Section 25A and Section 26AAA

[3.1] In [2.492]–[2.505] above attention was given to the concept of an isolated business venture as an aspect of the ordinary usage meaning of income, and the question was raised whether that concept, as part of the concept of income for purposes of the Assessment Act, covered a field and should be taken to exclude the operation of s. 25A (formerly s. 26(a) within that field. In [2.171] there is some comment on the scope of the operation of s. 25A.

[3.2] In what follows, a closer examination is attempted of the correlation between the concept of isolated business venture and the specific provisions of s. 25A. The opportunity is also taken to explore the correlation between the two limbs of s. 25A(1). The specific provisions of s. 25A are then examined against the background of the judicial interpretations of s. 26(a). Section 25A(1) repeats the provisions of s. 26(a). In its other subsections, s. 25A is directed to overcoming weaknesses which it was considered had been revealed by the judicial interpretation of s. 26(a). These other subsections raise questions of interpretation and structure.

[3.3] The Assessment Act has included s. 26AAA since 1973. That section gives an income character to a profit on the sale of property purchased within 12 months of the sale. The correlation between s. 26AAA and the ordinary usage meaning of income as the latter has been received into the meaning of income for purposes of the Assessment Act, and the correlation between that section and s. 25A(1) are to some extent determined by the operation of provisions of s. 26AAA itself. But questions remain.

The Correlation between the Received Ordinary Usage Concept of an Isolated Business Venture and the Provisions of Section 25A

[3.4] Until the decision of the High Court in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 there remained doubt as to whether the ordinary usage meaning of income that relates to an isolated business venture—in the United Kingdom, “an adventure in the nature of trade”—was part of our law. It was possible prior to Whitfords Beach to argue that profit from an isolated business venture was not income for purposes of the Assessment Act, either because that part of the ordinary usage meaning of income had never been received by the Assessment Act, or that it had been excluded by s. 26(a) (the predecessor of s. 25A(1)), which provided a code in relation to isolated ventures. A correlation between the ordinary usage meaning and s. 26(a) of the kind proposed by Barwick C.J. in Investment & Merchant Finance (1971) 125 C.L.R. 249 would follow, so that ordinary usage supplied the meaning of income in relation to a continuing business while s. 26(a) exclusively supplied the meaning of income in relation to an isolated venture. Barwick C.J. said (at 255):

On this analysis the limitations on the operation of s. 26(a), established by judicial decision, had maximum significance. Those limitations, in relation to the first limb, included the requirement of purposive acquisition, the requirement of sale and the requirement of identity of the property acquired and the property sold. The first limb of s. 26(a) provided that “the assessable income of a taxpayer shall include profit arising from the sale by the taxpayer of any property acquired for the purpose of profit-making by sale”. Section 25A(1) repeats that provision. Limitations on the operation of the second limb were less firmly established, but Barwick C.J. had proposed a requirement that “there must be an identifiable specific scheme existing at the date of the acquisition of the property which is to be used to execute the scheme to make a profit” (Steinberg (1975) 134 C.L.R. 640 at 688). And he had proposed for a time a view that the second limb could not apply unless there had been an acquisition of property by way of purchase. The second limb of s. 26(a) provided that “the assessable income of a taxpayer shall include profit arising from … the carrying on or carrying out of any profit-making undertaking or scheme”. Section 25A(1) repeats that provision.

[3.5] The above analysis is one that was convenient in the respect that s. 26(a) was kept out of the field of continuing business where its operation—at least in regard to the first limb—would have been involved in irreconcilable conflict with the trading stock provisions of the Assessment Act.

[3.6] Whitfords Beach is a landmark decision in holding that the part of the ordinary usage meaning of income concerned with the notion of profit from an isolated business venture is some of the meaning of income for purposes of the Assessment Act. Gibbs C.J. and Mason J. decided the case by the application of that notion. Wilson J. was content to rely on the second limb of s. 26(a) without rejecting the possible operation of the ordinary usage notion. Wilson J. did not have to consider the consequences of a conflict between the ordinary usage notion and s. 26(a), because none arose in relation to the facts of the case. For the same reason Gibbs C.J. and Mason J. did not need to consider possible conflict in other circumstances, and they sought to lay the basis in doctrine for avoiding conflict by asserting that s. 26(a) had no application where the notion of isolated business venture will bring in a profit as income for purposes of the Assessment Act. Gibbs C.J. said (at 366):

Mason J. said (at 382–383):

[3.7] The idea of “conflict” between the notion of profit from an isolated business venture and the notion of profit under s. 26(a), calls for some comment. It is arguable that there is no conflict when both would bring in a profit of the same amount. In any case the conflict is without significance. There may be conflict when one would bring in a profit and the other would not, or when both would bring in a profit but the profits are of differing amounts because of differences in the principles applicable in their calculations.

[3.8] The conflict might be resolved in the latter circumstances by adopting a principle that the Commissioner is entitled to tax the higher amount. The principle has little to commend it, save that it would favour the Commissioner. The same principle might be adopted to allow the Commissioner to tax where one notion would not give rise to any tax and the other would. But in both cases a rational resolution of conflict should adopt the approach of Gibbs C.J. and Mason J. in Whitfords Beach, so that each notion is allotted a distinct field of operation. The allocation of fields suggested by those judges is that the isolated business venture notion occupied the field to the exclusion of s. 26(a) whenever the notion operated to bring in an amount that was income, or a loss that was deductible. If it did not bring in a profit that was income or a loss that was deductible, the circumstances might have given rise to a profit that was income or a loss that was deductible under s. 26(a) or s. 52. Such a resolution would have disappointed the Commissioner if s. 26(a) and s. 52 would have yielded a higher profit or a lesser loss, and would have disappointed the taxpayer if s. 26(a) and s. 52 would have yielded a lesser profit or a higher loss.

[3.9] The allocation of fields by preferring the notion of an isolated business venture whenever that notion would give rise to a profit or loss is not of course the only possible allocation. A field for an isolated business venture could be drawn in a way that would have excluded s. 26(a) even though the application of the notion did not give rise to profit that was income or loss that was deductible. The defining of the field would pose problems of analysis and of policy. An argument could be made that the notion of an isolated business venture covers the field though a transaction is aborted by the making of a gift of the property concerned.

[3.10] The need to resolve what is now the problem of the correlation between the operation of the ordinary usage notion of profit from an isolated business venture and the operation of s. 25A(1) has become the more acute. The adding of provisions to s. 25A will tend to expand its operation, within whatever field is allocated to it, and the adding of provisions to s. 52 will limit the losses that s. 52 can allow.

[3.11] Section 26(a) began its history as a reaction to the United Kingdom decision in Jones v. Leeming [1930] A.C. 415 which was thought to be a decision that a simple acquisition of property for the purpose of profit-making by sale and a sale of that property is not an isolated business venture. The suggestions are made by Mason J. in Whitfords Beach that Jones v. Leeming is not such a decision, and even if it is, it has been overruled by later decisions. The prospect is thus open that a transaction described by the words of the first limb of s. 25A(1) is an isolated business venture, so that a profit arising from it will be determined by the principles that make up that notion. If the view of Gibbs C.J. and Mason J. in Whitfords Beach as to the correlation of isolated business venture and s. 26(a) now represents the law and applies to the correlation of that notion and s. 25A(1), the elaborate new provisions in s. 25A and s. 52 will have little if any room in which to operate.

The Correlation between the Two Limbs of Section 25A(1)

[3.12] Whatever view is taken of the correlation between the notion of a profit from an isolated business venture and the notion of a profit under s. 25A(1), there will remain a problem of correlating the operations the two limbs of s. 25A(1). The resolution of that problem may leave even less room for the operation of the first limb of s. 25A(1).

[3.13] The repeal of s. 26(a) is expressed to take effect in relation to sales of property after 23 August 1983, except in so far as s. 26(a) relates to the carrying on or carrying out of any profit-making undertaking or scheme. And the operation of s. 25A commences in relation to sales of property after 23 August 1983, except in so far as the section relates to the carrying on or carrying out of any profit-making undertaking or scheme. An inference might be drawn that the two limbs of s. 25A(1), are mutually exclusive. It might be inferred that where property is acquired for the purpose of profit-making by sale in a profit-making undertaking or scheme, the first limb can have no operation. If this is a correct inference, and the view of Gibbs C.J. and Mason J. in Whitfords Beach as to the correlation of the ordinary usage notion of isolated business venture and of s. s. 25A is adopted, the first limb of s. 25A(1) will be crowded out by the ordinary usage notion and by the second limb.

[3.14] There is of course a question of defining the field of the second limb so that it is beyond the field of the ordinary usage notion. At one time, after McClelland (1970) 120 C.L.R. 487 it seemed that the provision had no field of its own. More recent authority, including Whitfords Beach, suggests that it had: something less in the system and organisation that it reflects may make a transaction a scheme within the second limb, though there is not sufficient system and organisation to make it an isolated business venture. Thus the protection of the doctrine of advantageous realisation explained in [3.68]ff. above, may be the more difficult to secure where the second limb is applicable than where the notion of isolated business venture would be applicable. The field of the second limb remains a matter of conjecture, but, if it can be identified, it seems that it will preclude the operation of the first limb.

