commissioner of Taxation [1932] HCA 46; (1932) 48 CLR 56 . Their Honours said : - "To invalidate the transaction into which the prospective taxpayer in fact entered is not enough to impose upon him a liability which could only arise out of another transaction into which he might have entered but in fact did not enter. Where, however, the annihilation of an agreement or arrangement so far as it has the purpose or effect of avoiding liability to income tax leaves exposed a set of actual facts from which that liability does arise, the provision effectively operates to remove the obstacle from the path of the Commissioner and to enable him to enforce the liability" (1932) 48 CLR, at p 77 . In Bell's Case (1953) 87 CLR 548 the "exposed set of actual facts" which gave the character of income to the receipt in question was "that on 3rd February 1948, 77,000 pounds, consisting entirely of profits, was withdrawn from the company's bank account, and 11,000 pounds of it passed, indirectly but by steps which are clearly traceable on the face of the bank's ledgers, into Bell's bank account ;". Bell was then "to be considered as remaining at that time a shareholder in the company, his transfer to Corlett being ex hypothesi void as against the Commissioner as an integral part of the arrangement". In Newton's Case (3) the "exposed set of actual facts" was that "a sum of 458,161 pounds has been distributed by Lanes out of its accumulated profits, and a sum of 402,679 pounds has been added to its issued capital in the shape of 402,679 B preference shares, which are fully paid. The original shareholders have acquired 402,679 fully paid B preference shares, and have also received 56,141 pounds in cash." There was an exact correspondence, apart from a sum of 659 pounds which was otherwise accounted for, between the first-mentioned sum and the total of the cash and the face value of the shares. It was thus revealed, the "arrangement" being eliminated, that profits of the companies had reached the hands of the shareholders in the shape of cash and "bonus" shares, and this meant that the shareholders had received dividends within the meaning of the Assessment Act. It was, in effect, in Newton's Case (1957) 96 CLR 577 ; [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 as in Bell's Case (1953) 87 CLR 548 , the tracing of money from its source in profits of a company into the hands of shareholders that gave the character of income to what the shareholders received. If the "arrangement" stood, what they received was the price of shares sold, and therefore capital. When the arrangement was destroyed, what they received was seen to be a share in a distribution of profits by a company to its shareholders, and therefore income. (at p272)
26. For the purposes of the present case it is necessary first to see what is avoided by s. 260, and then to look at what has been called the end result. What is destroyed, and what is left ? I do not think that s. 260 avoids the purchase by Rowdell of the Lefroy shares, although it must be taken to have been made in pursuance of an understanding between Rowdell and the Hancocks. What is no more than a genuine unconditional sale of a capital asset cannot be successfully attacked under s. 260, even though it be motivated by a desire on the part of the vendor to reduce the income tax for which he will be liable in the future. "The section does not include a conveyance or transfer of property, legal or equitable, as such" : Jaques's Case [1923] HCA 70; (1924) 34 CLR 328, at p 359 : cf. Purcell's Case [1921] HCA 59; (1921) 29 CLR 464, at pp 466, 467 . I think that what s. 260 does avoid is the contract of 30th April and the transfer in pursuance thereof of the Hancock shares to Rowdell, because those were the steps which had as their object and apparent effect the shifting of the burden of income tax on any distribution by Mulga Downs from the shoulders of the Hancocks to the shoulders of Rowdell, on which it would rest much more lightly. What then is the final result as distinct from the steps by which it was reached ? So far as Mulga Downs is concerned, the position has changed in that its assets have been depleted by the payment of 25,000 pounds out of its profits. So far as the Hancocks are concerned, their position has changed in that they have received 2,500 pounds in cash and they have become the owners of the shares which were originally the Lefroy shares, but were at the material time owned by Rowdell. (at p273)
27. Now, I do not think that the sum of 2,500 pounds can be traced in such a way as to identify it with any part of any dividend or payment out of the profits of Mulga Downs. That sum may perhaps be regarded as intended as an extra inducement to the Hancocks to enter into a transaction designed to make a profit for Rowdell. On the other hand, it is impossible to regard the Lefroy shares as income in the hands of the Hancocks. Their face value cannot, as in Newton's Case [1958] UKPCHCA 1; (1957) 96 CLR 577 ; (1958) AC 450 ; (1958) 98 CLR 1 , be treated as income by virtue of the definition of "dividend" in the Act. This, however, has not seemed to be the end of the matter. The shares are not income, but how were the shares acquired ? Whence came the money to pay for them ? When we look at Mr. George Hancock's account with Dalgety & Co. (Exhibit C) we see that the sum of 21,000 pounds was paid out of that account on 4th June, and that the same sum 21,000 pounds, had been paid into the account on the previous day. The former sum is the money which paid for the shares. The latter sum, as is shown by the current account of Rowdell with the Union Bank (Document 16 in Exhibit A), came from the dividends declared by Mulga Downs on 27th May. It purported to come from Rowdell, but we have to treat as void the arrangement which involved the transfer of the Hancock shares to Rowdell and the payment to Rowdell of the dividend on those shares. When we eliminate that arrangement from consideration, there is left only a payment of a sum of money by Mulga Downs and a receipt of that sum by the Hancocks. And, since the payment by Mulga Downs was a payment out of the profits of that company to persons who must be treated as shareholders, that payment is income in the hands of the Hancocks. (at p274)
28. I have said that it appears from Rowdell's bank account that the amount of 21,000 pounds paid by Rowdell on 3rd June was provided by the dividends declared and paid by Mulga Downs on 27th May. This conclusion may be reached by an application of the rule in Clayton's Case (1816) 1 Mer 572 (35 ER 781) , but I would prefer to place it on the broader ground of a general inference to be drawn from all the known facts. The conclusion could, I think, equally well have been reached if it had happened by accident that more than 21,000 pounds was standing to the credit of Rowdell's account before the payment in on 3rd June of the sum of 24,990 pounds 14s. 11d. It could, I think, equally well have been reached if, instead of exchanging cheques for 21,000 pounds, Rowdell and the Hancocks had on 3rd June simply agreed to set off the one amount payable against the other. Whether there was an exchange of cheques or an agreed set-off, the effect of what was done would have been that two payments were made - the one a payment by Rowdell to the Hancocks for the Hancock shares, and the other a payment by the Hancocks to Rowdell for the Hancock shares and the Lefroy shares. And the inference seems plain enough that the real money to make the latter payment was intended to be provided, and was in fact provided, by means of a dividend or dividends from Mulga Downs. The inference arises from the original arrangement and the whole course of events which followed upon it. (at p274)
29. The sum of 21,000 should pounds, in my opinion, be apportioned between Mr. George Hancock and Mr. Langley Hancock in proportion to their respective original shareholdings in Mulga Downs before the transfers to Rowdell. The figures will have to be checked, but I think this means that Mr. George Hancock must be treated as having received 18,283 pounds and Mr. Langley Hancock 2,717 pounds. (at p274)
30. My view of the case is not precisely in accord with that taken by the
Commissioner. The Commissioner has treated the whole of
the dividends (50,000
pounds) in fact paid to Rowdell as having been paid to the Lefroys and the
Hancocks, and has attributed a due
proportion of that total sum to George
Hancock and Langley Hancock respectively. Actually my view of the case is
slightly less favourable
to the taxpayer than the Commissioner's, but the
difference in the result is comparatively trifling. The appeal should, in my
opinion,
be dismissed.
Langley George Frederick Hancock v. Commissioner of Taxation. (at p275)
31. For the reasons which I have given in the case of George Hancock v. The Commissioner of Taxation I am of opinion that this appeal should be dismissed. (at p275)
32. From these decisions both taxpayers appealed to the Full Court of the High Court. (at p275)
33. F. T. P. Burt Q.C. (with him H. N. Guthrie and D. R. Anderson), for the appellants. (at p275)
34. L. D. Seaton Q.C. (with him W. H. Johnston), for the respondent.
Cur. adv. vult.
(at
p275)
1961, August 8.
The following written judgments were delivered:-George Hancock v. Commissioner of Taxation. (at p275)
DIXON C.J.
