Nadir Pty Ltd v Federal Commissioner of Taxation [1973] HCA 19; (1973) 129 CLR 595 (19 June 1973)

HIGH COURT OF AUSTRALIA

NADIR PTY. LTD. v. FEDERAL COMMISSIONER OF TAXATION. [1973] HCA 19; (1973) 129 CLR 595

Income Tax (Cth)

High Court of Australia.
Gibbs J.(1)

CATCHWORDS

Income Tax (Cth) - Companies - Public or private company - Whether carried on for purpose of profit or gain to individual members - Dividends declared in favour of shareholder company but not actually paid - Income Tax Assessment Act 1936-1970 (Cth), s. 103A (2) (c).

HEARING

Brisbane, 1973, June 4, 5;
Sydney, 1973, June 19. 19:6:1973
APPEALS under s. 187 of the Income Tax Assessment Act 1936-1970 (Cth).

DECISION

June 19.
GIBBS J. delivered the following written judgment:-
Before me are two appeals brought by Nadir Pty. Ltd. ("the taxpayer") Assessment Act 1936 (Cth) (as amended) ("the Act") in respect of the income years ended 30th June 1969 and 30th June 1970 respectively. The appeals have been heard together upon a statement of agreed facts supplemented by short oral evidence. The Commissioner disputes the relevance of certain of the facts which, subject to relevance, he accepts for the purposes of the appeals. (at p596)

2. The sole question in the case is whether the taxpayer in each year of income came within the description of a public company contained in s. 103A (2) (c) of the Act. If it did, it is common ground that the assessments, made upon the basis that it was a private company in respect of each of those income years, cannot be sustained. (at p596)

3. The taxpayer was incorporated in Queensland on 24th April 1969. Its issued capital at all material times was two dollars, represented by one fully paid ordinary share held by John Arthur King and one fully paid ordinary share held by his wife Kathleen Mary Miller King. The shares were held by those two persons beneficially for themselves and not for any other person. The taxpayer is described in its returns as an investment company. The objects for which it was established are set out in cl. 2 of the memorandum as follows:

"(a) to acquire and hold shares stock debentures debentures
(sic) stock bonds obligations and securities issued or
guaranteed by any company constitued or carrying on
business in the Commonwealth of Australia or elsewhere
throughout the world and debentures debenture stock
bonds obligations securities issued or guaranteed by any
government sovereign ruler commissioners public body
or authority supreme municipal local or otherwise whether
in Australia or abroad;
(b) to establish conduct acquire and carry on or assist
subsidize or contribute to or arrange for or be concerned
directly or indirectly in the establishment conduct
acquisition and carrying on of any business trade
industry occupation transaction pursuit undertaking or
enterprise whatsoever whether manufacturing trading
financial commercial or otherwise;
(c) except as to the powers contained in par. 23 of the Third
Schedule to The Companies Acts 1961-1964 (which power
is hereby expressly excluded pursuant to the provisions
of Section 19 of The Companies Acts) the powers set out
in the said Third Schedule shall be deemed incorporated
herein but so that each of the said powers shall be deemed
to be an object and it is hereby expressly provided that
none of the foregoing objects and powers contained in
this sub-clause or sub-clauses (a) and (b) hereof shall be
construed to authorise any distribution whether in money
property or otherwise to the members of the company
or to any relative of a member or members and it is
further expressly provided that the making of any such
distribution to any such member or relative either by
way of dividend or otherwise is hereby prohibited the
company not being formed for the purposes of profit or
gain to its individual members."

The power given by par. 23 of the 3rd Sch. to the Companies Act 1961-1964 (Q.), which cl. 2 (c) of the memorandum excludes, is a power "to distribute any of the property of the company among the members in kind or otherwise but so that no distribution amounting to a reduction of capital shall be made without the sanction required by law". Clause 3 of the memorandum provides:

"In addition to any notice required by the said The
Companies Acts in respect of any resolution to alter or amend
any provision of this Memorandum or the associated Articles
of Association the members hereby agree that no resolution
involving any proposed amendment to this Memorandum
or those Articles shall be considered at any meeting of
members unless notice of the resolution shall have been given
to all members not later than twelve months prior to the date
of the meeting at which the resolution is raised for consideration."

