Glenville Pastoral Co Pty Ltd (In Liq) v Federal Commissioner of Taxation [1963] HCA 36; (1963) 109 CLR 199 (26 September 1963)

HIGH COURT OF AUSTRALIA

GLENVILLE PASTORAL CO. PTY. LTD. (IN LIQUIDATION) v. COMMISSIONER OF TAXATION
[1963] HCA 36; (1963) 109 CLR 199

Income Tax (Cth)

High Court of Australia
Kitto(1), Taylor(1) and Owen(1) JJ.

CATCHWORDS

Income Tax (Cth) - Companies - Private company in liquidation - Distribution by liquidator out of income - "Income . . . properly applied to replace a loss of paid up capital" - Deficiency of capital after income distribution - Liability of private company to additional tax - Sufficiency of distribution - Income Tax and Social Services Contribution Assessment Act 1936-1956 (Cth), ss. 44, 47*, 104, 105A.

HEARING

Sydney, 1963, August 15, 16;
Adelaide, 1963, September 26. 26:9:1963
CASE STATED by Menzies J.

DECISION

September 26.
THE COURT delivered the following written judgment: -
This is a case stated by Menzies J. in an appeal from an assessment of Services Contribution Assessment Act 1936-1956 in respect of the income year which ended on 30th June 1957. In that year the appellant's taxable income was calculated by the respondent at 243,316 pounds which represented an assessable income of 243,402 pounds less certain minor expenses amounting to 86 pounds. Apart from its liability to additional tax under the provisions of Div. 7 the appellant was not liable to tax in respect of that income, because of the rebates for which provision is made by s. 46 of the Act. (at p203)

2. For the purpose of considering the problem which the case raises it is necessary to observe that the appellant was the holder of the whole of the issued shares in a company known as E. Killen and Sons Proprietary Limited (hereinafter referred to as Killens) and that this company went into voluntary liquidation on 22nd April 1955. At this time the appellant's assets consisted of its shares in Killens and a small sum on current account. But prior to 30th June 1957, and within the income year which ended on that date, the liquidator of Killens made four distributions to the appellant. The first was of a sum of 87,457 pounds made on 26th September 1956 and this was made out of a special reserve account which stood in credit to the extent of the amount distributed and which, with the exception of 1,597 pounds, represented accumulated trading profits of Killens which had borne undistributed profits tax under Div. 7. The second and third distributions were of sums of 42,000 pounds and 34,000 pounds and these were made out of funds standing to the credit of the profit and loss appropriation account. These distributions were made on 28th September 1956 and 5th February 1957 respectively. The fourth distribution was of the sum of 944,289 pounds. This was a final distribution and it was made on 20th June 1957. In calculating the taxable income of the appellant the respondent treated 777,618 pounds of this lastmentioned sum as exempt income and 867 pounds thereof as otherwise not forming part of the appellant's assessable income. The remainder, 165,805 pounds, was, as will appear presently, included therein. The appellant had no other receipts during the relevant income year and its assessable income consisted of four amounts previously mentioned. These were 1,597 pounds being part of the first distribution, 42,000 pounds and 34,000 pounds, being the second and third distributions and 165,805 pounds being part of the fourth distribution. These amounts were brought into the assessable income of the appellant by force of the operation of ss. 44 and 47 of the Act. Each amount was taken as the extent to which the relevant distribution was considered by the respondent to represent income derived by Killens and, therefore, deemed by s. 47(1) to be a dividend paid to the appellant by Killens out of the profits derived by it and, by force of s. 44(1)(a), the aggregate of the four amounts was the assessable income of the appellant. (at p204)

3. The appellant itself had gone into voluntary liquidation on 22nd October 1956 and, in turn, its liquidator made two distributions to the appellant's shareholders. The first of these, 39,062 pounds, was made on 30th April 1957, but we are concerned with the second distribution which was of the sum of 241,669 pounds and which was made on 29th October 1957. (at p204)