2. This appeal is from an order of Fullagar J. dismissing a taxpayer's appeal from an amended assessment of income tax. The year of income is that ended 30th June 1949 for which an accounting period was adopted ended 30th April 1949. The amendment which was appealed against increased the taxpayer's income by 17,759 pounds. This was done as a result of applying s. 260 of the Income Tax Assessment Act 1936-1949. The material part of that section, which of late has become as familiarly known as any provision of the enactment, provides that every contract agreement or arrangement shall so far as it has or purports to have the purpose or effect of in any way directly or indirectly . . . defeating evading or avoiding any duty or liability imposed on any person by the Act or preventing the operation of the Act shall be absolutely void, as against the Commissioner, or in regard to any proceeding under the Act, but without prejudice to such validity as it may have in any other respect or for any other purpose. (at p275)
3. It will be observed that the provision merely invalidates a transaction and does so only as against the Commissioner, or in regard to a proceeding under the Act. In the present appeal, as in so many cases under s. 260, the greater difficulty is not to say whether it avoids the transaction as against the Commissioner but to say what is the consequence upon the taxpayer's liability if it does so. Again like so many cases under s. 260 the tax which it is said that the taxpayer has sought to avoid is one or other of the alternatives which Div. 7 appears to make inevitable, viz. the tax upon the "private" company failing to distribute the profits or the tax upon the shareholders if the company does distribute the profits. The company in question is called Mulga Downs Pty. Ltd.: it owned a station property in Western Australia. The shares in the company were held by the members of two families the Lefroys and the Hancocks, the holding of the former being not inconsiderably greater than that of the latter. Apparently if within six months of the end of its accounting period ended 30th April 1949 the company did not make a sufficient distribution of its income of that period the use by the Commissioner of s. 104 would have meant that it paid at least 7,000 pounds in tax. In February 1949 H. K. Watson, a chartered accountant of Perth and moreover a tax adviser, suggested to one of the Hancocks that a company which Watson and his wife owned and which traded in shares and investments might buy all the shares in Mulga Downs Pty. Ltd. A company trading in shares and investments would, of course, take the sales and purchases into account in ascertaining its taxable income. Watson proposed that his company while holder of the shares in Mulga Downs Pty. Ltd. should by a distribution take the accumulating profits of the latter - milk it - and then resell all the shares at the reduced value or price which was consequential upon the loss of the assets representing the withdrawn profits. The head of the Hancock family had apparently always wished that his family should be the only persons interested in Mulga Downs and he readily entertained the suggestion on the footing that the resale of the shares should be to him. Needless to say this meant that a price must be given to the Lefroy family for their shares which would satisfy them, a price upon which, because it would be capital, no income tax would be payable, that the Hancocks would receive a capital sum for their shares and then that substantially all the shares in the Mulga Downs company, that is to say what had been the shares of the Lefroy family and of the Hancock family, would be sold back to the Hancocks at a very much lower price per share. The difference in the price would, of course, represent the profits of the Mulga Downs company which Watson's company would have received on a distribution as dividend or bonus. The distribution made in the event was 50,000 pounds. The distribution would mean that no tax under Div. 7 would become payable and, although, prima facie, it would mean that 50,000 pounds went into the assessable income of Watson's company, yet, pro tanto, inclusion in the assessable income of that figure would be answered by the loss that company would be shown to make on a comparison between the price at which it had bought the shares from the Lefroys and the Hancocks and the much lower price at which the company had resold them to the Hancocks. The "loss" shown by a comparison of the two prices would be treated as a deduction in arriving at the taxable income of Watson's company because its business was to trade in shares and investments. (at p277)
4. Of course that company would take a profit on the transaction and the profit would necessarily be one upon which Watson's company would pay tax, that is to say it would pay tax unless the profit were not wiped out by the results of some other transaction or transactions in the course of its business. The expected liability for 7,000 pounds under Div. 7 would be avoided and the transaction would involve none of the parties in any other liability for income tax, that is of course unless the Commissioner invoked s. 260 and did so with success, as in the result he has done at all events up to this point. (at p277)
5. The transaction was carried out substantially as suggested. When it had been completed the result was simple enough. The Hancocks held all the issued share capital in the Mulga Downs company. The Lefroys had sold their shares to Watson's company for a capital sum of 40,000 pounds, Watson's company had been temporarily the transferees of these and of the Hancocks' shares, the price on the sale to Watson's company being fixed at 23,500 pounds. Of the profits of Mulga Downs Pty. Ltd. 50,000 pounds had been distributed by that company to Watson's company as a dividend or dividends on the shares temporarily held by it. Watson's company retained 7,500 pounds as its profit : it paid 2,500 pounds in money to the Hancocks as part of the price of their shares, and it paid in money 40,000 pounds to the Lefroys. These amounts of course add up to 50,000 pounds the amount of the distribution of accrued and accruing profits. All the issued shares were sold back to the Hancocks at 21,000 pounds an amount which was met by set off with the balance of the price at which the Hancocks' shares were taken (23,500 pounds less 2,500 pounds paid in money), no tax was paid or remained payable under Div. 7, no tax was paid or incurred by any party to the transaction except so far as tax became payable by Watson's company in respect of its profit of 7,500 pounds. That is of course on the hypothesis that the transaction is not void under s. 260. (at p278)
6. Now although the plan was the product of Watson's ingenuity Hancock adopted it and he knew that an essential feature of it was the escape of the tax that must attach either to the company or to the shareholders if the profits were undistributed and alternatively of the tax which as shareholders they would pay if the profits were simply distributed as dividends. At the same time it was evidene enough that he had no prospect of buying the shares of the Lefroys, except by the application of funds which he might obtain by a distribution of the profits of the company. There was no sense or purpose in selling the Hancocks' shares to Watson's company and then back to Hancock or in Watson's company's buying the Lefroys' shares from that family for the purpose of reselling them to Hancock in lieu of the Lefroys selling them directly to the Hancock family, except to ensure that the distribution of profit by Mulga Downs Pty. Ltd. would not be to the Hancocks or the Lefroys who would incur tax but would be to Watson's company, a company trading in securities ; and the mechanics of the transaction were arranged wholly to ensure that the dealings otherwise were of a capital nature. (at p278)
7. In these circumstances I think that there was an agreement or arrangement to avoid either a liability imposed by the Act on Mulga Downs Pty. Ltd. or upon the Hancocks and to prevent the operation of the Act in respect of the liberation of the company's profits. The liability imposed by the Act on Mulga Downs Pty. Ltd. was to pay tax under Div. 7 if there was not a sufficient distribution of income to satisfy s. 104. It may be said that the company did on any view distribute a sufficient amount of income and that is why liability under Div. 7 was avoided. In the end if you treat the distribution as valid, that is so. But if you look at the matter as at the time the arrangement was made, the parties were confronted with a dilemma, a liability under Div. 7 or a liability under or by reason of s. 44 (Div. 2 sub-div. D) and a purpose of the plan evolved was to avoid the dilemma. The expression "preventing the operation of the Act in any respect" is generally regarded as difficult, but I treat it as simply meaning the operation which the Act would have in a given case if it were not for the contract agreement or arrangement made for the purpose (or having the effect) of preventing it. It is the operation of the Act in relation to the distribution and taxability of the profits of a private company that in part the plan was designed to "prevent". (at p278)
8. It appears to me that Watson and his company on the one side and Hancock and his son on the other side were the parties to the agreement or arrangement. I have purposely made compendious my statement of the making and carrying out of the plan because I think that the detailed steps by which, as it seems to me, the plan was reached and agreed have nothing but an evidentiary importance and otherwise tend to confuse the matter. It is sufficient that by steps the parties reached and carried out the arrangement and that it answered a description covered by s. 260. (at p279)