The articles of association of the taxpayer include the following provisions:

"5. The company may be (sic) ordinary or special resolution
as the Act requires or permits exercise from time to time
any power which by the Act a company limited by shares may
exercise pursuant to its Memorandum and Articles of Association
save and except:
(a) any power to distribute any of its property whether in
money property or otherwise to its members or to relatives
of its members either by way of dividend or otherwise and
it is expressly provided that any such distribution to any
such persons is expressly prohibited the company not
being carried on for the purposes of profit or gain to its
individual members;
(b) in addition to any notice required by the Act in relation
to any proposed resolution for the amendment of these
Articles or the Memorandum of Association no resolution
involving any proposed amendment to this Memorandum
or its Articles shall be considered at any meeting unless
notice of the resolution shall have been given to all
members not later than twelve months prior to the date
of the meeting at which the resolution is raised for
consideration."

"67. The payment of any dividend to all or any members
or member of the company is prohibited."

"74. In the event of a winding up and so far as is
consistent with the provisions of the Act the distribution of
the whole or any part of the property of the company to any
or all of the members of the company or to any relative of any
members is prohibited. Any property available for distribution
by the liquidator shall be distributed among such
persons associations corporations or organisations (not being
members of the company or relatives of members) as the company
shall by special resolution determine or in the absence
of such resolution among such persons associations corporations
or organisations (not being members of the company or relatives
of members) as the liquidator in his absolute discretion shall
determine."

No notice of any resolution involving any proposed amendment to the memorandum or articles has ever been given. (at p598)

4. The taxpayer was formed with the intention of conferring a taxation benefit on King & Sons Pty. Ltd., a company which was incorporated in 1959 and whose status in the relevant income years for the purposes of Div. 7 was that of a private company. John Arthur King and Kathleen Mary Miller King were at all material times shareholders in King & Sons Pty. Ltd., and Mr. King was the Governing Director of that company. Three other members of the King family also held shares. It does not seem material to mention the numbers or classes of shares held or the rights attaching to various classes of shares. On 24th April 1969, the day on which the taxpayer was incorporated, one ordinary share of one dollar in the taxpayer was allotted each to Mr. and Mrs. King. On the same day the taxpayer purchased from Mr. King 9,000 one per cent redeemable non-cumulative preference shares in King & Sons Pty. Ltd. for $18,000. No cash or cheque was given in payment, either for the allotment price of the two ordinary shares in the taxpayer, or for the preference shares in King & Sons Pty. Ltd. purchased by the taxpayer, but the taxpayer credited an account in its books in the name of John Arthur King with $18,000 and debited that account with two dollars, the allotment price of two ordinary shares. On 26th April 1969, at a meeting of King & Sons Pty. Ltd., it was resolved, inter alia, that a dividend of $1.20 be declared and paid on each of the 9,000 one per cent redeemable non-cumulative preference shares to absorb $10,800 of accumulated profits. On the same day a current account in the name of the taxpayer was opened in the books of King & Sons Pty. Ltd. and credited with $10,800 in respect of the dividend and an advance account in the name of King & Sons Pty. Ltd. was opened in the books of the taxpayer and debited with $10,800, being an amount equivalent to the dividend. No cash changed hands and no cheques were drawn. Similarly, in the second income year in question, it was resolved at a meeting of King & Sons Pty. Ltd. on 29th April 1970 that a dividend of twenty cents be declared and paid on each of the 9,000 one per cent redeemable non-cumulative preference shares to absorb $1,800 of accumulated profits and on the same day the taxpayer's current account in the books of King & Sons Pty. Ltd. was credited with $1,800 in respect of the dividend and the advance account in the name of King & Sons Pty. Ltd. in the books of the taxpayer was debited with $1,800. Again no cash changed hands and no cheques were drawn. The accounts of the taxpayer show that in the income years the taxpayer's income amounted to $10,800 and $1,800 respectively, which amounts are described as "Dividends ex King & Sons Pty. Ltd.", and that in those years the taxpayer incurred no expenditure and therefore made a profit of $10,800 and $1,800 respectively. (at p599)

