Federal Commissioner of Taxation v Bidencope [1978] HCA 23; (1978) 140 CLR 533 (14 June 1978)

HIGH COURT OF AUSTRALIA

FEDERAL COMMISSIONER OF TAXATION v. BIDENCOPE [1978] HCA 23; (1978) 140 CLR 533

Income Tax (Cth)

High Court of Australia
Barwick C.J.(1), Gibbs(2), Mason(3), Jacobs(4) and Aickin(5) JJ.

CATCHWORDS

Income Tax (Cth) - Assessable income - Profit-making undertaking or scheme - Purchase of majority interest in company with previous years' losses - Assignment of debts to new shareholders - No commercial purpose - Payment - Amount received exceeding consideration paid to original creditors for assignment - Whether excess assessable income - Income Tax Assessment Act 1936 (Cth), ss. 26, 26 (a).

HEARING

Hobart, 1978, February 7, 8.
Sydney, 1978, June 14 14:6:1978
APPEAL from the Supreme Court of Tasmania.

DECISION

June 14.
The following written judgments were delivered: -
BARWICK C.J. The taxpayer had been possessed of an area of land in Tasmania money in order to place it in a condition for such sale. He was unable or, at any rate, unwilling to undertake on his sole account the expenditure of this money. Consequently, he sought to interest two others in the venture. (at p536)

2. He engaged an accountant to make the necessary arrangements for him to carry out the subdivision in company with the two others, instructing the accountant that he wished to make as much out of the project as he could, paying as little tax as could legally be achieved. It would appear that he knew nothing of the available techniques to achieve his purpose and that he relied implicitly on what his accountant chose to do for him and his co-adventurers. (at p536)

3. The accountant decided that the best method of carrying out his client's wishes was to purchase one or more "loss companies" and to transfer the land in the first place into the name of such a company and later to transfer the then unsold residue of it to another such company, the taxpayer and the two others becoming shareholders in the companies in appropriate proportions. The "loss company" to be brought in each case had creditors: so the accountant arranged that the debts of each company should be sold by the creditors to the taxpayer as a means of protecting the taxpayer and his two associates as majority shareholders against demands by the minority shareholders in the company. (at p537)

4. Some two years prior to the accountant effecting these arrangements he had attended an accountancy seminar at which he had asked a person there, then a counsel of distinction, whether a person who acquired the debts of a company acquired as a "loss company" would be liable to tax in respect of amounts which he received from the company in satisfaction of the debts in excess of the amount which he had paid for their transfer to him. The evidence does not vouchsafe the terms of the wise counsel then given him but the accountant seems to have gathered the impression that the increase in the cash value of the debts would simply be "fructification". Although not obtained in connexion with the transaction here in question, no doubt this piece of useful information was present to the mind of the accountant when he arranged for the taxpayer to purchase the debts of the loss company being acquired. At the least, that knowledge, sketchy though it might be, removed any hesitation the accountant might otherwise have had in arranging for the transfer of the debts to the taxpayer. (at p537)

5. The land, having been transferred to one of the "loss companies", was in part sold by it in subdivision: a sufficient profit was realized to absorb the tax deductible losses of the company and to pay its debts. The balance of the land was then sold to another "loss company". That company sold subdivided land at a profit which absorbed its tax deductible losses. There were further transactions with the remainder of the land with which we are not presently concerned. (at p537)

6. The Commissioner of Taxation included in the taxpayer's assessable income the difference between the amount paid by the companies to him in satisfaction of the debts due by each respectively and the amounts which he had paid to the creditors of the respective companies for the transfer of the debts. The taxpayer objected to the resultant assessment: his objection was disallowed. It was referred, at his request, to the Supreme Court of Tasmania. The Supreme Court (Nettlefold J.) allowed his appeal and set aside the assessment (1977) 7 ATR 124; 77 ATC 4015 . The Court held that the transaction with the debts was no more than an incident of the acquisition of the "loss companies" and that the latter were acquired solely for the purpose of protecting the shareholders in the "loss companies" from possible demands of the minority shareholders to participate in the profits which might accrue from the sale of the taxpayer's land which had been transferred to those companies after the taxpayer and his associates had acquired their shares in the companies. (at p538)

7. The Commissioner of Taxation has appealed to this Court, contending that the assessment was correct. The basis on which the Commissioner so submits is that the acquisition of the debts was part of the entire "scheme", as counsel calls the plan to acquire each of the "loss companies", which it is claimed was in each case a profit-making undertaking or scheme within the meaning of s. 26 (a) of the Income Tax Assessment Act 1936 (Cth), as amended ("the Act"). Consequently, it was said that the "profit" arising from carrying out the scheme involving the payment in full of the debts was assessable income. As an alternative ground, the Commissioner says that, in any case, the gain made by the taxpayer out of the acquisition of the debts was income according to ordinary concepts and within s. 25 of the Act. (at p538)

8. Before considering the meaning of s. 26 (a) in relation to this case, it is as well to point out that, assuming that the taxpayer is to be identified with all the motives, knowledge and intentions of his accountant - a proposition the correctness of which I do not find it necessary for present purposes to examine - there was no evidence whatever that it had been decided - and particularly by or on behalf of the taxpayer - at the time that the arrangements were made for the purchase of either "loss company" and for the transfer of its debts, that the debts would at any time necessarily be paid in full. It is perhaps also worth remarking that it was never put to the accountant who gave evidence before the Supreme Court that that was his intention. There is nothing in the evidence, certainly nothing in the findings of the Supreme Court, to suggest that at the inception of the arrangements for the acquisition of the "loss companies" and the transfer of the land, there had been any decision as to the manner in which the affairs of any of the companies should be conducted if and when sufficient profit had been made to absorb the tax deductible losses. Those familiar with the various modes of extracting from a company profits it has made will readily recognize the various courses open to the company and its shareholders when the company had exhausted the advantages of the tax deductible losses by the making of profit. A company with a creditor who was a majority shareholder or one of the majority shareholders would not necessarily pay the amount of the debts due. Having exhausted the benefit of the tax deductible losses, the shareholders might well sell their shares at a premium reflecting the accrued profit. As part of the sale of the shares the shareholder having the benefit of the debts might agree to release them. Indeed, his fellow shareholders might be unwilling that he alone should gain by payment of the debts. They might rather insist that the entire gain from the venture should be shared in proportion to their shareholding. Or, having control of other companies, the shareholders might prefer to transfer their shares to another company and pay a dividend to the other company to be dealt with in that company in some fashion to their advantage. No doubt there are other possibilities in the situation. The matter I want particularly to emphasize is that the payment of the debts in full is not shown in the evidence of this case to be an actual, nor a necessary, part of any arrangement made at the time of the acquisition of the losses or at any other time. If it matters, it was not shown to have been intended by the taxpayer or the accountant. (at p539)