9. It follows that as against the Commissioner the arrangement is void so far as it has or purports to have the purpose or effect of in any way, directly or indirectly avoiding a duty or liability imposed or preventing the operation of the Act in any respect. It is important to keep steadily in view the fact that no longer does the provision now contained in s. 260 make contracts agreements or arrangements void : they are only void as against the Commissioner or in regard to a proceeding under the Act. The result is to require a consideration of the Commissioner's rights and duties on the footing that the contract agreement or arrangement is notionally void. But this notional treatment of the agreement or arrangement as void extends to all the ancillary or subsidiary steps for carrying it out. "But it" (the arrangement), said Lord Denning for the Privy Council, "must in this section comprehend, not only the initial plan, but also all the transactions by which it is carried into effect - all the transactions, that is which have the effect of avoiding taxation, be they conveyances, transfers or anything else. It would be useless for the commissioner to avoid the arrangement and leave the transactions still standing." : Newton's Case (1958) AC 450, at p 465 ; (1958) 98 CLR, at pp 7, 8 . What is the result in this peculiar case? The Commissioner can treat, as it seems to me, each and every step by which the ultimate situation of George Hancock, the appellant, was brought about as having no legal validity or efficacy or significance. What then does he proceed to tax? He is assessing George Hancock. Ex hypothesi nothing which has been done from the time the arrangement was reached between the Hancocks and Watson or Watson's company can stand in his way. The legal complexion which every step taken would otherwise bear cannot operate to impede him : for the step can have no legal validity in so far as it tends to do so. Again to quote the language of Lord Denning - "But the ignoring of the transactions - or the annihilation of them - does not itself create a liability to tax. In order to make the taxpayers liable, the commissioner must show that moneys have come into the hands of the taxpayers which the commissioner is entitled to treat as income derived by them" (1958) AC, at p 467 ; (1958) 98 CLR, at p 10 . It is here that the difficulty of the case arises. The change or enhancement in the position of George Hancock, what had come into his hands, what he had derived, at the ultimate end of the transaction was his proportion of the shares of the Lefroys and his proportion of the 2,500 pounds. I do not think that when Lord Denning employed the word "moneys" in the passage last quoted he intended to distinguish between moneys and any other form of asset the receipt of which may constitute the derivation of income such as an immediately convertible security. But shares in a proprietary company may not be within that category. In the transaction 21,000 pounds was put down as the price to be paid by the Hancocks for the acquisition from Watson's company of the whole of the shares in Mulga Downs Pty. Ltd., that is to say for the acquisition of the shares of the Lefroys and the reacquisition by the Hancocks of their own. One of the recommendations put forward for the proposal by Watson early in the piece was that "it would enable the Hancocks in due course to acquire all the issued capital of Mulga Downs without any cash outlay at all over and above their present resources". "Their present resources" is a phrase descriptive of their interest in the company as reflecting the funds of the company capable of manipulation ; and of course the undistributed profits which had accrued in the period ending 30th April 1949 and were estimated as accruing profits of the next period represented such funds. When all the movements of credit are treated as over and the result simply (as distinguished from the movements or ostensible movements of credit and money by which the result was accomplished) is looked at and compared with the position from which it began, what has been effected is seen to be the acquisition by the Hancocks of the Lefroys' shares together with a sum of 2,500 pounds added and the acquisition by Watson's company of 7,500 pounds, all done by the application of the Mulga Downs company's profit fund of 50,000 pounds. Indeed the point of the whole arrangement that has been considered void as against the Commissioner was to effect a liberation of the fund of profits without incurring tax and at the same time by means of the fund liberated to acquire the shares of the Lefroys. That was what was done. The Hancocks received 2,500 pounds in addition ; and as an incident Watson's company took 7,500 pounds profit. In the distribution of the fund the proportion referable to the shares held at the beginning by the present appellant George Hancock would be as 6,730 is to 18,945, for of the issued capital of 18,945 shares George Hancock held 6,730. For myself I do not see why he should not be assessed on the basis of this fraction of the distributable profit forming part of his assessable income. Section 260 authorizes the Commissioner to disregard every step in an obnoxious plan which stands in the way of a lawful assessment. It must be remembered that, by s. 19, income is deemed to have been derived by a person although it is not actually paid over to him but is reinvested, accumulated, capitalized, carried to any reserve sinking fund, or otherwise dealt with on his behalf or as he directs. The critical object the scheme or plan had in view was to produce without tax the very result which subject to tax could have been obtained by applying, under his direction, George Hancock's share of the distributable fund less the 2,500 pounds received in cash in or towards the acquisition of the Lefroy shares. Why should not all the intermediate steps be disregarded in pursuance of s. 260? That in fact seems to be what the Commissioner did when he increased the assessable income by 17,759 pounds. Perhaps some adjustments have taken place but if so what adjustment does not appear. I see no reason why any part of the profit taken by the Watson company should be considered as referable to the appellant's proportion of the profits. (at p281)
10. The view I have expressed depends in no respect upon tracing the identity of moneys employed in the steps taken to reach the result. When the purpose is to assess a taxpayer who has reached a situation which but for a scheme swept away by s. 260 would or might spell liability to tax, it does not appear to me to be necessary to trace the identity of moneys as if one were seeking to identify in an investment trust funds that had been misapplied. Section 260 is directed against the validity of arrangements designed to avoid taxation where, but for the cover the arrangement would give, taxation would fall. The resource of ingenious minds to avoid revenue laws has always proved inexhaustible and for that reason it is neither possible nor safe to say in advance what must be found, after a scheme is struck down under s. 260, before a consequential assessment can be justified. But it seems to me that what matters must be the resulting financial situation, one of change if not invariably of betterment, and the factors which would but for the void scheme have made it taxable. These factors will depend on general conceptions of what is taxable as income, but seldom, I should have thought, would the actual tracing of moneys be the test of that liability. For example when Watson's company actually bought and paid for the Lefroy shares, to finance the payment it was necessary to use the proceeds of bonds which the company had "bought on credit" from Mulga Downs Pty. Ltd. for the purpose and resold for cash, and also to depend to some extent upon some moneys belonging to Watson's company. That does not seem to me to matter. It was all balanced out afterwards, of course, and was only part of the financial expedients for carrying that part of the plan through. It does not seem to me to matter at all what interim financial expedients were resorted to or which moneys or whose credit was used in the course of carrying out the transaction. It is the result that exposes the taxpayer to liability : a result necessarily involving the employment by the taxpayer of a distribution of the profit fund. The means, if otherwise they could be considered significant upon a question of ultimate liability, would be swept away like other parts of the "arrangement" and the steps by which it was carried into effect. In the present case the only difficulty, as it seems to me, lies in the form in which the appellant George Hancock derived in the end the greater part of benefit of the transaction, namely shares, the Lefroy shares. But for the reasons that I have given that should not be regarded as inconsistent with his having derived income, once the disguising elements of the "arrangement" are stripped away under s. 260. (at p282)
11. In my opinion the appeal should be dismissed.
Langley George Frederick Hancock v. Commissioner of Taxation. (at p282)
12. I understand that this appeal is to abide the fate of the appeal by George Hancock against the decision by Fullagar J. dismissing the appeal of the latter from the amended assessment of the Commissioner of Taxation. (at p282)
13. Accordingly the appeal in this case must be dismissed also. (at p282)
KITTO J.George Hancock v. Commissioner of Taxation. (at p282)
2. The question for decision in this appeal requires consideration of s. 260 of the Income Tax Assessment Act 1936-1949 (Cth) in relation to a somewhat complicated set of facts. The material provision of the section is that every contract, agreement, or arrangement shall, so far as it has or purports to have the purpose or effect of defeating, evading, or avoiding any liability imposed on any person by the Act or preventing the operation of the Act in any respect, be absolutely void as against the Commissioner. (at p282)
3. In this case the Commissioner relies upon the section to treat as void portion of what he says was an arrangement having or purporting to have the purpose or effect of avoiding a liability of the appellant to pay income tax. The notorious difficulties of the section have been the subject of a line of cases culminating in Newton v. Federal Commissioner of Taxation [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 . From what is said and implied in the reasons of the Privy Council in that case it is possible, I think, to work out some general propositions by reference to which the present case may be decided. (1) The word "arrangement" in s. 260 comprehends a plan made between two or more persons (whether it be legally enforceable or not) and all the transactions by which it is carried into effect. (2) An arrangement "has or purports to have the purpose or effect" referred to in the section if, and only if, the concerted action consisting of the making of the plan and the carrying out of the transactions by which it is given effect is properly to be characterized as a means to avoid income tax. (3) Whether it is to be so characterized is a question to be answered upon consideration of the overt acts by which the plan has been implemented. (4) If those acts are capable of explanation by reference to ordinary dealing, such as business or family dealing, without necessarily being labelled as a means to avoid tax, the arrangement does not come within the section. An example would be a simple sale or gift of shares, even though the motive of the seller or donor may have been to avoid receiving future dividends and incurring the liability to income tax which the receipt of them would have entailed. (5) But the overt acts will enable the arrangement to be characterized as a means for the avoidance of tax, if they have included a transfer of property from the taxpayer in consequence of which income from the property, instead of being received as such by the taxpayer, has followed either of two courses : (i) a course which has carried it through the hands of other persons to the taxpayer, but so as to reach him with the character of capital ; or (ii) a course which has amounted in effect to an application of the moneys by the taxpayer, and so has been a practical equivalent of a receipt by him followed by an expenditure by him. (6) If an arrangement has been a means for the avoidance of tax, the fact (if it be a fact) that it has been a means to other ends as well does not prevent the application of s. 260. (7) Where an arrangement is found to be within the section because of a transfer having such a consequence as is mentioned in (5) above, the transfer is to be considered as void to the extent mentioned in the section. The result is that income which has followed either of the courses referred to in (5) is to be regarded as income to which the taxpayer was entitled. Consequently the receipt of the income by the transferee in pursuance of the arrangement is properly to be treated by the Commissioner as a derivation of it, as income, by the taxpayer. (at p283)