5. The taxpayer has not at any time since its formation carried on any business. It has never operated on any bank account and has neither received nor paid any money. During the two tax years in question its only activities have been those already mentioned, and the performance of such duties as the lodgment of taxation and company returns. (at p600)

6. King & Sons Pty. Ltd. carries on the business of manufacturing radiators and of engineering. In each year since its incorporation it has made a profit. However, it has never in fact paid in cash any of the dividends which it has declared, and in the two years in question the total of the shareholders' current accounts with the company exceeded $100,000. The company has had problems of liquidity. From the date of incorporation of the taxpayer to the present time the liquidity position of King & Sons Pty. Ltd. has been such that it could not pay in cash dividends sufficient in amount to enable it to avoid Div. 7 tax and at the same time finance its manufacturing and trading operations under normal credit arrangements; on the other hand, if Div. 7 tax were payable, it could not pay that tax and also finance its manufacturing and trading operations under normal credit arrangements. These matters no doubt explain why it was decided to form the taxpayer. There is no prospect that the liquidity position of King & Sons Pty. Ltd. will materially improve. From the date on which the first dividend in favour of the taxpayer was declared until the present time King & Sons Pty. Ltd. has, because of its liquidity position, not been able to discharge its advance account in the books of the taxpayer by a payment in cash and there is no prospect that it will be able to do so. At no time since its formation has there been any prospect that the taxpayer would receive any sum in cash from King & Sons Pty. Ltd. or from any other source. These matters are, however, in the submission of the Commissioner, irrelevant to the determination of the questions now in issue. (at p600)

7. Section 103A (2) provides that, subject to certain other sub-sections which are immaterial, a company is a public company for relevant purposes in relation to the year of income if (inter alia):

"(c) the company has not, at any time since its formation,
been carried on for the purposes of profit or gain to its
individual members and was, at all times during the year of
income, prohibited by the terms of its constituent document
from making any distribution, whether in money, property
or otherwise, to its members or to relatives of its members."

The paragraph provides two conditions, both of which must be satisfied if it is to apply. The first condition relates to the purposes for which the company has been carried on and the second to the terms of the constituent document, which means in the present case the memorandum and articles of association (see s. 6 (1) of the Act, definition of "constituent document"). The effect of both of these conditions has recently been discussed by the Full Court in Federal Commissioner of Taxation v. Cappid Pty. Ltd. [1970] HCA 41; (1971) 127 CLR 140 . (at p601)

8. It is convenient first to consider whether the second of the prescribed conditions has been fulfilled. In Cappid's Case [1970] HCA 41; (1971) 127 CLR 140 the Court held, affirming on this point, Menzies J. (1971) 127 CLR, at p 148 , that the memorandum and articles of the taxpayer in that case satisfied the second condition of par. (c). Barwick C.J., with whom the other members of the Court agreed, said (1971) 127 CLR, at p 154 :

"It seems to me that it is sufficient that the constituent
document should by its terms express the requisite prohibition.
It is not necessary, in my opinion, that those terms should be
effective in fact and in law to prevent a distribution in breach
of them. The situation in point of fact is dealt with by the
first condition of the paragraph and in relation to a possibly
larger period of time than that with which the second condition
is concerned. The second condition is satisfied, in my opinion,
by the formality of the constituent. Therefore it
is nothing to the point in this case that the terms of the
constituent document which I have quoted would appear to be
unenforceable by any person."

The provisions of the memorandum and articles which were relevant in Cappid's Case are set out at (1971) 127 CLR, at pp 144-146, 151-152 . Clause 39 of the memorandum there provided as follows:

"The Company shall not be carried on for the purpose of
profit or gain to its individual members and is prohibited from
making any distribution whether in money property or otherwise
to its members or to relatives of its members."