[3.15] If the presence of an isolated business venture or of a transaction within the second limb will exclude the operation of the first limb, either will, it seems, exclude the operation of all the new subsections of s. 25A, and all the new subsections of s. 52 with the exception of s. 52(5) (a). All the new subsections of s. 25A are indissolubly linked with the first limb of s. 25(A(1) by the use of the phrase “acquired … for the purpose of profit-making by sale”, and, in most instances, by a reference to sales after 23 August 1983 which is the commencing date for the first limb of s. 25A(1). All the new subsections of s. 52, other than subs. (5) (a), are indissolubly linked with the first limb of s. 25A(1) by the use of the phrase “acquired for the purpose of profit-making by sale”. Section 52(5) (a) is linked in some measure with the first limb: significance is given by s. 25A to a sale in the “prescribed manner” only in the context of property having been acquired for profit-making by sale. But it may have a wider operation to deny a loss where the sale is made in carrying out a profit-making undertaking or scheme.

Background: The Interpretation of Section 26(a)

The first limb of section 26(a)

3.16 The first limb of s. 26(a) probably gave rise to more litigation than any other provision of the Assessment Act, though most often the issue was one of fact. Some of the interpretations of the provision imported fine legal analyses of a kind that is more appropriate in property law, some jurisprudential analysis of fundamental concepts such as intention, purpose and motive, and subtle refinements on onus of proof that might delight the student of the law of evidence.

The requirement that the property sold must be the property acquired

[3.17] A requirement of identity of the property acquired with the property sold became evident in White (1968) 120 C.L.R. 191. Windeyer J. rejected any possible application of the first limb on the ground that land acquired with growing timber on it is not sold when the timber is sold. The requirement of identity was asserted by Windeyer J. and Barwick C.J. in McClelland (1969) 118 C.L.R. 353 so as to justify rejecting the application of the first limb in a case where a half interest as tenant in common in land is acquired by a person who already has the other half interest, and the merged interests are sold. The requirement was assumed by the Privy Council in the same case: (1970) 120 C.L.R. 487. It was the basis of the decision in Miranda (1976) 76 A.T.C. 4180 that rights to new shares, attendant upon an existing holding of shares, were not property acquired when the existing shares were acquired. The requirement was accepted by Barwick C.J. and McTiernan J. in A. L. Hamblin Equipment Pty Ltd (1974) 131 C.L.R. 570: there was no relevant identity where rights under a hire-purchase agreement were exercised and rights as owner were sold, or where the lessee acquired the reversion under a lease and sold his rights as owner. Barwick C.J. in Steinberg (1975) 134 C.L.R. 640 appeared to think there was no identity if shares in a company were acquired and land received in the liquidation of the company was sold, though his decision may depend on another aspect of his interpretation of the first limb of s. 26(a) which would require that the acquisition of property sold must have been by purchase.

[3.18] The precise limits of the requirement of identity remained undetermined in some respects. Mason J. in Hamblin considered that there was identity if property was acquired, and newly created strata titles to parts of it were sold. There was no decision on how the acquisition of property and the sale of undivided interests in the property should be regarded.

Purpose of profit-making by sale

[3.19] There must have been an acquisition of property “for the purpose of profit-making by sale”. All authorities indicated that it was the purpose in fact of the taxpayer—the subjective purpose—that was relevant. The purpose in the first limb of s. 26(a) thus differed from the purpose to be predicated by looking at the overt acts of the taxpayer, a purpose that was relevant to the operation of s. 260 ([16.24]ff. below), and relevant to a conclusion that there is a continuing business ([2.444]ff. above).

[3.20] There was a distinction to be drawn, within the concept of purpose, between immediate purpose, which refers to the means to some end, and ultimate purpose, which refers to the end which the means will serve. Immediate purpose is sometimes referred to as intention, and ultimate purpose is referred to as motive. Subject to a possible inference to be drawn from McClelland, to which reference is made in [3.23] below, and to the implication of a view taken by Jacobs J. in Macmine referred to in [3.25] below, the first limb of s. 26(a) was concerned with immediate purpose.

[3.21] In most circumstances immediate purpose and ultimate purpose, as they were relevant to the operation of s. 26(a), are the same—the taxpayer buys to sell at a profit and the profit is both the immediate and the ultimate purpose. And the taxpayer does not have any competing purpose. If he does have a competing purpose, for example to hold for enjoyment or investment, the first limb of s. 26(a) required that his dominant purpose be determined: was his purpose to sell profitably the principal determinant of his actions?

[3.22] Analysis became more complex where the taxpayer acquired property with a purpose, as to part of the property, to sell profitably, and a distinct purpose, as to another part, to hold for enjoyment or investment. If the part of the property to which the purpose to sell profitably related was fixed at the time of the acquisition, no special difficulty would arise. If it was not fixed, analysis would remain simple if the subsequent fixing was taken to identify the property about which he had the purpose to sell profitably, though there was some conflict with a view that the purpose which brought s. 26(a) first limb into operation had to subsist at the time of acquisition of the property. If the subsequent fixing did not operate in this way, the analysis had to proceed on a dominant purpose as to the whole of the property approach, or on an approach which would characterise the purpose to hold for enjoyment or investment as the ultimate purpose as to the whole, and may assert that this is the relevant purpose. The former approach would tend to concentrate on the value of the part of the property sold, compared with the value of the part held, and on whether the taxpayer was at all times compelled to acquire the whole of the property if he was to acquire any of it. The latter approach would tend to concentrate on this factor of compulsion, and on the relationship between the purpose of selling profitably and the purpose of holding: was it commercially necessary or advisable for the taxpayer to sell what was sold in order to finance the acquisition of what was retained? The purpose of selling a part profitably might thus be made to appear the immediate but irrelevant purpose, and the purpose of holding the ultimate and relevant purpose, of the whole transaction.

[3.23] Chapman (1968) 117 C.L.R. 167 supported an analysis in terms of two immediate purposes, each relating to a distinct part, the parts in that case being identified after the acquisition. McClelland (1969) 118 C.L.R. 353, in the judgment of Windeyer J. at first instance, and of the majority in the Privy Council ((1970) 120 C.L.R. 487) supported an analysis in terms of immediate and ultimate purpose, the latter being the relevant purpose, though the case is a decision on the interpretation of the second limb of s. 26(a). New Zealand authorities on a provision which differs in some respects from s. 26(a) take an ultimate purpose approach in the Chapman situation: Plimmer v. C.I.R. (N.Z.) (1958) 11 A.T.D. 480; C.I.R. (N.Z.) v. Walker (1963) 13 A.T.D. 108; Land Projects Ltd v. C.I.R. (N.Z.) (1964) 13 A.T.D. 335.

[3.24] If ultimate purpose had in all circumstances been the relevant purpose under the first limb of s. 26(a), some unacceptable consequences would have followed. A taxpayer who saw an opportunity to profit by acquiring and selling property next door to his own, might have been able to establish that he was predominantly moved in acquiring the property by the opportunity to be rid of an undesirable neighbour, or by an opportunity to build on the property next door in a way that would ensure that his own desirable view would never be obstructed.

[3.25] In Macmine Pty Ltd (1979) 53 A.L.J.R. 362 at 376, Jacobs J. took the view that the acquisition and sale of the Minsec shares acquired in exercise of options which had not been acquired with any profit-making purpose, were simply steps in the advantageous realisation of those options. The advantageous realisation doctrine, imported from isolated business venture learning, is considered below in [3.68]ff. It is curious that the ultimate purpose which, it has been submitted, was not the relevant purpose under the first limb should become relevant because the acquisition and sale were “steps” in a scheme, more especially when the scheme escaped the second limb. The view of Jacobs J. may amount to a rejection of the view that purpose in relation to the first limb referred to immediate purpose. Alternatively it is the assertion of a view that an acquisition with the subjective purpose of profit-making by sale was not within the first limb if it was a part of a scheme that was within the field of the second limb. Either view casts some doubt on Executor Trustee & Agency Co. of S.A. Ltd (Bristowe’s case) (1962) 36 A.L.J.R. 271. Where a rights issue was made in relation to shares which were not acquired for resale at a profit, Bristowe’s case was authority that the first limb might be applicable to shares acquired in exercise of those rights, the profit which is income being calculated in a way that allowed the value of the rights as a cost. But the acquisition of the shares in exercise of the rights in Bristowe’s case might have appeared to be an advantageous realisation of the rights in the same way as the acquisition of the Minsec shares in Macmine was regarded by Jacobs J. as a step in the advantageous realisation of the options. The view taken by Jacobs J. raised a question of the correlation between the first and second limbs—a matter considered in [3.12]–[3.15] above. Where the circumstances amounted to a scheme within the second limb, there was good reason to treat the first limb as excluded. It is at least unsatisfactory analytically to treat an acquisition and sale which was an aspect of a scheme as a transaction within the first limb. There were problems, however, in defining the field of the second limb—the field from which the opertion of the first limb is excluded. The view of Jacobs J. would delineate the field in a way that would have included circumstances where a scheme did not give rise to a profit that was income. The consequences favour the taxpayer. The prospect was raised that a transaction, otherwise within the first limb, would escape tax because it was within the field of the second limb, and the circumstances within the field of the second limb escaped tax because they did not give rise to a profit that was income. The view of Jacobs J. in Macmine was adopted and applied by Tadgell J. in Leibler (1982) 82 A.T.C. 4005.

[3.26] There are questions as to what was meant by purpose “of profit-making by sale”. A purpose to retain property “in the hope or expectation that its value will increase” is not such a purpose, and a purpose to “hedge against the loss of value in the currency” is not such a purpose: Steinberg (1975) 134 C.L.R. 640 at 686 per Barwick C.J. The first observation would have the support of the Privy Council judgment in McClelland. The second observation is a recognition of the falseness of an assumption otherwise made in the Assessment Act that a dollar is of unchanging value. That assumption would require that a purpose to hedge be treated as a purpose of profit-making by sale, unless sale is not contemplated by the taxpayer.