9. It is said that, because as things turned out the debts were paid in full, an inference should be drawn that their payment in full was part of the initial arrangements. For my part, I would refuse to draw any such inference for it does not at all logically follow. Also I have mentioned practical considerations which would deny the propriety of making any such inference. In addition, as I have mentioned, the matter was not investigated before the trial judge, nor was the point put to the accountant when he was giving evidence and available expressly to state what, as far as he was concerned, were his own intentions. Further, if the "scheme" is that of all three shareholders, there clearly was no shred of evidence that all three had decided, as part of the acquisition of the "loss companies", upon the payment in full of the company debts. (at p539)

10. I turn then to the application of s. 26 (a). (at p539)

11. In Steinberg v. Federal Commissioner of Taxation (1975) 134 CLR 640 I sought to give to the second limb of s. 26 (a) some content on the assumption that, upon its proper construction, it was not merely tautological and repetitive of some aspects of s. 25. I did so also on the view that, as pointed out by the Privy Council in McClelland v. Federal Commissioner of Taxation [1970] HCA 39; (1970) 120 CLR 487 s. 26 (a) as a whole contemplates that a transaction to fall within its scope will be a business, i.e. some trading transaction. (at p539)

12. If a taxpayer in the course of the conduct of a business makes profit it is income within s. 25. Whether what he is doing constitutes a business would in general be determined at least in part by its repetitive nature: but not necessarily so. There are other circumstances, as the decisions would evidence, in which lack of repetitive activity has not denied the business nature of what has been done so as to make its product income. (at p540)

13. These considerations have led me to think that the second limb of s. 26 (a) is directed to the use of an asset, not being itself acquired for profit-making by resale, as an element in an undertaking of a business nature. The use of the description "profit-making" indicates the trading nature of the activity. The language of the provision is anything but clear and the concepts which prompted it perhaps not fully defined in the mind of the draftsman. I have regarded s. 26 (a) as a whole as an endeavour to bring into assessment gains which were not in themselves income according to ordinary concepts or according to any other statutory provision. The aim seems to be to treat a capital gain in a single transaction as assessable income because of the trading nature of the transaction which has produced it. The description of the circumstances in which this may take place under the second limb is, as I have indicated, far from clear. The tendency of my mind is to think that the application of that part of the section to a transaction which does not fall within the first limb must of necessity in practice be rare. If the view of the section which I have expressed be accepted, it then seems to me that to bring a gain within the scope of s. 26 (a) it must have been gain made in a profit-making activity, using the word "profit" in the restricted sense it has in business, i.e. as the product of trading. Of course, this has been demonstrated now to be true of the first limb. It is the use of the capital asset as the means of profit-making by resale which makes the gain thus made income rather than a mere capital gain. So, also, in the case of the second limb, I think that the undertaking must be of its nature a trading activity so that the gain, though otherwise of a capital nature, is to be treated as income. (at p540)

14. The description of a scheme as a plan or concerted action is facile enough in expression but it seems to me most difficult in application. The argument in the present case is illustrative. If a taxpayer, for reasons of his own, were to purchase at a discount a debt due by another who at the time looked unlikely to be able to pay it, but doing so in the firm expectation that in course of time the debtor might be able to pay in full, the gain made on such payment could scarcely be said to constitute income. Nor could it be said, in my opinion, that the decision to buy and the expectation of ultimate payment was a scheme, plan or undertaking. It would be what it purported to be - a straightout purchase with a view to ultimate gain by realization in due course of the value of the asset: in other words, an investment. It has none of those indicia which would make what was done a business or profit-making undertaking in the proper sense of that description. Of course, the purchase of debts repetitively in the course of a business of doing so would be in a different case. (at p541)

15. If XCO Pty. Ltd. v. Federal Commissioner of Taxation [1971] HCA 37; (1971) 124 CLR 343 purports to decide that a single transaction of purchase of a debt for a price less that its amount constitutes a scheme or plan of a profit-making nature, I must say that I could not agree with its conclusion. In that case, a company formed for that purpose took assignments of the debts of a "loss company". The sole purpose of the formation and of the assignments was to protect the majority shareholders of the loss company (the promoters of the taxpayer) from possible participation by minority shareholders in the benefit of the purchase by the majority shareholders of the loss company and of the injection into that company of the capacity to make profits. This Court (Gibbs J.) accepted the witness who so deposed. But the Court thought that, although not originally intended, a purpose behind the formation of the company and the assignments was ultimate satisfaction in full of the assigned debts. (at p541)

16. The company was the taxpayer. But the Court found that the company was participating in the scheme of its promoters which included the purchase of a "loss company". Accordingly, it was concluded, as I understand the judgment, that the entire scheme (i.e. of the promoters of the taxpayer) represented a business deal and the excess of the amount paid in satisfaction of the debts in excess of the purchase price of their assignment was within the second limb of s. 26 (a). I regret to say I am unable to agree with that conclusion. I would have thought that the taxpayer company could scarce have been a party to a scheme which must have antedated its formation. For the relevant scheme to have been that of the taxpayer company, surely it must have had its origin after the company came into being. I do not understand how the taxpayer company could be infected by the scheme of its promoters, which incidentally could scarce be called a profit-making scheme by and for themselves. It was a scheme to reduce the amount of tax which might have been payable if the profit made by the loss company had been made in some manner other than that which in fact occurred. That, though a matter of business, is not, in my opinion, a profit-making scheme. (at p541)