That provision is indistinguishable in effect from the concluding words of cl. 2 (c) of the memorandum in the present case. However, other provisions of the memorandum and articles in Cappid's Case (1971) 127 CLR 140 created difficulties which had to be resolved as a matter of construction. Clause 23 of the 3rd Sch. to the Companies Act 1961 (Vict.) (which is in the same terms as cl. 23 of the 3rd Sch. to the Queensland Act) was not excluded but it was on the contrary provided in the memorandum that the powers set out in the 3rd Sch. were deemed to be main objects, so that cl. 23 was in effect incorporated in the memorandum. The articles began by expressing a prohibition against any distribution to members or relatives of members, but later articles relating to the reduction of capital and the distribution of assets in a winding-up cast some doubt on the absolute character of the earlier prohibition. In the present case, on the other hand, the articles do nothing but reinforce the prohibition which the memorandum contains. In Cappid's Case, Menzies J. held (1971) 127 CLR, at p 148 that the provisions of the memorandum and articles prohibiting the company from making any distribution to its members or to relatives of members were of overriding force and that the memorandum and articles therefore satisfied the requirements of the second condition of par. (c). The Full Court agreed with this conclusion. In the present case there is no problem of construction such as arose in Cappid's Case (1971) 127 CLR 140 and it follows from that decision, a fortiori, that the second condition of s. 103A (2) (c) is satisfied in the present case. (at p602)

9. On behalf of the Commissioner it was submitted that the decision of the Full Court in Cappid's Case (1971) 127 CLR 140 as to the second condition of par. (c) rested on a concession and was in any case given per incuriam. The Chief Justice, in that passage of his judgment which relates to the second condition and which I have already quoted, did not speak in the language of concession. He did not suggest that it was conceded that the second condition had been satisfied but stated his conclusions as to the effect of the condition and on the question whether it was satisfied in that case. However, in the submission of counsel for the Commissioner, it was erroneous to conclude that a memorandum and articles of association would satisfy the second condition of par. (c) simply because they contain a prohibition expressed in the words of that paragraph and the Court in Cappid's Case [1970] HCA 41; (1971) 127 CLR 140 overlooked that the word "relative" is given by s. 6 (1) of the Act a definition which gives it an extended meaning (including, for instance, adopted children and children of a spouse) which that word would not have when used in a memorandum and articles which do not contain a similar definition. Therefore, it was said, a prohibition contained in a memorandum and articles against a distribution to members or to relatives of members is not wide enough to satisfy s. 103A (2) (c), because such a prohibition may not extend to a distribution to persons who are not relatives in the ordinary sense, but are "relatives" within the definition in the Act. Reference was also made to the definition of "liquidator" in s. 6 (1) but that does not seem to me to advance the submission. I am not persuaded that this rather technical argument escaped consideration in Cappid's Case (1971) 127 CLR 140 simply because the court did not expressly refer to it and did not expressly discuss the effect of the definition of "relative" in s. 6 (1). In any case that definition is intended to have a restrictive, not an enlarging, effect (cf. Adelaide Motors Ltd. v. Federal Commissioner of Taxation [1942] HCA 25; (1942) 66 CLR 436, at p 444 ), and the word "relative", which has a very wide and indefinite meaning, is not narrower in scope in the context of the memorandum and articles than in s. 103A (2) (c). (at p603)

10. It was further submitted that the prohibition contained in the memorandum and articles was unreal, because if the only two shareholders, Mr. and Mrs. King, ignored its provisions, there would be no one else entitled to complain. It was said that a prohibition which is merely specious and lacking in reality is not enough to satisfy par. (c). and that the court in Cappid's Case (1971) 127 CLR, at p 154 was in error in saying that "it is nothing to the point ... that the terms of the constituent document ... would appear to be unenforceable by any person". This argument is quite unacceptable; it is opposed to the very basis of the decision in Cappid's Case (1971) 127 CLR 140 on this point. No doubt it would not be enough to satisfy the second condition of s. 103A (2) (c) that the memorandum and articles contained a prohibition in the terms of the paragraph if there were other provisions of the memorandum and articles which enabled that prohibition to be set at nought. That would be because the constituent document, properly construed, would not contain the requisite prohibition. In the present case, however, the terms of the memorandum and articles contain a complete and effective prohibition, and it is those terms which the paragraph requires must be regarded. It may be added that it is immaterial that the memorandum and articles, although perhaps difficult of alteration, are not unalterable, because at all times during the two years of income the prohibition in the memorandum and articles remained unaltered. (at p603)