4. The critical question for the purpose of determining whether the appellant is liable to additional tax pursuant to Div. 7 is whether, in the language of s. 104 of the Act, it was not, by s. 105A, deemed to have "made a sufficient distribution in relation to the year of income" and under the latter section it was deemed to have made a sufficient distribution if it had, during the prescribed period, paid in dividends (other than special fund dividends) an amount not less than the excess of its distributable income of the year of income over the retention allowance in respect of that distributable income. By definition the distributable income of a private company is its taxable income less certain prescribed deductions. But none of such deductions was applicable in the case of the appellant and its taxable income represented its distributable income. Nor are we concerned with any question of special fund dividends or with the question whether any relevant dividend was paid beyond the prescribed period. We start, therefore, with the proposition that, for the purposes of Div. 7, the appellant's distributable income was 243,316 pounds. (at p204)

5. It is the appellant's contention that the distribution of 241,669 pounds which its liquidator made to its shareholders on 29th October 1957 constituted dividends pursuant to s. 47 and that these dividends together with an amount of 1,747 pounds carried forward pursuant to the provisions of s. 106, aggregated more than the appellant's distributable income for the relevant year. On the other hand, the respondent maintains that part only of the distribution of 241,669 pounds constituted dividends. Originally this part was calculated at 75,770 pounds and the calculation was made in the following manner. It was said that on 22nd October 1956 (when the appellant went into liquidation) the shareholders' funds, apart from paid-up capital, and a comparatively small sum applicable to special fund dividends, amounted to 80,927 pounds. This amount, it was then said, was increased by the receipt of income after that date and prior to 30th June 1957 by an amount of 33,905 pounds; but out of the sum of these two amounts, 114,832 pounds, the liquidator had, on 30th April 1957, distributed 39,062 pounds which had been allowed as a dividend for the purposes of Div. 7 in respect of the previous income year. The balance, 75,770 pounds, it was then said, was the only amount "capable of being deemed a dividend in terms of s. 47 . . . and allowable in accordance with s. 105A". The precise figures in this calculation are not of importance in the case for they have been recast, and according to current calculations the amount in dispute is now 159,271 pounds that being the difference between the amount of the appellant's distributable income (243,316 pounds) and the sum of the amounts of 82,298 pounds, which the respondent now regards as a "deemed dividend" under s. 47, and 1,747 pounds, an amount to which reference has previously been made. What is of importance is that the amount of 82,298 pounds, as at present calculated, represents the amount by which the appellant's funds as at 30th June 1957, with certain minor adjustments not necessary to mention, exceeded the amount of its paid-up capital, and the amount of 159,271 pounds represents the amount by which, after the distribution of 29th October 1957, its funds fell short of the amount of its paid-up capital. In those circumstances the respondent has treated the sum of 82,298 pounds only as a "deemed dividend" and has assessed the appellant for additional tax under Div. 7 on the basis that in relation to the relevant income year it has paid only this amount in dividends and that it was not, therefore, deemed to have made a sufficient distribution in relation to that year. To this assessment the appellant objected claiming, inter alia, that the whole of the sum of 241,699 pounds constituted a "deemed dividend". (at p205)