17. I do not regard this case as having decided that the purchase of the debts by the taxpayer company was in itself a scheme, or a profit-making scheme. It only became such in the Court's view by the addition to that purchase of the activities of the taxpayer company promoters. As I have indicated, if I am in error in this interpretation of the judgment, I cannot agree with that aspect of it. (at p542)

18. Now, in the present case, it may be conceded that the accountant had a plan. Actually it was a plan for all the shareholders who took up shares in the "loss company", including the taxpayer. All three shareholders had an interest to ensure, if they could, that the other shareholders did not have access to the profits which were made by the company through the assets which had come to the company at the instance of the shareholders. They were also interested, all three, to see that the creditors of the company did not get access to those profits by means of insistence on the payment of their debts. Thus, it might be said that the three shareholders included in their plan of acquisition of the "loss companies" and the transfer of the land, the transfer of the debts to one of their number as a means of protecting themselves against creditors and against other shareholders. There was, in fact, as I have already pointed out, no evidence of any agreement between the three shareholders that the taxpayer would not share with them any benefit obtained from the purchase of the debts. The truth probably is that neither the accountant nor any shareholder put his mind definitively to the question of the future of the debts. (at p542)

19. Further, it could scarcely be said with reason that it was a plan of the three shareholders that they should make profits by the acquisition of the debts. If they had all participated in the benefit of the payment of the debts, it would merely have meant that the company had made that much less profit from the land sales; or, in practical rather than technically accurate terms, they had taken their profit from the entire transaction, including the purchase of the "loss company" in two parts. Nor could it be said that any of the companies, which were quite distinct from the shareholders, was going to make any profit by the purchase of the debts. (at p542)

20. I find it quite impossible to describe the arrangements made by the three shareholders to acquire the "loss companies", including, if you will, the transfer of the debts to the taxpayer, as of its nature a profit-making undertaking or scheme. To obtain control of the companies did not produce profit. It produced a tax advantage which was not in itself a profit. Profits that the companies were to make were exclusively derived not from any arrangements made by the three shareholders to acquire the "loss companies", but by the acceptance by the respective companies of the transfer of land and by its exploitation in subdivision. (at p543)

21. It seems to me that when an attempt is made to utilize the second limb of s. 26 (a), a very close examination is required of the facts and a very clear analysis of their significance. It would be unsatisfactory to resort to the description of "scheme, plan or undertaking" on insufficient examination and analysis. It is quite clear that to come within the second limb of s. 26 (a), the scheme or undertaking must be the taxpayer's scheme. Here, the only activity on the part of the taxpayer alone was, on the one hand, to become a shareholder of each company, to transfer his land to the company and, on the other hand, to accept a transfer of the debts for a price which he paid. It seems to me not proper to regard the purchase of the "loss companies" as solely his plan or undertaking, or part of his plan or undertaking. It was, as I have said, an arrangement made for and thus by all three shareholders. (at p543)

22. The finding of the trial judge that the debts were purchased solely for the purpose of protecting the shareholders from the creditors and other shareholders in the acquired companies seems to me to negative any possibility that the acquisition of the debts was by way of a separate business transaction on the part of the taxpayer. If it were only incidental to the acquisition of the shares in the "loss companies", and if that acquisition amounted to a scheme, it was not the taxpayer's scheme. (at p543)

23. In this connexion it is perhaps worth pointing out that had the taxpayer been willing to undertake the entire cost of preparing the land for subdivision, the result of the sales of that land would not have brought him assessable income. When he transferred the land to the companies in exchange for a price he thereby gave to the companies the means of making profit which, through shareholding, would inure not solely for himself but for his two associates as well. Looking at the matter overall, he did not in reality gain anything by the fact that the companies could resort to the tax deductible losses, though his two associates did. (at p543)

24. Thus, for a variety of reasons, I would dismiss the appeal. In the first place, I do not see in the evidence any scheme or undertaking of a profit-making nature which was the taxpayer's scheme or undertaking. I do not see that the payment of the debts in full was part of any plan or arrangement. Also, I do not see that the arrangement made for the three shareholders to purchase the "loss companies" and the acquisition of the debts regarded as an entirety, was itself a profit-making scheme or undertaking. (at p544)

25. So far as the taxpayer is concerned, I do not see that, on balance, if one takes into account his prior situation, the taxpayer in fact profited by the elaboration of transferring the land to the companies in the circumstances, except that this course enabled him to attract capital from two associates so as to minimize his own capital outlay in the preparation of the land for subdivision. Other reasons apart, it would indeed be odd in these circumstances that he should be assessed to tax on the realization of the value of the debts transferred to him. (at p544)

26. Consequently, I would dismiss the appeal. (at p544)

GIBBS J. This is an appeal brought by the Commissioner of Taxation from a decision of the Supreme Court of Tasmania (Nettlefold J.) allowing appeals by the taxpayer, Mr. Bidencope, against assessments to income tax. The present appeal, which is against part only of the decision, relates to the years of income which ended respectively on 30th June 1966, 30th June 1967 and 30th June 1968. The question for decision is whether sums received by the taxpayer in those years in payment of debts of which he had become an assignee, less the amounts which he had paid to acquire his interest in the debts, formed part of his assessable income. (at p544)

2. The facts of the case are not in dispute. In 1964 the taxpayer was the owner of land in Tasmania which he wished to subdivide and sell at a profit. Although it does not matter, the land had not been acquired by him for the purpose of profit-making by sale. The taxpayer, thinking that the costs of the proposed subdivision might be considerable, and more than he wished to commit himself to, decided to invite two others, Messrs. A. B. Moore and T. K. Shadforth, to join him in the venture. The form of the arrangements which were made was suggested by Mr. Geary, an accountant whom the taxpayer consulted. It was decided that the land should be sold to a company which the three men would control, and that the company should be one which had incurred losses which, under s. 80 of the Income Tax Assessment Act 1936 (Cth), as amended ("the Act"), would be available as deductions from any profit that might result from the subdivision and sale of the land. In May 1964 the taxpayer and Messrs. Moore and Shadforth each bought two shares in Denis Lewis Pty. Ltd., a company whose name was thereupon changed to Denland Development Pty. Ltd. ("Denland"), a company which had accumulated losses of over $17,000. The consideration paid for each share was $2, and the shareholding thus acquired represented 75 per cent of the total shareholding. There remained unacquired two shares which were held respectively by Mr. and Mrs. Lewis, the original shareholders in the company. At about the same time the taxpayer and Messrs. Moore and Shadforth took an assignment of all the debts owed by the company to its creditors. The consideration for the assignment was $2,588 and the total amount of the debts assigned was shown in the schedule to the agreement of assignment as $17,504. Somewhat oddly there were added to the typewritten schedule of creditors, below the total just mentioned, the names of Mr. and Mrs. Lewis and the amount of debts said to be owing to them ($1,023 and $371 respectively), notwithstanding that the agreement recited (correctly as the evidence shows) that Mr. and Mrs. Lewis had given an absolute release of all their claims against the company. In about September 1964 an agreement by the taxpayer to sell to Denland the land in question was completed. Thereafter Denland commenced to subdivide and sell the land. (at p545)