11. For these reasons I hold that the condition contained in the second limb of par. (c) of s. 103A (2) is satisfied. It then becomes necessary to consider the effect of the first condition contained in the paragraph. It is established by Cappid's Case [1970] HCA 41; (1971) 127 CLR 140 that "the function of the word 'individual' in par. (c) is not to import the idea of 'personal' or 'beneficial' profit or gain. Its function ... is to exclude from the operation of the paragraph those incorporated companies and unincorporated associations ... which are carried on for the profit or gain of the membership as a whole and those which are carried on for the profit or gain of some specified person or body not being a member" (per Barwick C.J. (1971) 127 CLR, at p 153 ). It was further held in that case that in considering the application of the first limb of par. (c) the court is not "concerned with 'purposes' in the sense of the subjective intention of the shareholders or of those who caused the taxpayer to come into existence" but "with the objective conclusion to be drawn from the circumstances of the operation of the company" (per Barwick C.J. (1971) 127 CLR, at p 154 ). In that case the company had in fact been carrying on a business and had been earning and accumulating very considerable profits and it was held that there was no room to doubt that the company was carried on for the purposes of profit or gain. The further question that there arose, and that gave rise to the real dispute in the case, was for whose profit or gain the company had been carried on. The memorandum and articles there under consideration did not nominate any person or body as the person or body for whose benefit any profit or gain must enure, but, as Barwick C.J. pointed out (1971) 127 CLR, at p 155 , normally a "company which is trading for profit is carried on for the purposes of profit or gain to its individual members". It was held that it had not been established that the company had not been carried on since its incorporation for the purposes of profit or gain to its individual members, and in this regard it was mentioned (1971) 127 CLR, at p 155 that "whenever any distribution of the profits or gains of the taxpayer takes place it must be either to or upon the order of the shareholders". Similar reasoning would lead to the conclusion that if it is right to hold that the taxpayer in the present case has been carried on for the purposes of profit or gain, it should also be held that it was carried on for the purposes of profit or gain to its individual members. The articles here differ in some respects from those considered in Cappid's Case (1971) 127 CLR, at pp 144-146 , but it remains true to say that no one is nominated as the person for whose benefit any profit or gain must be paid or made available, and that if a distribution of profits or gains were to take place upon a winding-up it would be within the power of the shareholders to direct the application of those profits or gains for their own benefit (e.g., to a company formed in their interests) even though they themselves could not directly participate in the distribution (see art. 74). The crucial question in the case then becomes whether the taxpayer was carried on for the purposes of profit or gain. (at p604)

12. The present case is distinguishable from Cappid's Case (1971) 127 CLR 140 in that the taxpayer here has conducted no business and received no money. It then becomes necessary to consider the circumstances of the operation of the taxpayer, with a view to drawing an objective conclusion as to the purposes for which it was carried on. It of course follows from Cappid's Case (1971) 127 CLR 140 that it is not permissible to consider the subjective purpose of those who brought about the formation of the taxpayer - the purpose of enabling King & Sons Pty. Ltd. to find a way of escape from the incidence of Div. 7 tax. (at p605)

13. The taxpayer has described itself as an investment company. It has bought shares on which dividends have been declared. Although those dividends have not been paid, they are debts due from King & Sons Pty. Ltd. to the taxpayer for which the taxpayer is entitled to sue (In re Severn and Wye and Severn Bridge Railway Co. (1896) 1 Ch 559 ). The taxpayer in its accounts has treated the amount of those dividends as profits. All these circumstances support the conclusion that the taxpayer has been carried on for the purpose of profit or gain. (at p605)

14. On the other hand, King & Sons Pty. Ltd. has never paid in cash any dividend it has declared. Its liquidity position has been such that it could not at any time since the first dividend was declared discharge its advance account in the books of the taxpayer by a payment of cash and there is no prospect that its liquidity position will be such that it will be able to do so; there has never been any prospect that the taxpayer would receive any sum in cash from King & Sons Pty. Ltd. or any other source. These facts in my opinion are relevant; they are part of the circumstances of the operation of the taxpayer which must form the basis of an objective conclusion as to the taxpayer's purposes. They lead to the conclusion that the taxpayer had no expectation of receiving payment of the dividends. No doubt, in theory, the taxpayer could force a winding-up of King & Sons Pty. Ltd., and on a winding-up might receive payment in respect of the dividends in whole or in part, but it cannot be inferred that the taxpayer has ever had any intention to bring about a winding-up. Any inference would be to the contrary. The conclusion from these facts is that the taxpayer was carried on for the purpose of being credited with dividends which there was no prospect would be paid. It gained rights which it had no intention to enforce. It never had the purpose of receiving any cash as the result of its activities. (at p605)