[3.27] The purpose of profit-making by sale had to subsist at the time of acquisition of the property. A change of purpose thereafter would not abort the operation of the first limb: Moruben Gardens Pty Ltd (1972) 46 A.L.J.R. 559. There are questions as to what was the relevant moment of acquisition. Where the acquisition is completed by the exercise of an option, the moment of acquisition was the exercise of the option: Macmine Pty Ltd (1979) 53 A.L.J.R. 362 per Gibbs J. At least this was so where the option did not relate to a specific item of property. Where it did, there were, it seems, two acquisitions—one at the time the option was acquired, and the other on the exercise of the option: A. L. Hamblin Equipment Pty Ltd (1974) 131 C.L.R. 570. If the purpose subsisted only at the time of the second acquisition, problems of identity, considered in [3.17]–[3.18] above, might have precluded the operation of the first limb.

Purpose in relation to income derived through an intermediary or an agent

[328] A company is a taxpayer, and it is the company’s purpose that controlled the operation of the first limb of s. 26(a). Sometimes it may be difficult to identify the person or persons whose subjective purpose will be attributed to the company. In Coburg (1960) 104 C.L.R. 650 and Point Cook Pastoral Co. Pty Ltd (1979) 79 A.T.C. 4419 it was not difficult to identify the relevant person. There was more difficulty in Macmine Pty Ltd (1979) 53 A.L.J.R. 362. Where there has been collegiate action, for example by the board, it may be necessary that a majority have the relevant purpose.

[3.29] Where “net income” of a partnership for purposes of s. 90 of the Assessment Act was to be determined, it seems that a separate calculation of “net income” had to be made in relation to each partner where there was any partner who did not have the purpose of profit-making by sale: Pascoe (1956) 30 A.L.J. 402. Where the “net income” of a trust for purposes of s. 95 of the Assessment Act had to be determined and there were several trustees, presumably the majority of trustees must have had the purpose of profit-making by sale. There can be only one calculation of “net income”.

[3.30] The principle referred to in [3.27] that a change of purpose after acquisition would not abort the operation of the first limb of s. 26(a) would apply to a change of purpose of a company which may, for example, follow a change in control: Moruben Gardens. It may be asked whether a partner entering a partnership after the acquisition of property by the partnership was subject to the operation of the first limb of s. 26(a), because of the purpose of those who were partners at the time of acquisition of the property by the partnership. Tikva Investments Pty Ltd (1972) 128 C.L.R. 158 may suggest that he was. Pascoe would, however, suggest that he was not. There is, it should be noted, no deemed disposal by the original partners, and acquisition by them and by the new partners. Section 36 and s. 36A, considered in [14.59]ff. below, had no application in relation to s. 26(a).

[3.31] It may be asked whether a change of trustee, or the addition of a new trustee, would have aborted the operation of the first limb of s. 26(a). There was, one would think, no room for reasoning that might be drawn from Pascoe, despite the similarities of the language of s. 90 and the language of s. 95. On the other hand, there was no compelling reason for preferring the analogy with a change in control of a company.

[3.32] The calculation of “net income” under s. 95 is made “as if the trustee were a taxpayer”. Following the analogy with a change in control of a company would require an interpretation of those words which would abstract the concept of trustee from the persons who are for the time being trustees, and this may not accord with the general law of trusts. None the less the abstraction might be justified by the reference to “trust estate” in s. 95, which expresses such an abstraction. The reference is not to the trust property but to the trust entity. The difficulty of reconciling the abstraction with the relevance of the subjective purpose of the actual trustee at the time of acquisition of the property, is no greater than the difficulty in the similar context of a company and its directors. The agent’s purpose is attributed to his principal.

Purposive acquisition

[3.33] McClelland (1970) 120 C.L.R. 487 and N. F. Williams (1972) 127 C.L.R. 226 are authority that the purpose of profit-making by sale must have actuated the acquisition of the property. In the case of a receipt under a gift, this would require, at the least, that the gift must have been solicited by the taxpayer. Barwick C.J. indeed held the view that an acquisition under a gift could never attract the operation of the first limb of s. 26(a): there had to be an acquisition by purchase (N. F. Williams and Steinberg (1975) 134 C.L.R. 640). His view depended primarily on the need for a cost upon which the profit could be determined, and on an assumption that a receipt under a gift does not have a cost. The view of Barwick C.J. was not generally accepted. It was not taken by Kitto J. in McClelland in the High Court ((1969) 118 C.L.R. 353) nor by Lord Pearson in the Privy Council in that case. It was not accepted by the other judges in N. F. Williams.

[3.34] The need for purposive acquisition became a basis of tax planning which relied on it to immunise a spouse from a s. 26(a) first limb liability where property was received by way of gift from the other spouse. The other basis of the planning—that a gift is not a sale by the donor spouse—is referred to in [3.36] below.

[3.35] The requirement that there had to be a purposive acquisition would generally have excluded shares received in a bonus issue, or rights or options issued by a company, from the operation of the first limb of s. 26(a). Miranda (1976) 76 A.T.C. 4180 is authority that these bonus shares, rights or options were not acquired when the shares in relation to which the issues were made were acquired by the taxpayer shareholder. And it would appear from Macmine Pty Ltd (1979) 53 A.L.J.R. 362 that there was no purposive acquisition at the time of issue of the bonus shares, options or rights, save, perhaps, where the taxpayer controlled the company making the issue, and participated in the decision to make the issue.

Sale by the taxpayer

[3.36] If property was given away there was no sale and the first limb of s. 26(a) had no operation. In any case a gift would not have generated a profit unless there were some provision, such as s. 36, which would have deemed the gift to be a sale at market value.

[3.37] “Sale” was held to extend to a compulsory sale following resumption of property: Coburg Investment Co. Ltd (1960) 104 C.L.R. 650 and Steinberg. In Coburg Windeyer J. held that there had been a sale, notwithstanding that the disposition by the taxpayer was as a result of a notice to treat issued by a public authority. He referred to the fact that the price had been fixed by negotiation, at the same time expressing the view that compulsion or pressure did not prevent a disposition being a sale under s. 26(a). There remained a question whether there was a sale under a different resumption procedure.

[3.38] The sale had to be “by the taxpayer” who acquired the property with the purpose of profit-making by sale. A sale by the estate of a deceased person would not, it seems, satisfy the first limb of s. 26(a), though there was an argument that s. 101A (considered in [11.150]ff.) would supplement the words of s. 26(a) so that the profit was income of the estate. A sale by the official receiver of a bankrupt would not satisfy the first limb: Official Receiver in Bankruptcy (Fox’s case) (1956) 96 C.L.R. 370. But, it seems, a sale by the liquidator of a company would satisfy: St Hubert’s Island Pty Ltd (1978) 138 C.L.R. 210.

The calculation of profit

[3.39] It was noted above that, in relation to the first limb, Barwick C.J. took the view that the acquisition had to be by way of purchase—presumably purchase in circumstances where the price set does not reflect any element of gift. The view taken by other members of the High Court was that, provided the acquisition was purposive, an acquisition by receipt of a gift might bring s. 26(a) into operation. In these circumstances, the cost would be the market value of the property at the time of acquisition. United Kingdom authority, in cases relating to continuing business situations, supports the fixing of cost in this way in the determination of profit: Jacgilden v. Castle [1969] 3 W.L.R. 839, Petrotim Securities Ltd v. Ayres [1964] 1 W.L.R. 190 and Skinner v. Berry Head Lands [1970] 1 W.L.R. 1441. There is support in the judgment of Kitto J. in Becker (1952) 87 C.L.R. 456, and the decisions in relation to the second limb in Bernard Elsey Pty Ltd (1969) 121 C.L.R. 119 and Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355.

[3.40] In Becker, Kitto J. said (at 467) that business conceptions determined what was a profit for purposes of s. 26(a). One must deduct, he said, “the amount or value of all that it in fact has cost the recipient to obtain [the] ultimate sum”. The determination of cost in a case where there had not been a purchase of the property for cash, for example where the property had been acquired by way of exchange, posed problems of valuation. And there were problems in characterising the transaction. In Becker a finding that Becker had sold to the company for cash and thereupon subscribed for shares would have involved the result for which the Commissioner contended. Where the property had been purchased, there was a question whether the purchase price was definitive as to the cost of the property for purposes of calculating the profit. So far as s. 51 is concerned, Cecil Bros Pty Ltd (1964) 111 C.L.R. 430 would appear to suggest a principle which virtually precludes the Commissioner from going behind the purchase price where it exceeds market value. It may be asked whether the principle in Cecil extended to the determination of “cost” for purposes of calculation of a profit under s. 26(a). Section 65 was not available to the Commissioner: it is not concerned with the subtraction of cost in computing a profit.

[3.41] Property may have been acquired at less than its market value, perhaps by a member of a family from another member who did not wish to realise a profit. There is a question whether it was open to the purchaser to argue that his cost was greater than the price he paid, contending that the element of donation must be included. The cases referred to in [3.39] supported the purchaser’s argument.

[3.42] While the determination of profit for purposes of s. 26(a) involved recourse to accounting conventions, it was ultimately for the court to say what conventions were appropriate.