4. A word may be added in explanation of propositions (5) and (7). A clear example of income following the first of the courses mentioned is provided by Bell's Case (1953) 87 CLR 548 , where it was found possible to trace dividend moneys from a company to Bell, and show that although they had in fact reached Bell as capital they were the produce of shares formerly held by him and transferred under an arrangement which ensured that he would receive them, but receive them transformed into capital and so made free of income tax. The Privy Council regarded the bulk of the moneys in question in Newton's Case [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 as in the same category. The second of the courses described in (5) above is illustrated by the Privy Council's treatment of the moneys retained by Pactolus in Newton's Case [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 . It is easy to imagine other possible instances of it. One would be the case in which, by arrangement between A and B, A has transferred his shares to B, and B has applied dividend moneys therefrom in making a payment to C but really as a gift to C from A, or in paying for property to be transferred by C to A, or in securing some benefit or advantage for A, and then (making plain the tax-avoiding nature of the whole arrangement) B has retransferred the shares to A. The contrast with the case of an ordinary straight-out sale or gift by a taxpayer is clear. Such a sale or gift does result, it is true, in the future dividends going to the buyer or donee instead of to the taxpayer ; but the diversion of the money from the taxpayer is neither to enable it to be received by him as capital instead of income and therefore free of income tax, nor to enable such an application of it to be made that there is achieved by a single step what, but for the arrangement, would have required the two steps of a receipt by the taxpayer (with consequential tax liability) and an expenditure by him. (at p284)
5. I turn to the facts of this case. It relates to the year of income ended 30th June 1949. By an amended assessment, the appellant was assessed to tax on the footing that in that year he derived as assessable income an amount of 17,759 pounds over and above the amount which he had included in his return. This was done, and is now supported by the respondent Commissioner, on the ground that by the carrying out of an arrangement between the appellant and his son on one side and a company named Rowdell Pty. Limited (which I shall call Rowdell) on the other, dividend moneys to that amount, which would have been assessable income in the appellant's hands if he had received them from the company which declared the dividends, were paid instead to Rowdell, but the payment, because it was followed by steps which show that the arrangement was a means for the avoidance of a tax liability upon the appellant, should be treated, by an application of s. 260, as a payment of dividend moneys belonging to the appellant and therefore as derived by him so as to form part of his assessable income. An appeal against the amended assessment was dismissed by Fullagar J., who considered that an even higher sum, namely 18,283 pounds, was brought into the appellant's assessable income by the operation of s. 260. From his Honour's decision an appeal now comes before the Full Court. (at p285)
6. That there was a plan, evolved between the appellant and his son on the one side and Rowdell on the other, there is no dispute. It had been worked out by 14th April 1949, on which day there was an interchange of letters and a concluding telephone conversation. The course of negotiations which had led up to it is traced in the judgment of Fullagar J., and need not be described again. The situation upon which the plan was to operate was this. The appellant held 6,730 and his son 1,000 shares in a grazing company called Mulga Downs Pty. Limited, which will be referred to as Mulga Downs. That company's issued capital consisted of 18,945 shares, all fully paid. Of the shares not held by the Hancocks, 11,210 were held by members of a family who may be called collectively the Lefroys. The remaining five shares were held by a Mrs. Hancock, who is not included in references in this judgment to the Hancocks. The plan provided for three main transactions. First, the Hancocks were to sell and Rowdell was to buy all but two of the Hancocks' shares in Mulga Downs, to be transferred at once, for the price of 23,500 pounds payable as to 2,500 pounds immediately (as a deposit) and as to the balance, 21,000 pounds, on or before 30th June 1949. The carrying out of this transaction was made binding upon the Hancocks and Rowdell by a deed which they executed on 30th April 1949. Secondly, Rowdell was to buy in the Lefroys' shares in Mulga Downs for 40,000 pounds, the Lefroys having already signified their willingness to sell at that price. Thus Rowdell would hold all but seven of the issued shares in Mulga Downs. Finally, after registration of the transfers to Rowdell, Mulga Downs was to distribute 50,000 pounds by means of dividends, and Rowdell, having received its proportion, that is to say almost the whole, of the distributions thus made, was to re-sell all its shares in Mulga Downs. (at p285)
7. Fullagar J. considered that the plan included two other points of great importance in connexion with the third of the planned transactions, namely, that the resale of the shares by Rowdell should be to the Hancocks, and that the price should be 21,000 pounds. In this respect his Honour's interpretation of the evidence has been challenged, but with an immaterial qualification as to the price it should clearly be accepted. The two points just mentioned were left in the realm of unenforceable arrangement it is true, but they were undoubtedly the subject of a definite understanding which was as much a part of the plan as the stipulations which were made contractually binding. The first concrete proposal which Rowdell made to the Hancocks, contained in a letter of 15th February 1949, included a statement that Rowdell, when it should be ready to sell the shares acquired from the Hancocks and the Lefroys, would be prepared to give the Hancocks the first right of refusal at 21,000 pounds, and indeed to give them a formal option at that figure. In the letter by which the general assent of the Hancocks to the plan was announced, namely a letter dated 14th April 1949 from the Hancocks' accountant to Rowdell, it was said that the sale by the Hancocks to Rowdell would be conditional upon the abovementioned option being given ; but Rowdell in its reply of the same date expressed disinclination to give any binding option at any fixed price until after Mulga Downs should have held its annual meeting and paid out the contemplated dividends. The explanation offered was that there would then be no room for dispute as to the precise nature and extent of the assets and liabilities of Mulga Downs ; and by way of example it was said that Rowdell might decide to take out a dividend of, say, only 40.000 pounds instead of 50,000 pounds in which case they would want a price of 31,000 pounds instead of 21,000 pounds (i.e. for the shares ex dividends). The Hancocks gave up the point. They agreed to the plan, and in particular they agreed to sell to Rowdell all their shares but two for 23,500 pounds, without receiving the option. But it is to be observed that at no time was it suggested by Rowdell that the resale might be made otherwise than to the Hancocks if the latter should wish to buy : it was only the price that was kept open for adjustment according to circumstances, and the inference was clear that otherwise the position would be as if the option had been given. Rowdell's managing director, Watson, had known from the time when he first turned his attention to the question of buying into Mulga Downs that the Hancocks had particular reasons which would probably make them desirous of buying all Rowdell's shares in Mulga Downs if they could find the money with which to do so when the time came. In evidence he said that he told the Hancocks at the time when agreement was reached that he would be a seller of the shares in June and that if they wanted them they could have them. When the time came to sell, Watson reported to a general meeting of his company that "as anticipated" the Hancocks desired to buy the shares for 21,000 pounds and the sale was agreed to. It seems too clear for doubt that at every stage there was a clear understanding between the Hancocks and Rowdell, though resting only in good faith, that the Hancocks should be given the first opportunity to buy, and that the price should be 21,000 pounds, subject to adjustment to allow for any deviation from the intention that the distributions by means of dividends should amount in all to 50,000 pounds. (at p287)
8. To understand the plan, it is not unimportant to see how the adjustable resale price of 21,000 pounds was considered at the time to compare with the assets value of the shares to be resold by Rowdell. This appears from Exhibit D, which contains an approximate analysis by Watson of the affairs of Mulga Downs as at 14th April 1949, the day on which the sale of the Hancocks' shares to Rowdell was finally agreed to. Fixed assets were taken at 52,000 pounds and current assets at 29,000 pounds, giving a total of 81,000 pounds. There were no external liabilities apart from taxes. Taxes were provided for as follows : 3,600 pounds for taxes on 1947-1948 profit, 6,900 for income tax on an anticipated profit of 24,000 pounds for the year ended 30th April 1949, and 7,000 pounds for undistributed profits tax on the latter profits. These figures gave a net worth of 63,500 pounds for the 18,945 pounds issued shares. But if the proposed distribution of 50,000 pounds were to be made, the 7,000 pounds provision for undistributed profits tax on the 1948-1949 profits would not be required. Adding this back, the value from which the 50,000 pounds would be taken becomes 70,500 pounds; so that after the distribution the assets value of the issued shares would be 20,500 pounds, of which nearly the whole would be the value of the shares resold. (at p287)
9. The plan was carried into effect between 30th April 1949 and 3rd June 1949. Rowdell bought the Lefroys' shares for 40,000 pounds, which it paid in cash. Rowdell also bought all but two of the Hancocks' shares for 23,500 pounds, paying 2,500 pounds in cash and agreeing by the deed of 30th April 1949 to pay the remaining 21,000 pounds before 30th June 1949. When the transfers of the Lefroy and the Hancock shares had been duly effected, Mulga Downs declared and paid dividends totalling 50,000 pounds, of which Rowdell received its due proportion. Rowdell then offered all its shares in Mulga Downs to the Hancocks for 21,000 pounds, and the Hancocks accepted the offer. The price, as will have been noticed, was the same in amount as the deferred portion of the price payable by Rowdell to the Hancocks for the 7,728 shares which the latter between them had sold ; and in fact the two amounts were paid by means of an exchange of cheques, on 3rd June 1949. (at p287)
10. So, by the time all this was completed, the Hancocks, without having had to find a penny otherwise than from the carrying out of the plan, had come to hold the Lefroys' 11,210 shares as well as all those which they themselves had originally held, and had received 2,500 pounds in cash. The Lefroys had received 40,000 pounds in cash for their shares. Rowdell had emerged the richer by about 7,500 pounds. Mulga Downs, on the other hand, had distributed out of its profits 50,000 pounds, equal to the total of the three amounts of cash just mentioned. Of the profits distributed, 17,759 pounds was in respect of the 6,729 shares which the appellant had transferred to Rowdell, for that is the figure which is obtained by applying the fraction 6,729 over 18,945 to 50,000 pounds. (at p288)
