Opinion Number. 732

Subject

INCOME TAX WHETHER BONUS ISSUE OF SHARES AMOUNTS TO INCOME WHERE COMPANY CATEGORISES ISSUE AS A DISTRIBUTION OF PROFITS AMONG SHAREHOLDERS

Key Legislation

INCOME TAX ASSESSMENT ACT 1915, s. 14 (b)

Date
Client
The Acting Commissioner of Taxation

The Acting Commissioner of Taxation has forwarded the following memorandum for advice:

I shall be glad of your advice as to the law in the following case. A company had at the credit of its profit and loss account a sum of £114,000 and there was a further sum of accumulated profits existing in a reserve fund which had been built up during a period of years.

In September 1915 the company decided to issue additional shares to the existing shareholders to the extent of one new share for every two old shares held.

The distribution was to be subject to an application being received from the shareholders for the new shares.

The meeting at which the decision was to have been made was adjourned until a few days later in order that the applications from all the shareholders for new shares might be received. When all these had been received the company held its meeting and the resolutions as per the accompanying statement were passed. A copy of a shareholder's application for shares is also attached. The company, relying on the judgment of the High Court in the case Mitchell v. Hart, New South Wales Weekly Notes of 25 July 1916, Vol.33, referred to in the case of the Perpetual Trustee Company v. Cohen on page 77 and again in the case of Douglas v. Lawler on page 82, claim that these resolutions had the effect of capitalising the profits appropriated to pay for the shares before any credit was made to a shareholder, and that therefore section 14 (b) of the Income Tax Assessment Acts 1915 cannot apply, as that section only requires a shareholder to include as income any profit credited or paid to him.

The representative of the company who discussed this case with me contended further that the total amount appropriated did not represent any cash but represented capital assets which had been purchased, so that apart from the resolutions mentioned, it was contended that there had been a capitalisation of the profits.

The shares that were issued of course represent capital, but the resolutions of the company seem to imply that a credit of profit was passed to the shareholder and the latter then handed it to the company in payment of the new shares.

I shall be glad of your opinion as to whether the judgment in Mitchell v. Hart applies in this case as contended.

Section 14 (b) of the Income Tax Assessment Acts 1915 provides (inter alia) that the income of any person includes dividends, interest, profits, or bonus credited or paid to any member or shareholder of a company.

The words of the Act are very plain and there is no reason for giving them other than their ordinary meaning.

The company, by the very terms of its resolution, declares that it is distributing profits among its members, so that there can be no doubt that the members have received profits from the company. The representative of the company has referred to the case of Mitchell v. Hart [19 C.L.R. 33]. This case and a number of other cases cited therein are based on the leading case of Bouch v. Sproule [12 App. Cas. 385]. Although these cases are authorities on the question of capital and income as between tenant for life and remaindermen under a will I do not think that they are any authority when dealing with a taxing Act. In Commissioner of Income Tax (Queensland) v. Brisbane Gas Company 5 C.L.R. 96 Griffiths C.J. said [at p. 104]:

The majority of the learned Judges of the Supreme Court, and the learned Judge of the Court of Review, thought the case was to a great extent governed by the principles laid down in Bouch v. Sproule, but that was a case between tenant for life and remainderman, under the terms of a will by which the income was given to the tenant for life. Very different questions arise in a case of that sort. There, what the Court had to do was to discover what was the meaning of the testator's words. When he said the tenant for life was to have the income, did he intend to cover a case of a division of past accumulated profits? The House of Lords held in that case that he did not. Here the question is the construction of a taxing Act.

In the same case Isaacs J. said [at p. 108]:

When a company openly asserts that it has profits available for distribution among its shareholders, and formally announces that distribution, then to that extent there was thought to be no need to call for further evidence, for there really can be no better evidence against the company than its own public recognition of the fact, and that is made by the Act conclusive, and the Commissioner, if satisfied to accept that as proving the taxable income, may do so without question.

It would, in my opinion, be altogether reversing the manifest intention of Parliament if the simple and undeniable circumstance of a dividend actually declared were allowed to be controverted and turned into the subject of such difficult questions of law and complicated elements of fact as have been raised here. No such defence is possible, according to my reading of the Act, where the Commissioner relies on the mere declaration of a dividend of profits.

I hold, therefore, that Bouch v. Sproule has no relevancy whatever to the present case.

The question then in deciding whether a sum is liable to taxation is whether the company has distributed profits among its shareholders. If a company openly declares that it distributes profits among its shareholders, I think the Commissioner is justified in acting on this declaration as being conclusive evidence of what has taken place.

That Parliament intended to tax the distribution of profits of a company is evidenced by the fact that a certain class of accumulated profits are specially exempted from taxation.

By section 14 (b) of the Act an exception is made in respect of the taxation of profits subsequently distributed, in that profits accumulated prior to 1 July 1914 are not taxable in the hands of the shareholders, but amounts carried to the credit of the profit and loss account are not to be treated as accumulated profits.

In the present case the company expressly declares that it is making a distribution of profits, and unless any portion of the sum is exempted by coming within the first proviso to section 14 (b) the whole sum would be taxable in the hands of the shareholders.

From the resolutions it appears that £33,000 in the general reserve was accumulated prior to 30 June 1914, but that £111,300 was taken from the profit and loss account. The amount of £33,000 would be exempted from taxation by the first proviso to section 14 (b), but the sum of £111,300 taken from the profit and loss account would under the third proviso be entitled to no such exemption.

In my opinion, the sum of £111,300 in the hands of the shareholders is taxable as income under the Act as being profits credited to shareholders of a company.

[Vol.14, p. 406]