3. In December 1964 the taxpayer and Messrs. Moore and Shadforth acquired 55 per cent of the shares in Bathurst Motors Pty. Ltd. (which later changed its name to Bathurst Finance Pty. Ltd.) ("Bathurst"), another company which had accumulated losses. They also took an assignment of all the debts owed by Bathurst, which were shown as amounting in all to $13,908, although that total included debts owed to Mr. and Mrs. Fitzgerald, the original shareholders of Bathurst, notwithstanding that the assignment recited that they had released all their claims against the company. The consideration for the assignment was $3,162. Also in December 1964 the directors of Bathurst offered to buy from Denland twenty blocks of the subdivided land owned by the latter company, and this offer was accepted. This sale was completed in March 1965 and Bathurst thereupon proceeded to arrange for the sale of the land thus purchased. (at p545)

4. Subsequently, the taxpayer and Messrs. Moore and Shadforth took part in the acquisition of shares in another loss company, R. Evans and Co. Pty. Ltd., but the activities of that company are not relevant to this appeal. (at p545)

5. By 30th June 1965 Denland had made a profit greater than the amount of the accumulated losses. On 13th August 1965 the outstanding two shares of Mr. and Mrs. Lewis were acquired by the taxpayer and Messrs. Moore and Shadforth, and on the same day it was resolved by the directors of Denland "that surplus cash funds be repaid proportionately to the contributing creditors of the company". A payment was then made to the taxpayer and to Messrs. Moore and Shadforth on account of the debts that had been assigned to them. Further such payments were made or credited to them on 30th June 1967 and 1st September 1967. The company first declared a dividend on 29th April 1966. (at p546)

6. Bathurst also immediately commenced to make profits; in each of the years 1965, 1966, 1967 and 1968 a net profit was shown, but it was not until the last of those income years that the accumulated losses were fully recouped. The company first paid a dividend in the year ended 30th June 1969 and in that year the outstanding shares (which were held by one of the original shareholders, Mr. Fitzgerald) were purchased by the taxpayer and Messrs. Moore and Shadforth and two other associates of the taxpayer. In the meantime, however, on 13th August 1965 and 14th December 1966 repayments were made to the taxpayer and to Messrs. Moore and Shadforth in respect of the debts that had been assigned to them. The balance left owing was then only $81.19, and that was repaid on 1st July 1967. (at p546)

7. The taxpayer, at the time when he entered into these transactions, had only a general idea of the effect of acquiring shares in a loss company for tax purposes. He did not understand that part of the operation involved taking an assignment of the debts due by the company to its creditors and he did not understand how a taxable profit could be made from taking such an assignment. He relied on the advice of Mr. Geary, his accountant. Mr. Geary had not previously taken part in the operations of a loss company, but he had a theoretical knowledge of the manner in which such a company was operated. He knew that it involved an assignment of the debts owed by the company. He said that it was necessary for the persons acquiring shares in a loss company to protect themselves against claims that might be made by the creditors of the company by taking an assignment of the debts owed by the company. He knew that if the company traded profitably its debts, although valueless at the time of their acquisition, would prove to be worth their nominal value, and he believed that the surplus or gain that would result to the persons taking the assignment would not be liable for income tax. (at p546)

8. The Commissioner has assessed the taxpayer to tax on the footing that the amounts received by or credited to him by way of realization of the purchased debts were assessable income. He has accordingly included in the income of the taxpayer for the years 1966, 1967 and 1968 the respective sums of $3,006, $1,150 and $4,086 which are arrived at after giving credit for the amounts paid by the taxpayer as his share of the consideration payable for the assignments of the debts. The calculations are not in dispute and we are not concerned with the correctness of the figures adopted. What is in issue is whether any amount is taxable. (at p547)

9. The main contention on behalf of the Commissioner was that the proceeds of realization of the debts constituted "profit arising . . . from the carrying on or carrying out of any profit-making undertaking or scheme" within the meaning of the second limb of s. 26 (a) of the Act. Alternatively it was contended that they were income within ordinary concepts, and so within s. 25 (1). (at p547)

10. In XCO Pty. Ltd. v. Federal Commissioner of Taxation (1971) 124 CLR, at p 349 , I expressed the effect of some of the authorities which have explained the meaning of the second limb of s. 26 (a) as follows:
"The word 'scheme' simply means plan, design or programme of action . . . It is not necessary, to constitute a scheme within s. 26 (a), that the action planned should involve a series or repetition of acts. 'The alternative "carrying on or carrying out" appears to cover, on the one hand, the habitual pursuit of a course of conduct, and, on the other, the carrying into execution of a plan or venture which does not involve repetition or system' . . . The scheme must, however, be one which is carried out by the taxpayer himself or on his behalf; it is not enough that the taxpayer derives a receipt from somebody else who has obtained it by carrying out a scheme of profit-making . . . "
I do not understand the correctness of that statement to be disputed. (at p547)