11. Of course, Rowdell may be liable to be assessed to income tax on the footing that the dividend moneys it received from Mulga Downs formed part of its assessable income. If s. 260 applies in relation to the Hancocks so as to include in their assessable incomes a part of the same dividends, the result may seem odd since it would mean that dividend moneys from Mulga Downs are to be treated as if they had been derived as income twice, and by different taxpayers. But that would be because, by the express terms of the section, the avoidance which it produces is only as against the Commissioner, so that the Commissioner may treat transactions as void but no one else is enabled to do so. (at p288)
12. In the course of the argument an attempt was made on behalf of the Commissioner to trace the whole of the dividend moneys received by Rowdell on the shares it bought from the Hancocks, with a view to showing that they reached the Hancocks in the end, in the form of 2,500 pounds in money and the balance in the form of the Lefroy shares. Even assuming that a tracing into property other than money is relevant for the purpose of applying s. 260, the attempt that was made in this case could not succeed so far as it related to the excess over the 2,500 pounds. Still, it may help towards an understanding of the case as a whole if I describe what Rowdell did with the dividends it received and how it paid for shares it acquired. (at p288)
13. The dates on which the dividends provided for in the plan were declared and paid by Mulga Downs were 30th April 1949 and 27th May 1949. On the former day there were two dividends, one of 3,500 pounds out of the profits of the year ended 30th April 1948, and the other of 21,500 pounds out of the profits of the year ended 30th April 1949. Rowdell received from these dividends a total sum of 24,990 pounds 14s. 11d., and paid the cheque into its bank account on the same day. It appears from the bank statement that Rowdell began the day with a credit balance of 18,627 pounds 8s. 8d. Of this sum, 1,840 pounds 11s. 2d. had come from sources irrelevant to this case, and 16,786 pounds 17s. 6d. consisted of the proceeds of sale of some bonds which Rowdell had bought from Mulga Downs on terms of deferred payment. The purpose of the bond transaction was to assist in financing the payment of 40,000 pounds to the Lefroys for their shares in Mulga Downs. That payment is the next item appearing in the account, and it is followed immediately and on the same day by the deposit of the dividend moneys that have been mentioned. The result was that of the 40,000 pounds that was paid to the Lefroys for their shares, 1,840 pounds 11s. 2d. came from Rowdell's original moneys, 16,786 pounds 17s. 6d. came from the proceeds of the bonds, and 21,372 pounds 11s. 4d. (i.e. 24,990 pounds 14s. 11d. less 3,618 pounds 3s. 7d.) came from the dividends of 30th April 1949. The credit balance then remaining in the account, namely 3,618 pounds 8s. 7d., consisted wholly of dividend moneys. Out of this credit balance the 2,500 pounds was paid to the Hancocks as the deposit on their shares. The cheque for that amount did not go through the account until 2nd May 1949, but in the interval there had been no operation on the account. The 2,500 pounds was therefore paid wholly out of the dividend moneys deposited on 30th April 1949. Of course it was a capital receipt in the hands of the Hancocks, being part of the purchase price of their shares; but if the sale and transfer of those shares had not been arranged and carried out there would have been nothing to give it the character of capital, and it would have retained the character of assessable income by reason of its being a distribution by a company to a shareholder: see s. 44 (1) and the definition of "dividend" in s. 6. The arrangement was therefore, to that extent at least, one for avoiding income tax on the Hancocks; and to that extent at least it must fail by force of s. 260. (at p289)
14. Returning to Rowdell's bank account, it appears that between 2nd and 25th May 1949 the moneys remaining in the account were depleted by sundry debits, and with these we are not concerned. Until 27th May 1949 there were no payments into the account, so that on that day the credit balance, which then stood at 630 pounds 8s. 7d., consisted entirely of dividend moneys from Mulga Downs. Then on 27th May 1949 that company declared the second batch of dividends. One was a further dividend of 2,500 pounds to be paid out of the profits of the year ended 30th April 1949, and the other was an interim dividend of 22,500 pounds to be paid out of the profits of the year ending 30th April 1950, and, as to any deficiency in the amount of those profits, out of accumulated profits standing to the credit of profit and loss appropriation account. Rowdell received as its proportion of these two dividends 24.990 pounds 14s. 11d., which was paid into its bank account on 27th May 1949. On that day there was only one other operation on the account, namely a payment of 17,300 pounds to Mulga Downs to meet a promissory note. This was the deferred payment for the bonds which Rowdell had bought from Mulga Downs and sold in order to finance the purchase of the Lefroy shares. The payment was made out of the combined dividend moneys, and it left a balance of 8,321 pounds 3s. 6d. Then, after a small payment of 47 pounds which is irrelevant, there took place on 3rd June 1949 the exchange of cheques for 21,000 pounds each, one cheque being that given by Rowdell for the balance owing by it on its purchase of the Hancock shares, and the other being the cheque given by the Hancocks for the purchase price of the former Hancock and Lefroy shares. (at p290)
15. It is said for the Commissioner that when you find that the 17,300 pounds which Rowdell owed for the bonds was paid out of Mulga Downs dividends, you should deal with the case just as if the proceeds of the sale of the bonds had consisted of dividend moneys, and therefore as if the 40,000 pounds which Rowdell paid for the Lefroy shares had been paid out of dividends except to the extent of 1,840 pounds 11s. 2d. only. If you take that step, it is said, the rest follows: the Lefroy shares ultimately got to the Hancocks, ergo so much of the dividends which those shares represented as was proportionate to the Hancock shares should be treated in the Hancocks' hands as dividends, and therefore as assessable income, once s. 260 has annihilated the sale and transfer of the Hancock shares to Rowdell. (at p290)
16. This argument fails, I think, at two points. In the first place, there is no justification for treating the proceeds of the bonds which Rowdell sold as constituting dividend moneys. They were not, in fact, dividend moneys, and there is nothing in the Income Tax Assessment Act, or in any general legal principle, to give them that character retrospectively simply because Rowdell utilized dividend moneys, when they later came in, to pay for the bonds. All the steps taken in relation to the bonds were no doubt taken in execution of the overall plan, but no disregarding of any of those steps advances the Commissioner's case. Even if the sale of the bonds by Mulga Downs were to be disregarded, and consequently the 16,786 pounds 17s. 6d., which was the proceeds of their sale and formed part of the 40,000 pounds paid to the Lefroys, be considered as having belonged all along to Mulga Downs, that would not make them dividend moneys distributed by Mulga Downs by way of advance payment in respect of the second batch of dividends. Nothing less than that would suffice to give the Commissioner a foothold for his contention that the Lefroy shares, when they reached the Hancocks, contained 1949 dividend moneys in a converted form. Secondly, the Lefroy shares were bought by and transferred to Rowdell before any of the dividends were declared. The bank statement correctly reflects the order of events on 30th April 1949: it was of the essence of the plan that the Lefroy shares should be, and in fact they were, bought and paid for and duly transferred before the dividend was declared. By contrast, the bank statement does not correctly reflect the order of events in relation to the dividends of 27th May, for the promissory note for 17,300 pounds had of necessity to be met, for the most part, out of those dividends. There is, therefore, no justification for the view that the dividend moneys received by Rowdell were used, wholly or in part, to buy in the Lefroy shares. (at p291)
17. But while the examination that has been made of the steps taken to carry out the arrangement shows, as I think, that the Commissioner cannot succeed in an endeavour to support the impugned assessment wholly by means of a process of tracing, it also puts beyond all question that the transfers which enabled Rowdell to receive so much of the 50,000 pounds as was distributed by Mulga Downs in respect of the 7,728 Hancock shares formed part of an arrangement which was a means for producing to the Hancocks, first, a portion (2,500 pounds) of the distributions, in cash but as capital instead of as income, and, secondly, the Lefroy shares. As regards the 2,500 pounds the case is indistinguishable from Bell's Case (1953) 87 CLR 548 : the money followed a course of the first kind mentioned in proposition (5) above. As regards the rest of the distributions on the 7,728 shares, the money followed a course of the second kind: the Hancocks have never received the money, but they have received the Lefroy shares instead. I say instead, because the practical result which the carrying out of the arrangement achieved was an exchange by the Hancocks of the right to participate in the planned distributions of Mulga Downs for the Lefroy shares in the "milked" company. The effect was exactly that which, in the absence of an arrangement, could have been produced only by the Hancocks retaining their shares, receiving the dividend moneys in respect of them free of income tax, and applying all but 2,500 pounds in purchasing the Lefroy shares after the dividends thereon had been paid. The arrangement was, therefore, a means for avoiding the income tax which the Hancocks would have been liable to pay if they had achieved the same results without an arrangement. One may accept without hesitation their stoutly-maintained assertion that in their minds the arrangement was predominantly a means for getting in the Lefroy shares. That was, no doubt, their longstanding ambition. It was that which drew them into the arrangement when it was proposed to them. But the stubborn fact remains that, for whatever else the arrangement was a means, it was a means for the avoidance of tax. The consequence which s. 260 produces is that the transfers of the 7,728 shares to Rowdell are to be treated as void, and Rowdell's receipt of the dividend moneys in respect of those shares is to be considered a receipt of the Hancocks' moneys by arrangement with them, and therefore as a derivation of those moneys by the Hancocks, with the character of company distributions still upon them. (at p292)
18. In my opinion, the amended assessment was correct, and the appeal from
the order of Fullagar J. should be dismissed.