6. It appears from the case stated that the appellant was notified by the respondent on or about 12th September 1957 that its taxable income had been calculated at 243,316 pounds. But, as already appears, no ordinary tax was payable. The notice of assessment to additional tax payable under Div. 7 was issued on 28th February 1958. In the meantime the distribution of 29th October 1957 had been made. It is unnecessary to refer in detail to the various entries in the appellant's books relating to the receipt of its distributions from Killens and to the subsequent distribution made by the appellant's liquidator. But it is clear that the final distribution of 944,289 pounds from Killens was originally taken into the appellant's accounts as a capital receipt and no part of it was shown in the income tax return originally lodged by it in respect of the year ended 30th June 1957. Indeed, apart from the effect of the provisions of s. 47(1), it was wholly a capital receipt. But that section, as was said in Parke Davis & Co. v. Commissioner of Taxation [1959] HCA 15; (1959) 101 CLR 521 was enacted "to meet the situation, made clear enough by Inland Revenue Commissioners v. Burrell (1924) 2 KB 52 which decided in effect, that a distribution of a mass of assets, although in a colloquial sense they represented or contained profits, was a distribution of capital" (1959) 101 CLR, at p 530 After having been notified that its taxable income for the relevant year had been calculated at 243,316 pounds the books of account of the appellant were amended. This was done on 15th October 1957 for the purpose of appropriating 167,402 pounds of the amount received from Killens to the appellant's profit and loss appropriation account. In the result the amount standing to the credit of the profit and loss appropriation account became 244,311 pounds and the small credit which the capital account previously disclosed was transformed into a debit of 160,235 pounds. Following these entries an amended income tax return was lodged by the appellant, together with amended accounts. Then on 29th October 1957 the appellant's liquidator made the distribution in question and he purported to make it out of the sum standing to the credit of the profit and loss appropriation account. We do not think it is in doubt, and it was not contested, that it was the intention of the liquidator to make a distribution to the full extent of the appellant's distributable income. But, nevertheless, it is said by the respondent that the only part of the distribution which qualified as a "deemed dividend" under s. 47 was the amount by which the appellant's funds exceeded the amount of its paid-up capital. (at p206)

7. Section 47(1) of the Act provides that distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up capital, shall, for the purposes of the Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it. In no sense, apart from the provisions of this section, did any part of the distributions which the appellant received from the liquidator of Killens constitute income of the appellant. But since, to the extent of 243,402 pounds, they represented income derived by Killens they were to that extent to be deemed, for the purposes of the Act, to be dividends paid to the appellant by Killens out of the profits derived by it. As already mentioned, one result was that to that extent what the appellant received from Killens constituted by force of s. 44(1)(a) the appellant's assessable income for the year in question. But the purposes of the Act are not limited to the purposes of s. 44(1)(a); they include the purposes of every provision of the Act: see Archer Brothers Pty. Ltd. v. Federal Commissioner of Taxation (1953) 90 CLR 140, at pp 147, 148, 154 Accordingly, in applying s. 47(1) itself in relation to distributions by the appellant to its shareholders, it is necessary to treat the amount the appellant received from Killens as constituting, to the extent of 243,402 pounds, dividends paid out of Killens' profits and therefore as being income derived by the appellant. That being so, the whole amount of the distribution made by the appellant's liquidator on 29th October 1957, namely 2418669 pounds, must be deemed to have represented income derived by the appellant, and therefore to be deemed dividends paid by the appellant out of its profits except as regards any part of it which had been "properly applied to replace a loss of paid-up capital". (at p207)

8. It is upon the words just quoted that the respondent Commissioner must rely in order to justify the step in his assessment which consists of treating as a distribution of capital so much of the sum of 241,669 pounds as reduced the appellant's remaining funds below the amount of its paid-up capital. The train of thought which the assessment reflects is that where a liquidator distributes an amount which leaves insufficient remaining assets to answer the whole of the paid-up capital, the amount of the deficiency of paid-up capital which would exist if the distributed amount were to be regarded as wholly a distribution of profits must be considered as properly applied to replace a loss of paid-up capital. The ultimate question in the case is whether this proposition is sound. (at p207)