11. I do not doubt that the taxpayer carried out a scheme from which there arose the realizations which the Commissioner now seeks to treat as assessable income. The taxpayer was party to a concerted plan to acquire the requisite number of shares in the loss companies, to take an assignment of the debts owed by those companies for a consideration much less than their face value, to cause the companies to make profits and to repay the assigned debts out of profits if and when they were made. It may be accepted that the taxpayer himself was not aware, when he embarked on the scheme, of the significance of the assignment of the debts, and that he did not consciously advert to the possibility that he would make a profit from their repayment, but it is clear that he acted in accordance with Mr. Geary's advice, and Mr. Geary's intentions must be imputed to him. The conclusion which ought to be drawn from Mr. Geary's evidence, that from the beginning it was intended that the assigned debts should be paid out of any profits that the companies might make, is supported by what actually occurred; the debts were in fact promptly paid out of profits, and there is not the least suggestion that this was done other than in pursuance of the original plan. The benefit which the taxpayer received when he was paid his share of the debts which had been assigned to him was not accidental but part of the original design. (at p548)

12. It then becomes necessary to decide whether the scheme was a profit-making scheme within the meaning of the section and whether the net amount received by the taxpayer when the debts were paid was a profit arising from that scheme. The two questions are related, but it is convenient first to consider whether the net amount realized on the payment of the debts was a profit. In Federal Commissioner of Taxation v. Becker [1952] HCA 77; (1952) 87 CLR 456, at p 467 , Kitto J. said:
"Whether a given amount is to be characterized as a profit within the meaning of the provision is a question of the application of a business conception to the facts of the case. This does not mean that formal steps that have been taken are to be ignored on the ground that the same result might have been achieved in another way; but it does mean that, however many and complicated the steps employed may have been, a profit is not found to have arisen until there has been deducted from the ultimate sum received the amount or value of all that in fact it has cost the recipient to obtain that ultimate sum."
In the present case the taxpayer outlaid a small sum to obtain an interest in the debts, and, as he had intended, received a larger sum when the debts were paid. The excess represented a profit in the ordinary sense of the word. It was said in argument that no profit had arisen, because all that had taken place was a fructification of his interest in the debts. An analysis of the facts of the case is not greatly assisted by shrouding them in metaphor, but in any case the use of this metaphor is not very helpful to the taxpayer's argument, because if capital "fructifies and produces income, as it may, the income is still income": Joshua Bros. Pty. Ltd. v. Federal Commissioner of Taxation, per Isaacs J. [1923] HCA 3; (1923) 31 CLR 490, at p 497 . Nor does it seem to me to be relevant that the profits made by the companies as a result of the dealings in the land might have been channelled to the taxpayer in other ways, e.g., by the declaration of dividends or by putting the companies into liquidation. In fact the taxpayer acquired an interest in the debts by paying very much less than their face value, and the debts were repaid at their face value, thus yielding the taxpayer a profit. (at p549)

13. However in the course of argument it was suggested that in deciding what it cost the taxpayer to obtain what he received when the debts were repaid, it is necessary to take into account that the taxpayer provided the land which, when subdivided, produced the profits for the companies and also that he bought the shares whose value may have been reduced when the companies paid the debts. I do not understand these arguments to be covered by the taxpayer's notice of objection, or to have been relied upon in the Supreme Court, but there are in any case a number of answers to them. In the first place, the taxpayer, upon whom the onus lay of showing that the assessments were excessive, produced no evidence to show that he sold the land to Denland at an undervalue. The fact that the sale of the land produced a profit to the companies did not show that it was worth more at the time when Denland bought it than was paid for it, because at the time of the sale it was intended that it should be developed in subdivision at a cost which the taxpayer did not wish to bear himself. In this respect the case is distinguishable from Federal Commissioner of Taxation v. Becker [1951] HCA 53; [1952] HCA 77; (1952) 87 CLR 456 . In that case the taxpayer, to escape the operation of provisions of the law then in force controlling the price of land, sold to a company which he had formed land, which he believed to be worth $12,000, for a price of $8,000 under a contract which provided that the price was to be satisfied by the issue of shares in the company. At about the same time the taxpayer agreed to sell the shares for $12,000. It was held that the value of the land at all material times was $12,000 and that there was no profit either from the sale of the land or from the sale of the shares. In the present case however it may be inferred - or at least the taxpayer has not disproved - that the land increased in value by reason of the expenditure of money and energy in developing it in subdivision after the taxpayer sold it. So far as the shares were concerned the cost to the taxpayer was merely nominal - that was proved in relation to the shares in Denland and it seems a fair inference that the same was true of the amount paid for the shares in Bathurst - at least the contrary was not established by the evidence. Moreover the value of the shares was not diminished when the company paid the debts, because the liability to pay the debts was subsisting and had to be taken into account in valuing the shares. For reasons which I am about to give it is unnecessary to consider whether that statement needs qualification to the extent to which those debts which had been released by the original creditors were included in the payment; no argument was directed to that question, and it would in any case have only a small effect on the result. (at p550)

14. However there is a more basic reason why no account should be taken of the value of the land or of the shares in the calculation of the profit made by the taxpayer. A profit-making scheme may be complex, and may involve activities other than those designed to produce a profit to the taxpayer. In determing what profit to the taxpayer has arisen from the carrying out of the scheme it is necessary to set off against the amount received by the taxpayer what it cost him to obtain that amount, but it is not necessary to take into account other amounts expended by the taxpayer, or losses suffered by him, if those things from a practical point of view cannot be regarded as the cost of obtaining the amount received. When the transactions in the present case are analysed it is not right to say that from a practical point of view the cost to the taxpayer of obtaining the amounts which he received when the debts were repaid included any sum representing part of the value of the land which he sold to Denland or any amount which he paid for the shares or any diminution in the value of the shares. To get his interest in the debts, he had to pay his share of the consideration stipulated in the agreements providing for the assignment of the debts, and nothing more. The amounts he received when the debts were paid, less the amounts which he paid under the agreements in order to obtain his interest in the debts, was a profit. (at p550)