Langley George Frederick Hancock v. Commissioner of Taxation. (at p292)
19. It follows from my reasons for judgment in the appeal of George Hancock that in my opinion this appeal too should be dismissed. (at p292)
MENZIES J.George Hancock v. Commissioner of Taxation. (at p292)
2. At the beginning of the time with which we are concerned (i.e., the first half of 1949), the taxpayer, George Hancock, and his son, L. G. F. Hancock, were minority shareholders in Mulga Downs Pty. Ltd., a pastoral company owning and operating the Mulga Downs station near Wittenoom Gorge in Western Australia. The original majority shareholder was one Wittenoom, for whom the appellant George Hancock had in the first place managed the station, but upon the death of Wittenoom the majority shareholding passed to members of the Lefroy family. The paid up capital was 18,945 shares of one pound each, of which the Lefroys held 11,210, and the taxpayer 6,730, his son L. G. F. Hancock 1,000 and Mrs. L. Y. M. Hancock 5. These last can be disregarded, so that when I speak of the Hancocks I mean George and L. G. F. Hancock. The company was in a strong financial position and in February 1949 had, in addition to the station and stock, Commonwealth bonds to a face value of 17,500 pounds, a credit with Dalgety & Co. Ltd. of 5,400 pounds, and was owed 5,000 pounds by the appellant. The profits for the year ending on 30th April 1949 were estimated at about 24,000 pounds, and it seems that its anticipated profits for the year to end on 30th April 1950 were of the same order. (at p292)
3. It was in these circumstances that Mr. H. K. Watson, who is a chartered accountant and taxation consultant and who with his wife owned all the shares in a share-dealing company, Rowdell Pty. Ltd., asked L. G. F. Hancock, whom he knew socially, about the possibility of acquiring the Hancock shares in Mulga Downs and was told that the Hancocks would be much more interested in becoming the holders of all the shares in that company. Some time after this conversation, Rowdell, by a letter dated 15th February 1949, put forward to the Hancocks the proposition that it should purchase the Hancock shares for 23,000 pounds and the Lefroy shares for 40,000 pounds with a view to taking 50,000 pounds out of Mulga Downs by way of dividends during May 1949 and then selling all the shares for 21,000 pounds, giving the Hancocks the first refusal to purchase. It was pointed out that this offer "would enable the Hancocks in due course to acquire all the issued capital of Mulga Downs without any cash outlay at all over and above their present resources. Indeed, at the conclusion of all the purchases and sales the Hancocks' cash position would be about 2,000 pounds better off than it is today". It was also stressed that the sale to Rowdell Pty. Ltd. at the prices mentioned "would give the Lefroys and the Hancocks a substantial capital profit on which income tax would not be chargeable". It would also give Rowdell a profit of 8,000 pounds, although this was not adverted to. (at p293)
4. The proposition thus put forward was, after some negotiation and with
minor adjustments, carried out, and on 30th April 1949
18,937 shares in Mulga
Downs Pty. Ltd. were transferred by the Hancocks and the Lefroys to Rowdell
and one share to Watson, making
the shareholding of the company as follows:
Rowdell Pty. Ltd. . . . . . . 18,937 shares.
George Hancock . . . . . . . . . . 1 share.
L. G. F. Hancock . . . . . . . . . 1 share.
Mrs. L. Y. M. Hancock . . . . . . .5 shares.
H. K. Watson . . . . . . . . . . . 1 share. (at p293)
5. Payment for these shares was made as follows: (1) 40,000 pounds by bank
cheque obtained by Rowdell to A. L. B. Lefroy on 30th
April in full payment
for the Lefroy shares. (2) Rowdell's cheque for 2,500 pounds of 30th April to
the Hancocks in part payment
for their shares. (3) Rowdell's cheque for 21,000
pounds of 3rd June 1949 to the Hancocks in payment of the balance for their
shares.
(at p293)
6. The financing of these payments was a work of art. On 22nd April, by
arrangement with Rowdell, the Lefroy directors had retired
and George Hancock,
the only remaining director, appointed L. G. F. Hancock a member of the board.
On 23rd April 1949 Mulga Downs
sold its Commonwealth bonds to a face value of
17,500 pounds to Rowdell for 17,300 pounds payable on 27th May 1949 and a
promissory
note by Rowdell was given for this amount. Rowdell then sold these
bonds to a face value of 17,000 pounds for 16,786 pounds 17s.
6d., which was
paid to the credit of its account. On 30th April 1949 Mulga Downs declared a
dividend by a resolution of the directors
as follows: "That after the
registration of the aforesaid transfers in the Register of Members there be
declared and paid to the
members then standing in the Register, according to
their respective rights and interests, a further dividend of 3,500 pounds out
of the profits of the year ended 30th April, 1948 and an interim dividend of
21,500 pounds out of the profits of the year ended 30th
April, 1949, viz:-
Number Dividend from Dividend from
Member of 1947-48 1948-49
Shares Profits Profits
Pounds Pounds
Rowdell Pty. Ltd. 18,937 3,498 10 6 21,490 18 -
George Hancock 1 3 8 1 2 9
L. G. F. Hancock 1 3 8 1 2 9
Mrs. L.Y.G.Hancock 5 18 6 5 13 9
H. K. Watson 1 3 8 1 2 9
18,945 3,500 0 0 21,500 0 0" (at p294)
7. It is to be observed that of this dividend Rowdell received 24,990 pounds
14s. 11d., which it banked. As Rowdell's bank account
was in credit to the
extent of 1,845 pounds 11s. 2d. prior to the receipt of the foregoing amounts,
the account was sufficiently
in credit to meet the Lefroy cheque for 40,000
pounds and the Hancock cheque for 2,500 pounds and leave a credit balance of
about
1,100 pounds, but there remained to be paid the promissory note for
17,300 pounds and the 21,000 pounds balance of purchase money
for the Hancock
shares. To enable these payments to be made, Mulga Downs on 27th May 1949
distributed 25,000 pounds by way of dividends,
of which Rowdell again received
24,990 pounds 14s. 14d. This distribution was as to 2,500 pounds out of
profits for the year ended
on 30th April 1949 and as to 22,500 pounds out of
the anticipated profits for the year ending 30th April 1950. To complete the
transaction,
the Hancocks purchased 18,938 shares in Mulga Downs from Rowdell
for 21,000 pounds. This occurred on 2nd June 1949 and about this
purchase a
further word must be said. The original proposal of 15th February was that the
Hancocks should have the "first right of
refusing our offer to sell all the
shares at that figure of 21,000 pounds" and it was emphasized, as appears from
the passage from
the letter quoted earlier, that this would enable the
Hancocks to obtain all the shares without any cash outlay. When the formal
agreement between Rowdell Pty. Ltd. and the Hancocks was drawn up and
executed, however, the option to purchase was omitted in accordance
with the
following explanation which Rowdell gave in a letter dated 14th April 1949 to
R. A. Long, the Secretary of Mulga Downs :
- "Moreover, since the position is
rather complicated and uncertain at the moment, we are disinclined to give any
binding option
at any fixed price until after Mulga Downs has held its Annual
Meeting and paid out its Dividends. The position will then have clarified
so
that there will then be no possible room for dispute as to the precise nature
and extent of the assets and liabilities of the
Company at the time when the
option is granted. For example, we may finally decide to take out a dividend
of, say, only 40,000 pounds
instead of the 50,000 pounds as is our present
intention. In such case the price we would want for our shares would then be
31,000
pounds and not 21,000 pounds." Fullagar J., who heard the taxpayer's
appeal and from whose decision this appeal is brought, decided
nevertheless
that "there was an understanding (perhaps a contract) that Rowdell would,
after "milking" Mulga Downs of a further 25,000
pounds, sell the whole of the
shares in that company to the Hancocks for 21,000 pounds". This was clearly
the case, and at a general
meeting of Rowdell on 2nd June 1949, the chairman
reported that "as anticipated the Hancocks desired to buy the 18,938 1 pound
shares
in Mulga Downs Pty. Ltd. for the sum of 21,000 pounds", and it was
resolved "that the seal of the Company be affixed to the various
transfers of
shares aggregating 18,938 in Mulga Downs Pty. Ltd. for the sum of 21,000
pounds to Messrs. G. Hancock and L. G. Hancock
and Miss K. L. Hancock and Mrs.