[3.43] Tax accounting for a profit from the sale of property where there is no continuing business is concerned with actual or constructive receipts: Thorogood (1927) 40 C.L.R. 454. There is a derivation of a profit only when and to the extent that the profit is found in an actual receipt or constructive receipt. There may be a constructive receipt (by the ordinary usage meaning of derivation or under s. 19) if the transaction involves a loan by the taxpayer to the buyer of the amount of the purchase price. If there is a constructive receipt, the whole profit will fall to be included in income on the making of the sale.

[3.44] If the contract is rescinded for the default of the buyer and under the contract instalments already received are retained by the seller, the profit arising will include the whole of the instalments received: L’Estrange (1978) 78 A.T.C. 4744.

The effect of interposition of a company

[3.45] George W. Cheverton Pty Ltd (1962) 12 A.T.D. 461 demonstrated that the application of the first limb of s. 26(a) might be attracted, though the original acquisition of property by a taxpayer was not for the purpose of profit-making by sale, if he vested the property in a company which thereafter disposed of it. In Cheverton, Crawford J. was able, on the facts, to escape an inference that the company had acquired for purpose of profit-making by sale. But in other situations the first limb of s. 26(a) would have made the profit derived by the company income. Of course the company must have made a profit: this depended on the price at which the property had been sold to the company and whether that price was definitive in determining the company’s cost for purposes of calculating any profit it had made. Bidencope (1978) 140 C.L.R. 533 affords another illustration of how the interposition of a company could generate income under s. 26(a). The property sold to the company might have been sold to a third party without generating any tax liability. The acquisition and sale by the company raised the prospect that income had been generated.

[3.46] In Hobart Bridge Co. Ltd (1951) 82 C.L.R. 372 the sale by the holding company of its shares in its subsidiary did not give rise to an operation of s. 26(a). These shares had not been acquired for resale at a profit though the subsidiary held property acquired by it for profit-making by sale. Section 26(a) did not apply to bring in any amount as income of the holding company on the sale of those shares. Hobart Bridge suggested tax planning whereby a taxpayer mad use of a “shelf” company in which he was a shareholder to acquire property which the taxpayer believed would substantially increase in value, the intention being that the taxpayer would at an appropriate time sell the shares rather than have the company sell the property. The “shelf” company might be one that had been formed for some other purpose, and which for a time had engaged in activities related to that purpose. In these circumstances there would have been no evidence from which an inference could be drawn that the original acquisition of the shares was for the purpose of profit-making by sale. It might however have been open to the Commissioner to argue that what was done amounted to a profit-making scheme within the second limb of s. 26(a). In Hobart Bridge the circumstances did not show any scheme to generate an increase in the value of the assets of the subsidiary in order that the shares held by the taxpayer might ultimately be sold at a profit. But on other facts there could have been an argument that such a scheme was involved. There would be a question as to how far the acts of a company were acts in the carrying out of a scheme by a shareholder. In McRae (1969) 121 C.L.R. 266, the company’s acts were so regarded. But some of the judgments in Macmine Pty Ltd (1979) 53 A.L.J.R. 362, more especially that of Jacobs J. in relation to the Petsec shares, suggest that the company’s acts could not always be so regarded.

The element of “business deal”

[3.47] The judgment of the majority of the Privy Council in McClelland (1970) 120 C.L.R. 487 brought a good deal of confusion into the interpretation of the first limb of s. 26(a). The majority judgment might be taken to have rejected the application of the first limb because of the failure to satisfy the identity principle in relation to the half interest the taxpayer acquired from her brother, and because of the failure to satisfy the purposive acquisition principle in relation to the taxpayer’s own half interest. There was, however, an inference to be drawn from the majority judgment that the requirement of “business deal”, said to be implicit in the second limb of s. 26(a), was also a requirement of the first limb.

[3.48] In the majority judgment a business deal requirement was implied into the second limb by a process of reasoning which first asserted that the second limb was simply a statement of part of the ordinary usage meaning of income. It was a statement, perhaps a limited statement, of that part of the ordinary usage meaning which in the United Kingdom is expressed in the notion of an adventure in the nature of trade and which was considered in [2.495]ff. above. The phrase “business deal” identified the central element in the notion of adventure in the nature of trade.

[3.49] The importing of the requirement of a business deal into the first limb of s. 26(a) would, as pointed out by Lord Pearson in his dissenting opinion in McClelland, have restored Jones v. Leeming [1930] A.C. 415 as part of the law in Australia despite the attempt in 1930, by the enactment of the predecessor of s. 26(a), to reject it.

[3.50] In a number of cases, in the period immediately after McClelland, the High Court referred to the possibility that the business deal notion might be an aspect of the first limb. In A. L. Hamblin Equipment Pty Ltd (1974) 131 C.L.R. 570 at 576 Barwick C.J. asserted that the Privy Council in McClelland had concluded that “as to both limbs of s. 26(a) the transaction … must exhibit features which give it the character of a business deal” and expressed the view that the Privy Council’s conclusion was binding on the High Court. It followed, he thought, from the business deal notion that “the taxpayer in acquiring the property [must have] the purpose of trading in it or with it”.

[3.51] No other member of the High Court expressed the same view. And later statements by Barwick C.J. created perplexity by asserting at once that the “business deal” notion was an element of both limbs of s. 26(a) and that s. 26(a) was intended to bring in gains which would otherwise be capital gains—by which the Chief Justice must have meant gains that would not be income by virtue of the ordinary usage meaning of income. In Bidencope (1978) 140 C.L.R. 533 at 540 he said:

[3.52] Both assertions by Barwick C.J. cannot have been true, unless “business deal” as imported into s. 26(a) had a different meaning from the meaning it has in any statement of the United Kingdom law on adventure in the nature of trade, or, alternatively, United Kingdom law on adventure in the nature of trade is not an aspect of the ordinary usage meaning of income. It is hard to imagine what the notion of business dealing, or of commercial dealing as it was sometimes called by Barwick C.J., may mean if it is to be distinguished from that notion in a statement of adventure in the nature of trade principles. And the reaction of the legislature in 1930 to the decision in Jones v. Leeming can only be explained by an assumpion, at that time, that adventure in the nature of trade principles were part of our law as principles of ordinary usage income.

[3.53] The continuing significance of the judgment of the Privy Council in McClelland (1970) 120 C.L.R. 487 in relation to the first limb of s. 26(a) was not a matter about which any firm conclusion could be drawn. One suspects that the possibility that a “business dealing” or “commercial dealing” element had been imported would in time have ceased to be considered by the High Court, and the first limb would again have been seen as extending the Australian law beyond the adventure in the nature of trade principles. A denial that “business deal” was an aspect of the first limb may be thought to have been the desirable outcome. The “business deal” element in the United Kingdom law may be thought to be unnecessarily restrictive.

Deduction of loss

[3.54] Section 52, in its terms while s. 26(a) existed, as now, provided that a loss incurred by a taxpayer upon the sale of any property or from the carrying on or carrying out of any undertaking or scheme, the profit (if any) from which sale, undertaking or scheme would have been included in his assessable income, is an allowable deduction. There is, however, a proviso which makes the deduction allowable only in the discretion of the Commissioner if the taxpayer has not given the notice specified in s. 52 that the relevant property was acquired for the purpose of profit-making by sale. Section 52 is linked by its language with s. 26(a) and now with s. 25A(1), and has no application to a loss that arises in circumstances where a profit would have been income only under s. 26AAA: Werchon (1982) 82 A.T.C. 4332.

[3.55] The deduction for a loss is available only when the property has been sold. The anticipation of a loss by writing down the value of an item of trading stock to its market value, which is possible under the trading stock provisions, is not possible in relation to property to which s. 26(a) applied or to which s. 25A(1) applies.

[3.56] There was no provision in s. 52 while s. 26(a) existed which would deny a loss deduction, in circumstances in which s. 26(a) was applicable, if the sale was not an arm’s length sale of the property and it was for an amount less than the market value of the property. The circumstances of the sale might have supported a conclusion that the property was not acquired for the purpose of profit-making by sale. But if the subjective purpose of profit-making by sale was established, a sale at less than the value of the property might, it seems, have limited the profit that was income or given rise to a loss. A new subs. (5)(a) added to s. 52 in 1984 has made a significant change in s. 52 in this respect. The new subsection is referred to in [3.109] below.

The second limb of section 26(a)

The identity principle

[3.57] In its terms, the second limb did not depend on the property sold being identified with property acquired with a relevant purpose, as did the first limb. The identity principle, which assumed so much importance in relation to the first limb, might therefore appear to have had no application. However, Barwick C.J. insisted on contemporaneity of commencement of the scheme and of the acquisition of property to which the scheme related: Steinberg (1975) 134 C.L.R. 640 at 688 (quoted in [3.69] below). A principle of this kind may have had as its corollary a principle corresponding with the identity principle in relation to the first limb.

[3.58] Miranda (1976) 76 A.T.C. 4180 considered in [3.17] above as a decision on the first limb, was accepted by the Commissioner in Macmine (1979) 53 A.L.J.R. 362 and expressly endorsed by Sheppard J., at first instance, and Gibbs J. in the High Court in that case. It was, however, possible that the profit—presumably the proceeds of sale of the rights less the costs of sale—on the realisation of the rights would have been income under the second limb. The relevant scheme would have involved the acquisition of the shares with the purpose of acquiring the rights and selling the rights. Such a scheme was found by Gibbs, Stephen and Murphy JJ. in Macmine in relation to the Petsec rights. Jacobs and Aickin JJ. thought there was no such scheme. If the threat of a second limb scheme was discounted, Miranda appeared to offer scope for tax planning that would have been proof against the operation of s. 26(a). Rights might have been issued exercisable at less than the market value of the shares in relation to which they were issued and the shares thereafter realised at a loss. Section 52A may have been available to the Commissioner to defeat such planning. And there was some prospect of the application of the first limb if the taxpayer had participated as a controlling shareholder in the decision to make the rights issue. The latter possibility is mentioned in [3.35] above.