15. In my opinion it is not necessary to inquire whether the profit made by the taxpayer was income within ordinary concepts. In the judgment of the majority of the Judicial Committee in McClelland v. Federal Commissioner of Taxation (1970) 120 CLR 487, at p 495 it was said:
"The undertaking or scheme, if it is to fall within s. 26 (a), must be a scheme producing assessable income, not a capital gain. What criterion is to be applied to determine whether a single transaction produces assessable income rather than a capital accretion? It seems to their Lordships that an 'undertaking or scheme' to produce this result must - at any rate where the transaction is one of acquisition and resale - exhibit features which give it the character of a business deal."
Later, their Lordships said (1970) 120 CLR, at pp 495-496 :
"The final contention of the respondent is that the profit which arose to the appellant is income according to ordinary concepts, since it arose from an adventure in the nature of trade. Whilst this claim is quite independent of s. 26 (a) it seems to their Lordships to introduce no new element into the problem such as would lead to some different conclusion. The whole of the facts have still to be considered; the same criteria have to be applied; the question to be asked and answered is still whether the facts reveal a mere realization of capital, albeit in an enterprising way, or whether they justify a finding that the appellant went beyond this and engaged in a trade of dealing in land albeit on one occassion only."
In these passages their Lordships certainly appear to accept that the second limb of s. 26 (a) includes only profits which are income and that a capital gain is outside its scope. But if that were correct it would appear that the second limb of s. 26 (a) is entirely meaningless and ineffective. If a profit is income according to ordinary usages and concepts (which is no doubt what their Lordships meant by "assessable income" in the first of the passages cited) it is brought to tax by s. 25 without the assistance of s. 26 (a). The very aim of the second limb of s. 26 (a) was to bring "what might otherwise have been thought possibly to be capital profits within the conception of income" (Clowes v. Federal Commissioner of Taxation, per Dixon C. J. [1954] HCA 10; (1954) 91 CLR 209, at p 217 ). I have already said that their Lordships cannot have intended to mean that the second limb of s. 26 (a) is entirely otiose: Federal Commissioner of Taxation v. Williams [1972] HCA 31; (1972) 127 CLR 226, at p 250 . It is true that there are conflicting dicta on this matter. Since McClelland's Case some members of this Court have said, in accordance with the dicta in that case, that the second limb of s. 26 (a) applies only to profits of an income character: see Eisner v. Federal Commissioner of Taxation, per Walsh J. (1971) 45 ALJR 110, at p 114 and Burnside v. Federal Commissioner of Taxation, per Aickin J. [1977] HCA 66; (1977) 138 CLR 23, at p 47 . Others have held expressly or by implication that s. 26 (a) extends to capital profits: see Steinberg v. Federal Commissioner of Taxation, per Barwick C. J. (1975) 134 CLR 640, at pp 687-688 ; Investment and Merchant Finance Corporation Ltd. v. Federal Commissioner of Taxation, per Menzies J. [1971] HCA 35; (1971) 125 CLR 249, at p 264 ; and Burnside v. Federal Commissioner of Taxation, per Mason J. (1977) 138 CLR, at p 31 . I do not understand any decision to depend upon the acceptance of either of the two views, although some of them do depend on the related, but distinct, proposition stated in the passages cited from McClelland's Case (1970) 120 CLR 487 , that the realization of a capital asset does not in itself yield a profit within s. 26 (a). In my respectful opinion, both limbs of s. 26 (a) are intended to include in the assessable income profits which would not be described as income in the ordinary sense, and would not be caught by s. 25. That intention would be defeated if the section were construed by reading into its words a limitation which they do not contain and which would restrict its operation to income within ordinary concepts. In other words, s. 26 (a) was intended to include receipts which would otherwise be regarded as capital, although it overlaps s. 25 to some extent and includes also receipts of an income character: see Reseck v. Federal Commissioner of Taxation [1975] HCA 38; (1975) 133 CLR 45, at pp 47-48, 52-53 . In the present case therefore I do not consider that it is relevant to inquire whether the profit derived by the taxpayer was income within ordinary concepts for it was in any case profit within the meaning of s. 26 (a). (at p552)

16. The second proposition which their Lordships asserted in McClelland's Case - that to come within the second limb of s. 26 (a) the scheme should exhibit features giving it the character of a business deal, at least where the transaction is one of acquisition and sale - has been accepted and applied in this Court. The reason for construing the section in that way is no doubt that if some such limitation were not placed on its generality it would include profits which were apparently not intended to come within its scope; for example, a mere realization of capital, carried out in an enterprising way, might then fall within the section. It is unnecessary for present purposes to consider whether there is an exception to the generality of the proposition so stated. In the present case the transaction in my opinion had the character of a business deal. It satisfied the test stated in McClelland's Case if that test applies to a case such as the present where the profit did not arise from the resale of property which had been acquired by the taxpayer. (at p552)

17. On behalf of the taxpayer it was nevertheless contended that the scheme in the present case was not a profit-making scheme within s. 26 (a). In XCO Pty. Ltd. v. Federal Commissioner of Taxation (1971) 124 CLR, at p 350 , I said:
"The second limb of s. 26 (a), unlike the first limb of that paragraph, does not refer in express terms to purpose but, in my opinion, a scheme is not a 'profit-making scheme' simply because it yields a profit when none was intended; in the ordinary sense of the words a 'profit-making scheme' is a plan devised in order to obtain a profit, and a scheme only answers that description if the taxpayer carries it out with the purpose of making a profit."
That statement was not challenged. In the present case the scheme was, as I have said, devised in order that the taxpayer should make a profit on the payment of the debts and he carried out the scheme with that purpose. However the principal argument put in opposition to the view that there was a profit-making scheme was that the purpose of profit-making was merely incidental to other purposes of the scheme. This argument was accepted by the learned primary judge, who said that the taking of the assignments was a step incidental to the purpose of acquiring the controlling interest in the loss companies and that the purpose of the taxpayer in taking the assignments should not be more widely defined than that of protecting the controlling interest in the loss companies. (at p553)

18. It is not an uncommon feature of schemes to use a loss company that the persons who buy the shares for the purpose of getting the benefits of s. 80 take an assignement of the debts owed by the company. In the present case it was said that the assignments were taken in order to protect the companies from claims by the creditors, but that purpose could equally well have been achieved by obtaining a release from the creditors. Another possible reason for taking an assignment was suggested in XCO Pty. Ltd. v. Federal Commissioner of Taxation (1971) 124 CLR, at p 346 , namely to guard against the possibility that the holders of the remaining shares might claim a right to share in the profits. It must be accepted that one important purpose of taking the assignments was to protect the interest which the taxpayer and his two associates acquired in the companies. On the other hand, the purpose of making a profit when the debts were repaid was not merely incidental to the purpose of acquiring a controlling interest in the companies; it was an element in the scheme and was pursued for its own sake. The taxation benefits under s. 80 could have been obtained if the debts had never been repaid. To repay the debts out of profits earned would, it was hoped, provide an additional taxation benefit, and the making of a profit on the repayment was one of the purposes of the scheme - an end in itself - and was not done merely for the purpose of protecting the interest of the taxpayer and his two associates in the companies. (at p553)