S. L. Sharpe". Miss K. L. Hancock and Mrs. S. L. Sharpe were daughters of
George Hancock and he arranged
for the transfers that were made to them. From
the foregoing account of the transactions, it is apparent that what had been
proposed
by Rowdell on 15th February 1949 was actually carried out with the
minor adjustment that L. G. F. Hancock sold his shares for 3,500
pounds
instead of for the 3,000 pounds that had originally been offered. (at p295)
8. I now turn to the income tax aspects of the foregoing transactions. In 1949 and 1950, Mulga Downs was making large profits and, as it was a private company, it would, unless it made sufficient distributions within the times limited, be liable to pay undistributed profits tax. Furthermore, whatever Mulga Downs were to distribute by way of dividend would attract heavy income tax in the hands of its shareholders had they remained as they were in February 1949. That state of affairs was, however, radically changed when Rowdell became the shareholder to whom dividends were to be distributed, because it was a share-dealing company and against any dividends that it might receive (which in the event approximated 50,000 pounds) it could offset a loss of 42,500 pounds if it were to sell for 21,000 pounds shares which it had purchased for 63,500 pounds. (at p296)
9. In these circumstances it seems to me that what was done was done pursuant to an arrangement between Rowdell, Mulga Downs and the Hancocks, which had the following purposes and effects : (1) that by distributing 50,000 pounds by way of dividends, Mulga Downs should make a sufficient distribution for the purposes of Div. 7 of Pt III of the Income Tax and Social Services Contribution Assessment Act so that no undistributed profits tax would be payable in respect of the years 1948 to 1950 ; (2) that substantially the whole of the dividends should be paid to Rowdell ; (3) that instead of receiving the proportion of the dividends to which they would have been entitled had they not sold their shares to Rowdell, i.e., 20,400 pounds approximately, the Hancocks should receive 2,500 pounds in cash and the shares (after dividends) which had belonged to the Lefroys ; (4) that what the Hancocks received should be capital, not income. (at p296)
10. Although it seems that the Hancocks did not realize that because Rowdell was a share-dealer, it would be able to set off its loss on the purchase and sale of the shares in Mulga Downs against the dividends it received from the company, it was an essential part of the arrangement that Rowdell should receive the dividends and that it should sell to the Hancocks for 21,000 pounds the shares which it was purchasing for 63,500 pounds. (at p296)
11. The conclusion of Fullagar J. that there was an arrangement which had the purpose and effect of avoiding the Hancocks' liability for tax is one with which I agree. Instead of receiving dividends as shareholders it was arranged that the Hancocks should receive capital. (at p296)
12. It was argued, however, that arrangement that the Hancocks should get the Lefroy shares after dividends plus 2,500 pounds from Rowdell instead of receiving dividends from Mulga Downs upon their own original shares (which is the true purpose and effect of the arrangement so far as the Hancocks were concerned) avoided no tax because what the Hancocks received was not income and so attracted no tax, but one of the points decided by Newton v. Federal Commissioner of Taxation [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 was that in an appropriate case s. 260 applies to an arrangement to avoid receiving dividends. It is true, as was stressed for the appellant, that the Hancocks were not only concerned to avoid receiving taxable dividends ; they wanted to become the holders of all the shares in Mulga Downs and, provided that the price was right, it did not matter to them that the company in which they became the only shareholders was a company from which the liquid assets had been withdrawn. It still owned the station and the stock which was what the Hancocks were particularly concerned to get. Again, however, Newton's Case (1958) AC 450 ; (1958) 98 CLR 1 decided that the section can apply if to avoid the receipt of taxable dividends is only part of the purpose and effect of the arrangement. I agree, therefore, with Fullagar J. that s. 260 applies, and as against the Commissioner that section avoided so much of the arrangement as had the purpose and effect of avoiding the Hancocks' liability to tax on the dividends that Mulga Downs was due to distribute. What was made void, therefore, as was the case in Newton v. Federal Commissioner of Taxation [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 and Bell v. Federal Commissioner of Taxation (1953) 87 CLR 548 , were the transfers by the Hancocks to Rowdell, with the consequence that for taxation purposes the Hancocks must be treated as having remained the holders of 7,730 shares in Mulga Downs. (at p297)
13. Section 260, however, does not impose tax liability ; what it does is to enable the taxpayer's liability to tax to be determined without regard to so much of what has been done as is void against the Commissioner. As in this case I do not think that goes beyond the transfers from the Hancocks to Rowdell of the 7,730 shares in Mulga Downs, it is necessary, in order to determine their tax liability, to find out whether the Hancocks received anything which would be taxable income if, instead of having transferred their shares to Rowdell, they had retained them. (at p297)
14. In the first place, they received 2,500 pounds in cash. This, it seems it me, came to them through Rowdell from the profits distributed by Mulga Downs, and in accordance with the decision in Newton's Case [1958] UKPCHCA 1; (1958) AC 450 ; (1958) 98 CLR 1 and Bell's Case (1953) 87 CLR 548 that 2,500 pounds is taxable. Its taxability does not depend upon exactly tracing the sum received through the account of Rowdell back to the dividend cheque ; it is sufficient that, in substance, the receipt was derived from the company's distribution of profits. (at p297)
15. The Commissioner, however, seeks to go further. First, it is contended for him that the Hancocks should be regarded as having received the whole of the dividends which Rowdell received in respect of the shares which ex hypothesi belonged to the Hancocks, i.e., 17,759 pounds in the case of the taxpayer. In support of this contention, reliance was placed upon that part of the decision in Newton's Case [1958] UKPCHCA 1; (1958) AC 450; (1958) 98 CLR 1 which decided that the taxpayers there must be regarded as having received that which Pactolus retained. As to this, the Privy Council said : - "He (i.e., the Commissioner) cannot trace the balance of 102,414 pounds actually into their hands. It remained in the pocket of Pactolus Limited. It was ostensibly the profit of Pactolus on buying the shares. But when the transfer is ignored, that profit is seen to be nothing more nor less than remuneration which the original shareholders allowed Pactolus to retain for services rendered. The position is the same as if the shareholders had received it as part of the special dividend and then returned it to Pactolus as remuneration. The commissioner can therefore treat this 102,414 pounds also as income derived by the shareholders" (1958) AC, at p 468 ; (1958) 98 CLR, at p 11 . I think, however, it would be going far beyond that part of the decision, which was reached in the very special circumstances of that case, to regard the Hancocks as having received approximately 18,000 pounds of the dividends which Rowdell received and either retained or used to pay the Lefroys. Here the difference between 20,400 pounds and 2,500 pounds was clearly not remuneration for Rowdell's services. The fact is, of course, that the Hancocks forewent any cash benefit beyond 2,500 pounds in order to get the Lefroy shares, and it would be to depart from the facts to disregard what they did receive and to regard them as having received something else. Furthermore, I can find no satisfactory justification for treating Rowdell as having acquired the Lefroy shares for the Hancocks by an application, with the authority of the Hancocks, of part of the dividends paid upon the Hancock shares. The Lefroy shares were bought by Rowdell, cum. div., for 40,000 pounds by a transaction which is not void against the Commissioner or at all; the same shares were sold, ex. div., by Rowdell to the Hancocks, together with the Hancock shares, again by a transaction which so far as it concerned the Lefroy shares was not void against the Commissioner or at all. The avoidance as against the Commissioner of the sale of shares by the Hancocks to Rowdell does not enable me to say that Rowdell, with the authority of the Hancocks, applied dividends upon the Hancock shares as purchase money to buy the Lefroy shares for the Hancocks. Had there been an arrangement whereby the Hancocks allowed Rowdell to receive and retain or use all but 2,500 pounds of the dividends upon their shares in return for the transfer of the Lefroy shares, ex. div., I would have no doubt that the Hancocks would have been taxable upon the dividends that Rowdell received without the aid of s. 260, but I do not think that the application of