Profit-making and business deal

[3.59] There was no express reference to purpose in the second limb. But the undertaking or scheme had to be a “profit-making undertaking or scheme”, and a purpose to profit by the carrying on or carrying out of the scheme was taken to be an essential element. In contrast with the first limb, the second limb looked not to the immediate purpose, but to the ultimate purpose of the taxpayer. This would appear to have been established by Bidencope (1978) 140 C.L.R. 533, rejecting the view of Gibbs J. in XCO Pty Ltd (1971) 124 C.L.R. 343. A conclusion as to the nature of the ultimate purpose might have excluded the operation of the second limb because the purpose found was not a profit purpose. And that conclusion might have excluded the operation of the second limb for another reason. It might have shown that the undertaking or scheme did not involve a “business deal”—the notion imported into the second limb by the decision in the Privy Council in McClelland (1970) 120 C.L.R. 487. In Bidencope the ultimate purpose in acquiring the debts and obtaining payment of them was the protection of the taxpayer shareholder against a claim to the profits of the company by the continuing shareholders. In the light of this ultimate purpose, the transaction did not have the quality of a business deal. In the language adopted by Barwick C.J. in Hamblin ([3.50] above), the taxpayer did not “trade in or with” the debts.

[3.60] Observations by Gibbs and Jacobs JJ. in Macmine would appear to establish that the ultimate purpose which the second limb required is as much subjective as the immediate purpose with which the first limb was concerned.

[3.61] The requirement of “profit-making” and the requirement of “business deal” were clearly interrelated, so that in most circumstances both would be satisfied or not satisfied. But in the case where the realisation of property was held not to be a business deal because it was merely an “advantageous realisation”, there would appear to have been profit-making but no business deal. Even in such a case there was a disposition to preserve the inter-relationship between profit-making and business deal by assertions that the transaction was one of “money-making” and not “profit-making”: White (1968) 120 C.L.R. 191 per Barwick C.J.

[3.62] In McClelland (1970) 120 C.L.R. 487, the ultimate purpose was held by the Privy Council to be a purpose of holding as distinct from selling at a profit. The Privy Council restored the view of the facts taken in the High Court ((1969) 118 C.L.R. 353) by Windeyer J. at first instance and by Barwick C.J. in the Full Court, and rejected the view of the facts taken by Kitto J.

Undertaking or scheme

[3.63] Prior to McClelland (1970) 120 C.L.R. 487 and the importation of the notion of business deal, the interpretation of the words “undertaking or scheme” concentrated on the degree of complexity that was necessary to make what was done an “undertaking or scheme”. Clowes (1954) 91 C.L.R. 209 insisted that merely to outlay money in the hope of more in return was not enough. Otherwise, every casual bet or purchase of a lottery ticket might have been caught by the second limb of s. 26(a). On the other hand in Official Receiver in Bankruptcy (Fox’s case) (1956) 96 C.L.R. 370 the reclamation, development and sale of land were held to be an undertaking or scheme. In Fox’s case it was assumed that the second limb might be satisfied in circumstances where the ordinary usage notion of income, applicable to an isolated venture, would not have been satisfied. However, Taylor and Owen JJ. in White (1968) 120 C.L.R. 191 at 219, in the High Court, anticipating McClelland in the Privy Council, insisted that “it is not to be thought that the mere realisation of a capital asset not acquired for the purpose of profit-making by sale would constitute a scheme for the purposes of … s. 26(a) even though the realisation is effected in the most advantageous manner”. Though the judgments of the High Court did not expressly say so, the court was importing into the second limb an aspect of the business deal notion recognised in the United Kingdom in relation to adventure in the nature of trade. The High Court put the emphasis on the need to satisfy the requirement of profit-making, but the result can also be explained in terms of the requirement of a business deal.

[3.64] The recognition of the doctrine of advantageous realisation as part of the law expressed in the second limb of s. 26(a), and the associated recognition of a requirement of business deal, came near to relegating the second limb to a role as a partial statement of the ordinary usage notion of income applicable to an isolated business venture. It would follow, on the correlation between ordinary usage and s. 26(a) adopted by Gibbs C.J. and Mason J. in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355, that it was left with no field in which to operate. It could of course be only a partial statement of the ordinary usage notion. A number of restrictive interpretations of the second limb ensured that this was so.

[3.65] There is in any event considerable difficulty in finding in the interpretation of the second limb any aspect that would have given it an operation beyond the ordinary usage notion of an isolated business venture, and thus given it a field of its own. A subjective purpose might have given the quality of profit-making scheme though the objective inference of profit-purpose, which may be thought to be required by the ordinary usage notion, could not be drawn. An ultimate purpose might have given the quality of profit-making scheme when the inference of purpose required by the ordinary usage notion is an inference of immediate purpose to profit. But there is no illustration of either observation in the cases. It may be that the doctrine of advantageous realisation was a more limited qualification in relation to the second limb than in relation to the ordinary usage notion. There was then a prospect that circumstances would amount to a second limb scheme because the scope and complexity of a development operation took it out of the notion of advantageous realisation for the purposes of that limb, when they would not take it out of virtually the same notion for purposes of the ordinary usage notion of isolated business venture. Apart from Whitfords Beach, the decisions of the High Court in relation to the advantageous realisation doctrine have been concerned with that doctrine in the context of the operation of s. 26(a), and there has been no discussion whether circumstances that would have gone beyond advantageous realisation for purpose of s. 26(a) would also go beyond advantageous realisation for purposes of ordinary usage. In N. F. Williams (1972) 127 C.L.R. 226 it was held that a subdivision and sale of property, even though it involved the provision of roads and services, was yet only an advantageous realisation. In the same case there is a statement by Menzies J. that if the development had extended to the building of houses on the subdivided land, the second limb would have been attracted. In McClelland (1970) 120 C.L.R. 487 the conclusion by the majority in the Privy Council that the taxpayer’s purpose was to hold, precluded the application of the second limb. It does seem, however, that had there been a purpose of profit-making, the facts would have attracted the operation of the second limb. Those facts involved a taxpayer who owned a half interest in land acquiring the other half interest and selling the land in subdivision. The doctrine of advantageous realisation would not have precluded the operation of the second limb. But in no case was any distinction drawn between advantageous realisation in the context of ordinary usage and advantageous realisation in the context of the second limb of s. 26(a).

[3.66] It may be that the “planned, coherent and organised” activity (Official Receiver in Bankruptcy (Fox’s case) (1956) 96 C.L.R. 370 at 381), reflecting some system and organisation, which would have amounted to a scheme for purposes of the second limb, will not be enough to amount to an isolated business venture for purposes of the ordinary usage notion. There is some suggestion of this in the High Court judgments in Official Receiver in Bankruptcy (Fox’s case). But the authorities offer no help in determining the point where the circumstances showed a scheme but not yet an isolated business venture.

[3.67] The recognition in Whitfords Beach that the isolated business venture aspect of ordinary usage is part of the concept of income for purposes of the Assessment Act, has made a close consideration of the meaning of the second limb generally unnecessary. If the views of Gibbs C.J. and Mason J. in Whitfords Beach are accepted, the isolated business venture aspect of ordinary usage over its field simply displaced the operation of s. 26(a) in either of its limbs. There was, it seems, no room any longer for a view that s. 26(a) covered a field and within that field excluded the operation of the ordinary usage notion. At one time almost all judgments of the High Court concentrated decision on a question of operation of s. 26(a), and ignored the possible operation of ordinary usage. In doing this the court left the impression that the field of s. 26(a) prevailed over ordinary usage, so that restrictive interpretations of some of the words of s. 26(a) might have had the effect of denying the income character of a profit, and yet excluded the operation of ordinary usage to give income character to that profit. Whitfords Beach, in the result, is a decision that the second limb of s. 26(a) was without function, unless it could be shown that in some respects of its operation it was in a field beyond the field of the ordinary usage principle. The prime difficulty, in terms of barriers set by judicial decision, in finding a field for the second limb beyond ordinary usage was the importing of the notion of business deal into s. 26(a) by the Privy Council in McClelland. That importing, if accepted, prevented there being any distinct field for the second limb.

Advantageous realisation is not a scheme

[3.68] The notion of advantageous realisation has been examined in [2.501] above in relation to that aspect of the ordinary usage meaning of income concerned with an isolated business venture. Reference has already been made to it in [3.25] above. Until now, discussion has focused on a possibility that the notion of advantageous realisation was a lesser qualification on the second limb of s. 26(a) than it is on the doctrine of isolated business venture. In one respect, however, it may have been a greater qualification on the operation of the second limb than on the ordinary usage doctrine. Jacobs J. in Macmine Pty Ltd (1979) 53 A.L.J.R. 362 contemplated that, in relation to the second limb, the advantageous realisation of property might include the the acquisition of additional property which was itself realised. Jacobs J. would attach the advantageous realisation purpose to the acquisition of the property acquired as a step in the realisation of the original property, so that the operation of the first limb of s. 26(a) was precluded. The view of Jacobs J. would have given the notion of advantageous realisation a very wide operation indeed. Despite Menzies J. in N. F. Williams (1972) 127 C.L.R. 226, the building of houses on land as a step in the development and sale of land would have been within the notion. And the acquisition and sale of other land which might conveniently have been developed with the original land will have been simply a step in an advantageous realisation, at any rate if it would enhance the price that could be obtained for the original land. The view of Jacobs J. did not have the support of other members of the court in Macmine. Gibbs J. took the view that there was no scheme to profit, because the shares had not been acquired with an immediate purpose of profit-making. Had he found they had been acquired with such a purpose, he would, it seems, have held that there was a profit-making undertaking or scheme within the second limb and not an advantageous realisation.