15. The phrase "profit or gain" is a familiar one although it is not easy to give it a precise definition. There seems no reason, in the context of s. 103A (2) (c), to give it the meaning of taxable profit or gain. The taxpayer earned assessable income within the meaning of the Act, since the dividends credited to it must be treated as dividends paid (see definition of "paid" in s. 6 (1)) and therefore as assessable income under s. 44 (1) of the Act. However, the statutory provisions directed to determining what is assessable income do not assist in deciding whether a company has been carried on for the purposes of profit or gain within s. 103A (2) (c). (at p606)

16. In my judgment, just as income may, according to ordinary business concepts, be regarded as derived when it is earned and before it had been received (as the discussion in Henderson v. Federal Commissioner of Taxation (1970) 119 CLR 612 and J. Rowe & Son Pty. Ltd. v. Federal Commissioner of Taxation [1971] HCA 80; (1971) 124 CLR 421 shows) so in appropriate circumstances the accrual of a valuable right may be taken into account in computing a profit or gain although nothing has yet been received in satisfaction of the right. It has not been established that the taxpayer's right to be paid the dividends would not be of value if the taxpayer chose to enforce it. The most that has been shown is that there is no prospect that the taxpayer will be paid in cash the amount of the dividends. However, a right does not cease to be of value simply because it is not enforced, subject of course to the effect of any statute of limitations. The facts therefore show that the taxpayer has been carried on for the purpose of holding shares on which dividends have been declared, and for the purpose of having the amount of the dividends credited to its account. It has thus acquired a right - the debt constituted by the dividends owing - which has not been shown to be valueless. In these circumstances it seems to me that it ought to be held that the taxpayer has been carried on for the purposes of profit or gain, since the acquisition of the right to be paid the amount of the dividends must be accounted a pecuniary gain. (at p606)

17. I should perhaps notice some contentions of the Commissioner that I feel bound to reject, notwithstanding that I have formed the view that he ought to succeed on this appeal. It was submitted that there were three further reasons - two of them applicable only to the first income year - for holding that the taxpayer had been carried on for the purposes of profit or gain to its individual members. It was said first that the taxpayer had made an allotment of shares for which the allottees paid nothing and that this was a financial gain to the shareholders. Of course the allotment price remains owing, but in any case it is impossible to hold that the taxpayer was carried on for the purpose of making an allotment of its shares. Then it was said that John Arthur King had used the taxpayer as a puppet to purchase his shares in King & Sons Pty. Ltd. at a price which he nominated and that this was a gain to him as a shareholder in the taxpayer. There is no evidence that the shares were sold at an under-value, but if Mr. King did derive any profit or gain from that transaction he did so as vendor to the taxpayer and not as a shareholder in the taxpayer. Finally it was said that when King & Sons Pty. Ltd. passed a resolution that a dividend be paid on the shares held by the taxpayer and the dividend was not in fact paid, a financial gain resulted to King & Sons Pty. Ltd. and that this entailed an indirect financial gain to the shareholders in King & Sons Pty. Ltd., two of whom are shareholders in the taxpayer. An indirect benefit of that kind cannot, in my opinion, be regarded as a profit or gain to the members of the taxpayer. (at p607)

18. For the reasons given I consider that the facts of the case, viewed objectively, lead to the conclusion that the taxpayer was carried on for the purposes of profit or gain, notwithstanding that the subjective intention of those who formed the company was solely to gain a tax advantage, and that it should further be concluded that the taxpayer was carried on for the purposes of profit or gain to its individual members. Although the second condition of s. 103A (2) (c) is satisfied the first is not, and the taxpayer was rightly treated as a private company. (at p607)

19. I dismiss the appeals. (at p607)

ORDER

Appeals dismissed with costs.

Usual order as to exhibits.