s. 260 to the arrangement that was made produces that result. Although void against the Commissioner, the transfers from the Hancocks to Rowdell were valid as between the parties and as between them. Rowdell without more was entitled to the dividends it received upon the Hancock shares. It was by virtue of valid transfers inter partes and not by virtue of any authority from the Hancocks that Rowdell received the dividends that it did and to infer an application authorized by the Hancocks of their dividends is to infer something which did not take place and could not have taken place in the circumstances that as between them and so far as Mulga Downs Pty. Ltd. was concerned the shares belonged to Rowdell, not the Hancocks. It is not sufficient for the Commissioner's purposes to point to the fact that so far as he is concerned the Hancocks were entitled to the dividends that went to Rowdell; he must show upon the actual facts that they received them or dealt with them; and a dealing with them is not to be inferred merely from the fact of their entitlement in the eyes of the Commissioner when as between the parties, and as between the parties and the company, Rowdell got nothing that it was not entitled to receive as a matter of right. Section 260 does not authorize the Court to make implications contrary to the facts to reconcile the actual state of affairs with the state of affairs vis-a-vis the Commissioner and the taxpayer resulting from its application. Notwithstanding the application of s. 260, the Hancocks obtained the Lefroy shares from Rowdell by purchasing them at an agreed price, which it can fairly be inferred was based upon asset backing. (at p299)
16. There are, however, two other ways in which what the Hancocks received over and above the 2,500 pounds might be regarded as taxable income. The first depends upon treating the arrangement as covering the acquisition by the Hancocks of the shares that were originally owned by the Lefroys and regarding the acquisition of the Lefroy shares as the receipt of a dividend. To do this would again seem to me to disregard the facts. Mulga Downs did not distribute the Lefroy shares and the Hancocks did not receive them as shareholders in Mulga Downs; the transfers by the Lefroys to Rowdell stand, as do the transfers from Rowdell to the Hancocks. Accordingly, I cannot accept this contention. (at p299)
17. This leaves for consideration the possibility of treating the 21,000 pounds which the Hancocks received as the balance of purchase price upon the sale of their shares to Rowdell as in part dividends which Mulga Downs distributed to Rowdell in respect of the Hancock shares. Upon an examination of what occurred, it does not seem to me possible to infer that the 21,000 pounds which Rowdell paid to the Hancocks on 3rd June was part of the company's profits. The payments that Rowdell made for shares totalled 63,500 pounds and that company made a profit of approximately 7,500 pounds, so that there had to be a fund of 71,000 pounds. This was provided from 50,000 pounds (approximately) dividends from Mulga Downs, and 21,000 pounds from the Hancocks for the purchase of the Mulga Downs shares. Upon the whole I am disposed to think that the substantial identity that can be established is that the dividends were used to pay the 40,000 pounds paid to the Lefroys, the initial 2,500 pounds paid to the Hancocks, and to provide the Rowdell profit, so that the 21,000 pounds which the Hancocks received on 3rd June really came from the money which they paid to Rowdell for the Mulga Downs shares. This would have appeared more obviously had the purchase price been 30,000 so pounds that the Hancocks would have had to provide money of their own. Even as it happened, however, it should not be overlooked that the 21,000 pounds exceeded so much of the dividends paid as could be attributed to the Hancock shares. (at p300)
18. Fullagar J. did not find that the initial 2,500 pounds paid to the Hancocks came out of the company's profits, but I regard the dealing with the company's Commonwealth bonds as doing no more than providing an advance against the dividend declared on 28th April so that it is a correct inference that the 40,000 pounds paid to the Lefroys and the 2,500 pounds paid to the Hancocks did come from the company's profits. His Honour did, however, find that the 21,000 pounds paid by Rowdell to the Hancocks on 3rd June did come from Mulga Downs profits, but I have already explained what I think happened to those profits and I add that if the Commonwealth bonds transactions are to be treated independently of the payment of dividends, then it was the promissory note for 17,300 pounds that part of the second dividend was used to pay. (at p300)
19. In the result I think the appeal should be allowed, that the amended
assessment appealed from should be reduced by substituting
for the 17,759
pounds added thereby the proportion of the 2,500 pounds paid by Rowdell Pty.
Ltd. to the Hancocks on 30th April, to
which the taxpayer was entitled as
between himself and L. G. F. Hancock. I calculate this at 2,177 pounds.
Langley George Frederick Hancock v. Commissioner of Taxation. (at p300)
20. For the reasons given in the earlier appeal I consider that this appeal should be allowed except as to 323 pounds. (at p300)
WINDEYER J. I agree in the reasons and the conclusions of the Chief Justice. I doubt whether it is possible to formulate mechanistic criteria for determining when s. 260 operates, for much must depend upon the circumstances of each case. But Kitto J. has shown that there are present in this case features that, in other cases, have been held to make plain a purpose or effect struck at by the section. I agree too that the effect of the section's operation is not to be ascertained by a tracing of particular moneys; but rather by looking at what is left when all the transactions that as against the Commissioner have to be swept away have been swept away. To use a phrase used by Viscount Simonds in another context, one must look to "the design and the result of the arrangement" (Commissioner of Stamp Duties of New South Wales v. Permanent Trustee Co. of New South Wales (1956) AC, at p 525; (1956) 95 CLR, at p 9 . Devious and circuitous routes taken pursuant to an arrangement may be indications that the arrangement is one to which s. 260 applies; but the section does not demand a following of particular moneys through each step of a devious and circuitous accounting. (at p301)
2. In a case under s. 260 one starts with the position that the arrangement that is void as against the Commissioner is valid as between the parties - that is to say that it is a legal reality and not a sham; because, if it were a sham, it would fall in any event, and without the aid of s. 260. But subordinate steps taken in the carrying out of an arrangement that is within s. 260 may, it seems to me, be shams. Indeed one of the indications that an arrangement is vulnerable under the section may be that it was to be carried into effect by fictitious procedures. Those who devise methods for enabling taxpayers to order their affairs so as to attract the least possible amount of tax do not always appreciate that, quite apart from s. 260, the taxpayer must enter into a real not a pretended transaction to effect his purpose. "It is now well settled that the substance, n law, of a transaction can be determined only by ascertaining what the transaction really was. If the ostensible transaction is a sham, a mere facade concealing a different transaction, it must be disregarded, and legal rights and liabilities determined according to the real transaction" : per Jordan C.J. in In The Estate of William Vicars Deceased (1944) 45 SR (NSW) 85, at p 93 ; and see the remarks by the same learned judge in Perpetual Trustee Co. Ltd. v. Bligh (1940) 41 SR (NSW) 33, at p 39 and Boydell v. James (1936) 36 SR (NSW) 620, at p 627 . It is one thing to say that the substance and nature of a genuine transaction are determined by the form in which it is cast. It is quite another to suppose that going through a form makes a pretended transaction real. An ostensible gift that was made only so that the subject of the gift might be at once given back may not, it seems to me, really cause a change of ownership even momentarily. And, in some cases, probably the same might be said of an exchange of cheques. But whether in a particular case a subsidiary and ancillary transaction, which is involved in carrying out an arrangement void under s. 260, falls with the demolition of the arrangement by the section or falls because of its own inherent instability, the Commissioner, I am inclined to think, cannot, while treating the arrangement as void under s. 260, treat such subsidiary and ancillary transaction as if it had taken effect and levy taxation accordingly. I doubt, therefore, whether he could in this case treat the dividends that Rowdell received in respect of the shares it acquired from the Hancocks as part of its assessable income. That question, however, does not arise for decision here and I do not express a concluded view on it. (at p302)
3. In my opinion these appeals should be dismissed. (at p302)
ORDER
Order in each appeal:Appeal dismissed with costs.
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