Acquisition of property and commencement of the scheme

[3.69] Barwick C.J. took the view, for example in Steinberg (1975) 134 C.L.R. 640, that the undertaking or scheme had to be formulated no later than the moment of acquisition of the property in relation to which the scheme would be carried out. In Steinberg he said (at 688):

Such a view did not appear to be directed by any of the words of the second limb, though the words of s. 52 lent some support. The view was not endorsed by other members of the High Court. Indeed it was rejected by Menzies J. in N. F. Williams and by Stephen and Gibbs JJ. in Steinberg.

[3.70] It will be recalled that in relation to the first limb Barwick C.J. took the view that the acquisition had to be by way of purchase. He considered that this was required because what was taxed was a profit, and there could not be a profit unless there was a cost. He did not, however, take the same view in relation to property acquired in carrying out a scheme. At one stage—at the time of White (1968) 120 C.L.R. 191 and McClelland (1969) 118 C.L.R. 353—such a view in relation to the second limb might be thought to have been dictated by another view he had expressed: he had said in McClelland (at 371) that if land acquired by inheritance is adventured “as the capital of a business, for example, of land jobbing or developing”, no part of the value of the inheritance will be deductible in determining the income of that business. Insisting that the second limb of s. 26(a) required acquisition by purchase would have avoided an unfair consequence of this kind. More recently however, in N. F. Williams, Barwick C.J. abandoned the view expressed in McClelland, and the need to escape the unfair consequence has gone.

[3.71] The subjective approach which, it was thought, applied to the question of “profit-making”, would also appear from Macmine Pty Ltd (1979) 53 A.L.J.R. 362 to have been applicable to the question of “undertaking or scheme”. It was the taxpayer’s actual planning of his actions that was relevant, not the objective inferences that might be drawn from those actions.

[3.72] The subjective approach raised questions as to the extent of planning that had to subsist at the time of commencement of the scheme, and as to the consequences of a change of planning. In Steinberg, Barwick C.J. said (at 687): “While it need not be fully conceived in all its details at the time of acquisition it must exist as a scheme which in principle embraces all the details yet to be worked out.” The other judges in that case, Stephen and Gibbs JJ., required rather less detailed planning at the time of commencement. Gibbs J. (at 699) said: “if the scheme had the requisite purpose it was a profit-making scheme notwithstanding that the exact manner in which the profit was to be made had not been finally decided.” Other authority, in particular that of Windeyer J. in Buckland (1960) 34 A.L.J.R. 60, is in line with Stephen and Gibbs JJ. The question of the necessary degree of detailed formulation was of less significance so long as the view of Barwick C.J. that the scheme must subsist at the time of acquisition of property subject to the scheme was not followed. But insufficient planning would, at the least, have deferred the moment when the valuation of any property subject to the scheme was to be made. And the exclusion of action prior to the moment of adequate formulation of the scheme might have prevented the scheme satisfying the requirement of business dealing. On facts such as were found by Kitto J. in McClelland, there was probably a business deal, but if the scheme to sell had not been held to commence till after the acquisition of the interest of the other tenant in common, the scheme would have been only an advantageous realisation and not a business deal.

[3.73] On the view taken by Barwick C.J., a change in planning was more likely to have put an end to the scheme—to abort the scheme—and would have raised the prospect that the planning after the change did not amount to a business deal. This was the outcome in Kratzmann (1970) 44 A.L.J.R. 293. The less detailed planning required to constitute a scheme, on the view taken by other judges, lessened the prospect of abortion.

[3.74] There was thus a notable difference between the operation of the second limb and the operation of the first limb. Once property had been acquired with a purpose, at the time of acquisition, of profit-making by sale, the operation of the first limb could only be prevented by the taxpayer failing to sell the property.

[3.75] The subjective approach to the question of the existence of a scheme gave rise to problems of the kind discussed in [3.32] above in relation to the first limb.

[3.76] The scheme had to be carried out by the taxpayer. Observations made in relation to the first limb in [3.38] above are equally applicable here.

The calculation of profit

[3.77] Where property to which a second limb scheme related had been acquired otherwise than by way of arm’s length purchase, or where the scheme commenced at a time subsequent to acquisition, the cost of the property for purposes of calculating the profit subject to tax was the market value at the time of acquisition or commencement of the scheme. Kitto J. in McClelland (1969) 118 C.L.R. 353 proceeded on this principle in remarking that the Commissioner had been generous in assuming that the market value of the taxpayer’s half interest was half the proceeds of sale of the merged interests.

[3.78] Observations made in [3.39]ff. above in relation to the first limb have relevance to the second limb. In McRae (1969) 121 C.L.R. 266, the taxpayer argued that the value of his shares had been increased by a gift—the sale of the flats at an undervalue—made not to him but to the company in which he held his shares. The court found that the sale to the company had been made at full value. If it had been found that there was an element of gift, this would have been relevant to the determination of the profit derived by the taxpayer on the sale of his shares.

[3.79] In McRae an argument that the amount paid up on the bonus shares issued by the company should be treated as a cost in determining the taxpayer’s profit from the scheme, was rejected by the High Court. The rejection of the argument, one would have thought, was inevitable having regard to the decision in Gibb (1966) 118 C.L.R. 628 that there is no derivation of income in a bonus issue that is within s. 44(2). A similar argument in the context of share trading operations was however upheld in Curran (1974) 131 C.L.R. 409, to which reference is made in [6.194]ff., [7.24]ff. and [12.78]ff. The provisions of s. 6BA, introduced to reverse the effect of Curran, applied to a s. 26(a) situation.

The correlation of isolated business venture and section 26(a)

[3.80] Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 went a substantial way towards an answer to the question of the correlation between the operation of the ordinary usage meaning of income expressed in the notion of an isolated business venture and the meaning of income supplied by s. 26(a). Whitfords Beach establishes that the notion of an isolated business venture supplies some part of the meaning of income for purposes of the Assessment Act. As recently as Macmine Pty Ltd (1979) 53 A.L.J.R. 362, the assumption both of the Commissioner and all judges, including Sheppard J. at first instance, would appear to be that the ordinary usage meaning supplies principles relevant only to a continuing business operation, and principles of the ordinary usage meaning relating to an isolated business venture are not part of our law. But an assumption which is not contested by the parties does not make law. Against the assumption in Macmine was an observation by Windeyer J. in White (1968) 120 C.L.R. 191 at 212 that s. 26(a) “does not … make ‘not income’ any sums, or parts of sums, which would on general principles be income”. The view of Gibbs C.J. and of Mason J. is that where the ordinary usage principles applicable to an isolated business venture were attracted s. 26(a) was denied any operation. But the precise field of operation of the isolated business venture remains to be settled. Some comment in this regard is offered in [3.8].

The Development of the Law by Section 25A

[3.81] In 1984 s. 26(a) was repealed and a new s. 25A added to the Assessment Act. The new section, in subs. (1), repeats the words of s. 26(a). The manner of the repeal and new enactment calls for some comment. Act No. 47 of 1984, by s. 11(a) and s. 60(8), repealed s. 26(a) of the Assessment Act retrospectively, save in one respect, so that s. 26(a) has no effect in relation to sales of property after 23 August 1983. This repeal is not retrospective, however, in so far as it relates “to the carrying on or carrying out of any profit-making undertaking or scheme”. The repeal of s. 26(a) so far as it relates to a profit-making undertaking or scheme has effect from the date of Royal assent: Act No. 47, s. 2. Royal assent was given on 25 June 1984. Sections 10 and 17 of Act No. 47, which inserted the new s. 25A in the Assessment Act and added subsections to s. 52, have a retrospective operation so that the new provisions apply in general to sales of property after 23 August 1983. But the new provisions do not have a retrospective operation
“in so far as they relate to the carrying on or carrying out of any profit-making undertaking or scheme”. So far as the new provisions relate to a profit-making undertaking or scheme, they have effect from the date of Royal assent.

[3.82] Comment on the significance of the manner of repeal of s. 26(a) and of the enactment of s. 25A is made in [3.12]–[3.13].

[3.83] It may be assumed that s. 25A(1), in adopting the exact words of s. 26(a), has confirmed the judicial interpretation of s. 26(a) explored in the background survey in immediately preceding paragraphs. It has, by a number of deemings in subss (2)–(12), corrected what were thought to be unacceptable aspects of that interpretation. The deemings do not however affect the validity of the assumption. Indeed they reinforce it. It follows that save where its operation is subject to a deeming, and then only to the extent of the specific terms of that deeming, s. 25A(1) will apply with the interpretations given by the courts to s. 26(a), and to any further development of those interpretations. And it may be assumed that, save where the subsections added to it make different provision, s. 52 will continue to receive the interpretation already given to subs. (1) of the section, in particular the interpretation given to that subsection in Werchon (1982) 82 A.T.C. 4332 referred to in [3.54] above.