9. In our opinion it is not sound. If the case of In re Hoare & Co. Ltd. (1904) 2 Ch 208 be read, and with it such cases as In re Bridgewater Navigation Company (1891) 2 Ch 317 esp at p 327; Bond v. Barrow Haematite Steel Company (1902) 1 Ch 353 and Stapley v. Read Bros. Ltd. (1924) 2 Ch 1, it will be seen what is meant in company law by applying profits to replace share capital that has been lost. Profits may, of course, be distributed by a company while a going concern even though a loss of paid-up capital previously incurred has not been made good. The profits may be distributed as soon as ascertained, or they may be carried to a reserve. Carrying an amount of profits to a reserve is not enough to convert it into capital, and accordingly it continues to be distributable. But provided there is nothing to the contrary in the articles of association or otherwise binding upon the company, the directors (or the general meeting, whichever is the appropriate body under the articles) may, by a positive and final decision, apply distributable profits to make good lost share capital. The amount of the profits is then carried to a capital account, and loses its identity as a detachable fund of profit. Thereafter the company cannot utilize the amount for the payment of dividends, any more than it can utilize for that purpose other moneys representing share capital. See particularly the observations of Romer L.J. and Cozens-Hardy L.J. in In re Hoare & Co. Ltd. (1904) 2 Ch 208, at pp 214, 218 It is this method of capitalization of profits that s. 47(1) recognizes and allows for in pursuing the policy of assimilating a distribution in a winding-up so far as it represents income - it does not apply to capital profits - to a dividend paid by a company which is a going concern. In so far as income has been properly applied to replace lost share capital, a distribution of it while the company was a going concern would have had to be by way of reduction of capital; it could not have been a dividend. Words are accordingly introduced into s. 47(1) to ensure that a distribution of it in the course of winding up is not regarded differently for purposes of tax. (at p208)

10. One further point is to be noticed. The expression in the section is "has been applied", not "is applied". The explanation is clear enough: the application of the income to replace lost capital could not be contemporaneous with the making of the distribution, because it could not properly be made once the company has ceased to be a going concern, a liquidator having no power to capitalize profits: Inland Revenue Commissioners v. Burrell (1924) 2 KB 52, at pp 60, 68 Nothing that was said in Archer Brothers Pty. Ltd. v. Federal Commissioner of Taxation [1953] HCA 23; (1953) 90 CLR 140 should be taken as supporting a different view. The statement there made that "by a proper system of book-keeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that these distributions could be made wholly and exclusively out of those particular profits or income" [1953] HCA 23; (1953) 90 CLR 140, at p 155 relates only to the selection of one income source rather than another for the payment of a particular distribution. It is true that on the same page words are used which assume that of certain distributions that had been made in a winding-up partly out of capital and partly out of profits the portion that represented profits had been applied by the liquidator to replace a loss of paid-up capital, and therefore were not deemed by s. 47 to be dividends. But in the circumstances of the case no other view of the facts was open. It was the view which the Commissioner had been invited to accept when considering his assessment, the assessment had been made on that basis, and it was not challenged by the taxpayer's objections which were directed only to the question of the applicability of s. 104 of the Act to companies in liquidation. The Court was, accordingly, obliged to proceed on the basis that the distributions under consideration were distributions of capital. The observations in the case must be read in the light of this fact. The statement that the liquidator could have made a sufficient distribution of taxable income to satisfy s. 104 "if there had been sufficient surplus assets, other than the income included in this taxable income, to distribute as a replacement of paid-up capital" (1953) 90 CLR, at p 155, in so far as it implies the negative, was not a pronouncement on a point which in that case there was any occasion to examine. (at p209)

11. There is nothing in s. 47 to support the notion underlying the assessment in the present case that if capital has been lost a distribution which represents income must be treated as excluded from the operation of the section on the ground that to the extent of the lost capital it has necessarily been applied to make good the loss. It is in accordance with the provisions of the section to hold, as we do, that a distribution of moneys which have been derived by the company as income is to be deemed a dividend paid out of profits, notwithstanding that the remaining assets are insufficient to provide the full amount of the paid-up capital, except insofar as the income, having been derived before the liquidation, has been applied to replace the lost capital, the application having been effected "properly", that is to say by a decision intended to be definitive made by a person or body having power under the articles so to act (and therefore before the liquidation), and otherwise in conformity with the articles and the company's legal obligations. (at p209)

12. In the present case, since the income represented by the relevant distribution was derived during the winding-up, no part of it, in our opinion, can be held to have been applied to replace a loss of share capital. Accordingly we are of opinion that the whole of the amount distributed by the appellant's liquidator on 29th October 1957 is to be deemed a dividend for the purposes of the Act, and the question in the case stated should be answered: The whole. (at p209)

ORDER

Question raised by the case stated answered "The whole". Costs of the case stated reserved for the Justice disposing of the appeal.