19. It is well settled that in considering whether property was acquired by a taxpayer for the purpose of profit-making by sale, within the meaning of the first limb of s. 26 (a), it is the main or dominant purpose of the acquisition that has to be considered. The reason why this is so was indicated by Fullagar J. in Pascoe v. Federal Commissioner of Taxation (1956) 30 ALJ 402, at p 404 :
"But it is, nevertheless, I think, broadly true to say that, when a man invests money in the purchase of any kind of property, it will generally be either with a view to holding it and deriving income from it, or with a view to realising sooner or later an enhanced capital value. And, while logically these 'purposes' are not mutually exclusive, it will generally be possible to say that the one or the other is predominant at the time when the purchase is made."
This statement is not however true when men enter into, and carry out, a scheme. Schemes are various, and it is not necessarily possible to say that one purpose of a scheme is predominant; many schemes are designed to secure a number of purposes. If a scheme is designed to secure a profit, it is a profit-making scheme, although it has other purposes as well. This was I think recognized by Jacobs J. in London Australia Investment Co. Ltd. v. Federal Commissioner of Taxation (1977) 138 CLR 106, at p 122 when he said that if the acquisition and disposal of property is part of a business of so doing, the purpose of resale need not be the sole purpose, or the primary or dominant purpose, as is the case under the first limb of s. 26 (a). The present is of course not a case in which property was acquired for resale, but once it is established that profit arose from the carrying on of a scheme, it is enough that the making of a profit of that kind was one of the purposes of the scheme. This question did not arise in XCO Pty. Ltd. v. Federal Commissioner of Taxation, where the persons who acquired shares in the loss company arranged for the debts to be assigned to the taxpayer, and the proper conclusion was that the intention to make a profit was not incidental to any other purpose of the scheme. The facts of that case distinguish it from the present, but the decision did not depend on the acceptance of the view that the purpose of profit-making must be the dominant purpose of the scheme if it is to fall within the second limb of s. 26 (a). In the present case, one of the purposes of the scheme was to make a profit, and it can rightly be described as a profit-making scheme. (at p554)

20. For these reasons, the Commissioner correctly included the sums in question in the assessable income of the taxpayer. (at p554)

21. I would allow the appeal, and would vary the judgment of the Supreme Court accordingly. (at p554)

MASON J. In my opinion the appeal should be allowed and the order of the Supreme Court of Tasmania varied. (at p554)

2. Subject to one reservation which may have little practical significance I agree with the reasons for judgment prepared by Gibbs J. I find it unnecessary to decide whether s. 25 and s. 26 (a) have an overlapping operation. It may be that they have operations which are mutually exclusive, s. 26 (a) applying only to profits not attributable to gross income that has already been captured by s. 25 - see my judgment in Federal Commissioner of Taxation v. St. Hubert's Island Pty. Ltd. [1978] HCA 10; (1978) 138 CLR 210, at p 233 . (at p555)

JACOBS J. The taxpayer was the owner of land which, upon findings of fact which have not been challenged, had not been acquired by him for the purpose of resale at a profit. He was therefore free to sell that land without any gain therefrom being taxable in his hands. He was also free to develop the lands for the purpose of selling the lands at the best prices and the greatest gain to himself without that gain being taxable in his hands. Certain reasons prompted him not to develop the lands himself but to do so, in conjunction with two other persons, as a shareholder in companies to which parts of the land were respectively sold and transferred. The companies selected were "loss" companies. These companies had creditors and as part of the arrangement for the acquisition of these loss companies the debts owing by the companies to these creditors were assigned to the taxpayer and the other two persons. The trial judge found that the taking of the assignments was not "anything more than a step incidental to the main purpose which was the acquisition of a controlling interest in the loss companies". He concluded (1976) 7 ATR, at p 135; 77 ATC, at pp 4024-4025 :
". . . That being so, the evidence does not establish that the profits arose from the carrying on or carrying out of any profit-making undertaking or scheme. The purpose of the taxpayer in taking the assignments should not be more widely defined than protecting the controlling interest in the loss companies. In the circumstances of this case an investment made with that purpose does not fall within s. 26 (a); it is simply a means to an end.

. . .
The profits derived by the taxpayer arose from his investment and not

from the carrying out of any scheme. The paying of a sum of money in the hope of later receiving a larger sum upon the happening of a future event does not, of itself, amount to the carrying out of a scheme. The word 'scheme' is not satisfied unless there is some programme or plan of action. Here, the taking of the assignments of the debts by the taxpayer were not acts done by him in the course of any trading by him in choses in action or land or any other commodity. His relevant acts were acts done in the capacity of an investor not in the capacity of a dealer." (at p556)

2. In my opinion, once the trial judge reached the conclusion that the purpose of the taxpayer was not the making of a profit but was incidental to the protection of his and other persons' controlling interest in the loss companies, he correctly concluded that the amount realized upon payment of the debts owing by the loss companies and which had been assigned was not a profit within s. 26 (a). If it were correct to isolate the taking of the assignments and the subsequent realization then it might well be possible to find in that isolated course of conduct sufficient to constitute it of itself a profit-making undertaking or scheme. See XCO Pty. Ltd. v. Federal Commissioner of Taxation [1971] HCA 37; (1971) 124 CLR 343 . However, in a case such as the present, it is not possible to isolate the assignments of the debts and the subsequent realization. There was no separate profit-making undertaking or scheme in relation to them. They formed part of the larger operation - in the case of the taxpayer the development of his lands through companies which were loss companies and the holding by him of substantial investments as a shareholder in those companies. He could do both those things without attracting a liability to tax because his initial acquisition of the land was not with the purpose of profit-making. However he set about the development of the lands, that gain would not be a profit from a profit-making undertaking or scheme. It is true that dividends declared by the companies and received by him after the losses had been absorbed would be taxable and it is also true that by repaying the debts the companies had less money available for distribution as dividends. But it does not seem to me that these are relevant considerations. There is no profit-making scheme involved in this reduction of the funds available for declaration of taxable dividends. There is a difference between a scheme which will reduce or eliminate the liability to tax on moneys received and a profit-making undertaking or scheme and it appears to me that the appellant Commissioner's arguments have tended to overlook this difference. It is to be observed that the payment of the assigned debts did not in the scheme as a whole result in any real gain to the taxpayer. The payment reduced by the amount thereof the funds available for distribution by the companies to the taxpayer by way of dividends. This was a tax advantage, not a profit-making undertaking or scheme. (at p556)