The transactions covered by subsections (2) to (12) of section 25A and subsections (2) to (5) of section 52

[3.84] The added subsections of ss 25A and 52 deal with five kinds of transactions:

(I) A taxpayer sells shares in a company or an interest in a partnership or an interest in a trust estate, which he did not acquire for the purpose of profit-making by sale. The company, partnership or trust estate, however, held property at the time of the sale that was acquired for the purpose of profit-making by sale. Transaction (I) is illustrated by the facts of Hobart Bridge Pty Ltd (1951) 82 C.L.R. 372. The relevant provisions are subss (2), (3), (7), (10)(a), (11) and (12) of s. 25A and s. 52(5)(b). They might be described as the Hobart Bridge amendments.

(II) A taxpayer who actually acquired property for the purpose of profit-making by sale, or is deemed to have acquired property for that purpose by the operation of s. 25A, sells the property in a non-arm’s length transaction for less than its value, or makes an inter vivos gift of the property, or, being a company, partnership or trust estate, distributes the property: these transfers are referred to as transfers “in the prescribed manner”. Thereafter the transferee disposes of the property. The relevant provisions are subss (5), (9) and (10)(b) of s. 25A and subss (2), (3) and (5)(a) of s. 52. They might be described as the N. F. Williams amendments.

(III) A taxpayer who actually acquired property for the purpose of profit-making by sale, or is deemed by the operation of any provision of s. 25A to have acquired property for that purpose, sells an interest in the property, or sells property in which the property acquired has become merged. The relevant provisions are subss (6), (9), (10)(c), and (12)(d) of s. 25A and s. 52(4). They might be described as the identity doctrine amendments.

(IV) Transaction (IV) involves elements of transactions (II) and (III). A taxpayer actually acquires property for the purpose of profit-making by sale or is deemed by the operation of any provisions of s. 25A to have acquired property for that purpose, and thereafter disposes of an interest in the property, or disposes of property in which the property acquired has become merged. The disposition is a sale of the property for less than the value of the property in a non-arm’s length sale, an inter vivos gift of the property, or, where the taxpayer is a company, partnership or trust estate, a distribution of the property. The relevant provisions are subss (6), (8), (9), (10)(c) and (11) of s. 25A and subss (2), (3) and (5)(a) of s. 52.

(V) A taxpayer actually acquires shares in a company for the purpose of profit-making by sale, or is deemed by the operation of any provisions of s. 25A to have acquired shares for that purpose, and the company makes a bonus share issue or a rights issue to the taxpayer. The relevant provisions are subss (4), (9), (10)(d) and (e) of s. 25A. They might be described as the Miranda amendments.

Sale of shares in a company, or an interest in a partnership, or an interest in a trust estate where the company, partnership or trust estate at the time of the sale holds property that was acquired for the purpose of profit-making by sale: Transaction (I)

[3.85] In Hobart Bridge (1951) 82 C.L.R. 372 the taxpayer held shares in a subsidiary company. Those shares had not been acquired for profit-making by sale. The subsidiary acquired land for the purpose of profit-making by sale. Thereafter the taxpayer sold its shares in the subsidiary. The High Court held that the taxpayer had not derived a profit that was income on the sale of those shares. The provisions of s. 25A that are directed to circumstances of this kind are subss (2), (3), (7), (9), (10)(a), (11) and (12) of s. 25A and s. 52(5)(b). They have some affinity with provisions that have appeared since 1982 in s. 26AAA, to which reference is made in [3.174]–[3.189] below.

[3.86] The provisions apply not only to the holding of shares in what might be called an intermediary company, but also to the holding of an interest in an intermediary partnership or an intermediary trust estate. The property acquired by the intermediary for the purpose of profit-making by sale may be identified as the underlying property.

[3.87] The intermediary company or trust estate must be a private company or private trust estate as defined in s. 25A(12). The holding of shares in the company, or an interest in the partnership or trust estate, may have commenced at any time, though the sale of the shares or interest must have occurred while the underlying property was held by the intermediary. The operation of s. 25A(2)(a) is to deem the shares or interest to have been acquired by the taxpayer for the purpose of profit-making by sale.

[3.88] Property acquired for the purpose of profit-making by sale may have been held not by the intermediary, but by a sub-intermediary, and the phrase “underlying property” may be applied to that holding. If at the time of sale by the taxpayer the intermediary held an interest through one or more interposed companies, partnerships or trusts—which need not be private companies or trusts—in property acquired for profit-making by sale by another private company, partnership or trustee of a private trust estate, s. 25A(2)(b) will deem the taxpayer to have acquired the shares or interest in the intermediary for the purpose of profit-making by sale.

[3.89] The taxpayer will be deemed to have acquired for the purpose of profit-making by sale “for the purposes of the application of the [Assessment] Act”. That deeming will bring the circumstances within the field of the first limb of s. 25A(1), if they are not already within that field. They will not however bring the taxpayer within the field of income by ordinary usage or the field of the second limb of s. 25A(1). And they will not prevent the exclusive operation of ordinary usage or the second limb if the circumstances otherwise lie within the fields of ordinary usage or of the second limb. These assertions follow from the views expressed in [3.6]–[3.14] above as to the correlation between the ordinary usage concept of income and s. 25A, and the correlation between the two limbs of s. 25A(1).

[3.90] The deeming will presumably operate even though the taxpayer is already within the field of the first limb, because he actually acquired for profit-making by sale. But the deeming is simply irrelevant if the taxpayer is already within the field of the ordinary usage concept, or the field of the second limb of s. 25A(1).

[3.91] The intermediary or sub-intermediary must at the time of sale by the taxpayer hold the underlying property as property acquired for the purpose of profit-making by sale, and the underlying property must not be “excepted property”. At first view, the holding by the intermediary should be a holding or deemed holding within the field of the first limb of s. 25A(1), which could not, on the views expressed in [3.6]–[3.14] above, be a holding that attracts the operation of the ordinary usage meaning of income or the second limb of s. 25A(1). A difficulty is however created by the definition of “excepted property” in s. 25A(12), which extends to trading stock, so that a holding of trading stock by the intermediary cannot engage the operation of s. 25A(2). It is true that the words “trading stock” will most often describe property acquired for the purpose of profit-making by sale, though, as explained in [14.38]ff. below, items may be trading stock as items taken into a business of trading though they were not acquired for profit-making by sale. If the inference is drawn from the definition of excepted property that the intermediary for purposes of s. 25A(2) may hold property acquired for the purpose of profit-making by sale even though it does not hold that property in circumstances within the field of the first limb of s. 25A(1), it ought not to be held to follow that s. 25A has a field which overlaps with or shuts out the operation of ordinary usage. The definition of “excepted property” was imported into s. 25A from s. 26AAA(1)(m). It was imported from a section that is applicable to circumstances within the field of the ordinary usage principles, though s. 26AAA(5)(a) excludes the operation of s. 26AAA if, as a result of a sale, a profit will be income of a business carried on by a taxpayer.

[3.92] One consequence of trading stock being excepted property is a confirmation of a conclusion that would have followed in any event, that s. 25A(2) has no operation in the very circumstances of Hobart Bridge Pty Ltd (1951) 82 C.L.R. 372 where, at least since St Hubert’s Island Pty Ltd (1978) 138 C.L.R. 210, the land held by the intermediary would be held as trading stock.

[3.93] Where a taxpayer is deemed by s. 25A(2) to have acquired for the purpose of profit-making by sale “so much (if any) of the proceeds of sale as, in the opinion of the Commissioner, is appropriate shall, for the purposes of the [Assessment] Act, be deemed to be profit arising from the sale by the taxpayer on the property”: s. 25A(9). Presumably the Commissioner has the function given him by subs. (9), even though the taxpayer in fact acquired the property for the purpose of profit-making by sale. But s. 25A(2) should not be interpreted so that its operation is attracted where the shares or interest held by the taxpayer are held in circumstances that are within the field of ordinary usage principles. Such an interpretation would reject the views expressed in [3.6]–[3.14] above, and it would lead to unmanageable consequences. Thus the taxpayer may be a share-trader who includes in his stock unlisted company shares. A function vested in the Commissioner to determine a profit that will be income cannot be reconciled with the operation of the trading stock provisions. It is not a sufficient answer that the Commissioner could forsake his function by the exercise of another function provided for in s. 25A(3)(b).

[3.94] The Commissioner is directed by s. 25A(10)(a) to have regard to a number of matters in determining the profit, where s. 25A(2) operates to deem the taxpayer to have acquired for the purpose of profit-making by sale. The direction is confined to circumstances where the underlying property was actually acquired by the intermediary for the purpose of profit-making by sale, and the shares or interest deemed to have been acquired by the taxpayer for the purpose of profit-making by sale were not “transferred to the taxpayer in the prescribed manner”. Prescribed manner is defined in s. 25A(11). It extends to transfers by way of inter vivos gift, transfers at less than value between taxpayers who are not at arm’s length, and distributions by a private company or private trust estate. The reasons for the exclusion of the direction given by s. 25A(10)(a) where the intermediary did not actually acquire for profit-making by sale is not apparent. The reason for excluding circumstances where the taxpayer acquired in a transfer in the prescribed manner is, presumably, to allow the Commissioner in the exercise of his function under s. 25A(9) to proceed uninhibited by s. 25A(10)(a). He may thus have regard to the increase in value of the underlying property, not only during the time the shares or interest were held by the taxpayer, but also during the time the shares or interest were held by the transferor to the taxpayer.