3. I would dismiss the appeal. (at p557)

AICKIN J. The facts in this case are set out in other judgements and I shall not repeat them. The Commissioner's case was that the taxpayer had entered into a profit-making scheme within the meaning of s. 26 (a) and that profits from this scheme should be included in the taxpayer's assessable income for the years ending 30th June 1966, 1967 and 1968. In the proceedings in the Supreme Court of Tasmania other issues had been determined which are not the subject of appeal. They have however an indirect bearing on the matters arising in this appeal. The Commissioner had by amended assessment included in the assessable income of the taxpayer what was said to be profits arising from the sale of land which had been acquired for the purpose of profit-making by sale. Some part of that land was the land which had been sold to the loss companies which had repaid the assigned debts in a manner which gave rise to the Commissioner's contention that there was a profit-making scheme. In the Supreme Court the trial judge found that none of the land in question had been purchased by the taxpayer for the purpose of profit-making by sale and that finding is not the subject of appeal. (at p557)

2. It is, I think, a reasonable inference that the land which was the subject of the sale to the loss companies was dealt with in the way it was by reason in part at least of an apprehension that the Commissioner would take the view that any excess over cost arising upon the sale of that land was assessable income. That apprehension turned out to be well founded in that the Commissioner took that view, although, as was held by Nettlefold J., he was wrong to do so. (at p557)

3. The taxpayer being apparently unwilling or unable to embark upon the subdivision of the land himself introduced two friends into the subdivisional project. Accordingly the shares acquired in the loss companies and the debts owed by those loss companies were acquired by the three in equal shares, and each provided further funds to finance the subdivision. (at p557)

4. On behalf of the Commissioner it was argued that the scheme embarked upon by the taxpayer and his two friends was as follows: first, to acquire 75 per cent of the issued shares of Denland, and 60 per cent of those of Bathurst; second, to acquire all the outstanding debts of each company for substantially less than their face value; third, to obtain control of the board of directors of each company; fourth, "to cause the company to make profits from land development", which presumably means that they proposed as directors to procure each company to purchase the land in question, subdivide it and sell the subdivided lots in the hope that it would thereby make profits; fifth, to derive gains to the taxpayer and his two friends from the profits made by each company by means of repayment of the debts; and sixth, the deriving of further gains from the profits of the company by the declaration of dividends and payment of director's fees and the like. The sixth element in the scheme was said not to have much present relevance. (at p558)

5. The trial judge however found that the taking of the assignments of the debts was not "anything more than a step incidental to the main purpose which was the acquisition of a controlling interest in the loss companies", and as such no more than a "means to an end". The relevant passage in his reasons is quoted in the judgment of my brother Jacobs and I do not repeat it. (at p558)

6. As the argument for the Commissioner developed, however, it was put that the scheme comprised the acquisition of the debts and the subsequent repayment of them out of the funds derived from the profits earned by the company. The trial judge's finding was that the purpose of the taxpayer in doing those two things was not the making of profit, but was the protection of the controlling interest in the loss companies. Not only was the plan or scheme much wider than that, but that part of it viewed in isolation could not, in the light of the trial judge's findings, be regarded as a "profit-making scheme" for those steps did not have that end in view. (at p558)

7. I agree that it is a mistaken view of the arrangement to look merely at the assignment of the debts and their subsequent repayment. It is, I think, clear from the findings of the trial judge that the arrangements made by the taxpayer were for the realization, in co-operation with two of his friends, of a capital asset of the taxpayer, i.e. a realization by means of subdivisional development, for which the land was then either ready or expected soon to be ready. The findings of the trial judge show that the sale by the taxpayer of the land in question, either in globo or in individual subdivided lots would not have attracted tax. What was done was no doubt a complicated arrangement by which the taxpayer was to obtain part of the realizable value of his capital asset on a subdivisional basis. This is not to say that the nature of the payments received was not as repayment of debts owed to him by the loss companies. The question whether those amounts were profits derived from a profit-making scheme depends upon wider facts, which when properly regarded give to the steps taken quite a different significance, the nature of which I have indicated above. The matter may be looked at in another way by examination of the scheme as propounded by the Commissioner. However there was in fact no evidence, and no finding, that it was an essential or an original part of the scheme that the debts should be repaid, nor is there any evidence as to the knowledge and intentions and purposes of the other two alleged parties to the scheme. (at p559)

8. An examination of the facts as a whole seems to me to demonstrate that the taxpayer made no "profit" when one compares the starting point and the end result, which must necessarily be a proper approach to every case said to fall within the second limb of s. 26 (a). What it amounted to so regarded is an elaborate, perhaps "enterprising", mode of realizing a capital asset. It is true that others participated in it by putting in funds which contributed to the costs of actual, as distinct from planned, subdivision so that the land might be put into a condition in which it could be sold at best advantage for land ripe or almost ripe for subdivisional sale. For this taxpayer it was a mode of realization, of which the payment of the assigned debts was no more than an incident. (at p559)

9. I do not find it necessary to consider what the position would be if the scheme were to be regarded as comprising merely the acquisition of the debts and the management of the affairs of the company in a manner deriving profit for it, profit which would have been taxable income but for the circumstance that there were allowable deductions in the form of prior losses, and thus leaving the company with funds sufficient to pay its debts. The facts as found do not give rise to that situation and I express no view about it. (at p559)

10. I am therefore of opinion that this appeal should be dismissed. (at p559)

ORDER

Appeal dismissed with costs.