[3.95] The Commissioner is directed to have regard to the extent to which, in his opinion, the proceeds of sale of the shares or interest derived by the taxpayer are attributable to the amount of any increase in the value of the underying property during the period which is common to both the holding of the underlying property by the intermediary and the holding of the shares or interest by the taxpayer. The amount of the increase in value is however to be reduced for the purpose of the calculation by any capital expenditure incurred by the intermediary in respect of the underlying property, excluding expenditure in respect of which a deduction has been allowed or is allowable to the intermediary.

[3.96] Section 25A(10)(a) does not require the Commissioner to confine his attention to the matters stated. He should have regard to the prospect that tax will be paid by the intermediary on the increase in value of the underlying property when that property is sold, s. 25A being applicable. The proceeds of sale by the taxpayer of its shares or interest will not fully reflect the increase in value of the underlying property where the sale of the underlying property will generate a tax liability on the intermediary.

[3.97] Section 25A(10)(a) is applicable whether the increase in value referred to is an increase in value of underlying property held by a first intermediary, or held by a sub-intermediary. Clearly, however, the Commissioner could not properly attribute to the proceeds of sale the whole of each of these increases in value of underlying property. At least some part of the increase in value of property held at the sub-intermediary level will be reflected in the increase in value at the first intermediary level, and is taken into account in attributing proceeds of sale to the latter.

[3.98] Section 25A(7) adopts the drafting of subs. (6), considered in [3.134]–[3.141] below, intended to overcome the identity doctrine which limited the operation of s. 26(a), so that an intermediary company, partnership or trust will be deemed to have acquired property for profit-making by sale where (i) it holds property which is an interest in property acquired by it for the purpose of profit-making by sale; or (ii) it holds property in which was merged an interest in property acquired by it for the purpose of profit-making by sale. The property deemed to have been acquired for the purpose of profit-making by sale is in the first instance the interest in the property acquired for the purpose of profit-making by sale, and in the second instance the property in which the property acquired for the purpose of profit-making by sale has merged. The deeming by s. 25A(7) is for the purpose of s. 25A(2). The inference is that s. 25A(6) would not have brought about a deeming for purpose of s. 25A(2), and there is a further inference that s. 25A(5), (8) and (4), considered in [3.143]–[3.159] below, would not bring about a deeming for purpose of s. 25A(2).

[3.99] The express provision in s. 25A(7) must have been moved by an assumption that the deeming provisions of subss (6), (5), (8) and (4) of s. 25A are applicable only to the affairs of the person whose assessable income is to be determined, identified by those provisions as “the taxpayer”.

[3.100] The identity doctrine is thus overcome by s. 25A(7) where the question is whether an intermediary has acquired property for the purpose of profit-making by sale, but N. F. Williams (1972) 127 C.L.R. 226 and Miranda (1976) 76 A.T.C. 4180 are not. Thus the calculation of a profit under the direction given to the Commissioner by s. 25A(10)(a) will not take into account an increase in value of bonus shares or rights issued to the intermediary in respect of a holding of shares. Nor will it take into account an increase in the value of property acquired by the intermediary in a prescribed transfer from a person who acquired for the purpose of profit-making by sale.

[3.101] The overcoming of the identity doctrine by s. 25A(7) has a consequence that may not have been intended. The calculation of a profit under the direction given to the Commissioner by s. 25A(10)(a) will take into account an increase in value of the whole property deemed to have been acquired for profit-making by sale, though it results from the merger of properties only one of which was acquired for profit-making by sale.

[3.102] Section 25A(3) gives the Commissioner a function to lift the operation of s. 25A(2) where he considers that it is not appropriate that it should apply. He is directed to have regard, inter alia, to the extent to which the assets of the intermediary immediately before the sale by the taxpayer consisted of underlying property, and the nature and extent at that time of the taxpayer’s control of the intermediary.

Disposition in the prescribed manner of property acquired or deemed to have been acquired for the purpose of profit-making by sale: Transaction (II)

[3.103] The description of Transaction (II) tends to hide the great complexity to which subss (5), (9), (10)(b) and (11) of s. 25A and subss (2), (3) and (5)(a) of s. 52 give rise. These provisions, which may be described as the N. F. Williams amendments, apply not only to a taxpayer who actually acquired for the purpose of profit-making by sale, but, save where there is, in some particular, a clear indication to the contrary, also to a taxpayer who is deemed by the operation of these provisions to have acquired for this purpose. And any operation of these provisions will lay the basis for their further operation in relation to another taxpayer, or will lay the basis for the operation of any other provision which depends for its operation on another taxpayer having acquired for the purpose of profit-making by sale.

[3.104] The general effect of the provisions referred to is that where a taxpayer takes property under a transfer in the prescribed manner made by a person who actually acquired the property for the purpose of profit-making by sale, or made by a person who is deemed under the provisions or any other provisions of s. 25A to have acquired the property for the purpose of profit-making by sale, the taxpayer is deemed to have acquired the property transferred to him for the purpose of profit-making by sale so that a sale of the property by him will attract the operation of the first limb of s. 25A(1). The deeming will not, on the view taken in paras [3.6]–[3.14] above, have any effect in supplying an element which may be necessary for a conclusion that the taxpayer has entered on a profit-making undertaking or scheme, so that he might come to derive income under the second limb of s. 25A(1). Moreover the acquisition by the transferor for the purpose of profit-making by sale that is required if subs. (5) is to operate, must be an acquisition within the field of operation of the first limb of s. 25A(1). Section 25A(5) can have no operation if a transfer in the prescribed manner is made by a person who holds property as trading stock, as a revenue asset of a continuing business, as an asset of an isolated business venture or as an asset of a profit-making undertaking or scheme. This would follow from the views expressed in [3.6]–[3.14] above as to the correlation between the ordinary usage concept of income and s. 25A, and the correlation between the two limbs of s. 25A(1). The views gain support from an examination of the difficulty that would be involved in seeking to apply the provisions of s. 25A(10) (b) in determining the profit that is income where the transferor’s actions were within a field other than the field of the first limb of s. 25A(1). Section 25A(10)(b) is considered in [3.108]–[3.127] below.

[3.105] In the case of trading stock, there is an express provision in the definition of “excepted property” that casts a shadow on these submissions. A transfer in the prescribed manner for purposes of subs. (5) includes a transfer by way of a distribution of property of a private company or private trust estate, but not where a transfer is made of “excepted property”. Excepted property is defined so that it includes trading stock of the company or trustee. It might be argued that the inference from the express exception is that the transferor’s holding of property need not have been acquired within the field of operation of the first limb of s. 25A(1), or, indeed, that the inference is that the field of operation of the first limb will embrace any circumstances that can be described by the words “acquired for the purpose of profit-making by sale”. Neither is a necessary inference. The definition of “excepted property” is taken in relevant respects from the definition in s. 26AAA(1)(m). Its function in the context of s. 26AAA is explained in [3.182] below, and, in the parallel context of s. 25A(2), in [3.91] above. If an inference of the kind suggested were intended, there should have been an express provision in the definition of transfer in the prescribed manner, so that a transfer by way of gift, or for less than value in a dealing not at arm’s length, would not have included a transfer of excepted property.

[3.106] An inference that s. 25A(5) has no application where a transferor held property as trading stock, an inference to be drawn from the impossibility of any sensible application of s. 25A(10)(b) in such circumstances, overcomes any inference to be drawn from the definition of excepted property. A disposition of trading stock in a transfer in the prescribed manner will normally give rise to assessable income in the amount of the market value of the trading stock, and the application of s. 25A(10)(b) will be absurdly distorted. Section 25A(10)(b), in determining the taxpayer’s profit that is income, would require an allowance for both the transferor’s cost and the amount of the transferor’s assessable income arising from the prescribed transfer.

[3.107] It will be noted that a transfer in the prescribed manner as defined in s. 25A(11) may include a sale of property. It will include a sale if the Commissioner is satisfied that the transferee and the person who transferred the property were not dealing with each other at arm’s length in relation to the transfer of the property, and the property was transferred for consideration the amount or value of which is less than the amount that, in the opinion of the Commissioner, was the value of the property immediately before the time of transfer. It follows that every purchaser of property is at some risk that he will be deemed to have acquired the property for the purpose of profit-making by sale. He is at risk whenever there is any ground for the Commissioner reaching a satisfaction that he and the seller were not dealing with each other at arm’s length in relation to the transfer, and there is any ground on which the Commissioner might form an opinion that the value of the property is an amount more than the consideration for the transfer. It will be noted that the Commissioner has two functions—to reach a satisfaction that the purchaser and the seller were not dealing with each other at arm’s length, and to form an opinion as to the value of the property. There is some contrast in the result with the provisions of s. 136AD in relation to international transfer-pricing. Under that provision whether or not the price is an arm’s length price is a matter of fact, unless “it is not possible or not practicable for the Commissioner to ascertain the arm’s length consideration”: subss (1)(c) and (4).

[3.108] Where the provisions operate, the Commissioner is given, by subss (9) and (10)(b) of s. 25A, a function to determine the amount of the profit arising from the sale by the taxpayer of the property. The Commissioner has this function whether or not the sale is itself a sale in the prescribed manner. But the fact that a sale is in the prescribed manner is not enough in itself to attract the Commissioner’s function. Where a taxpayer has actually acquired property for the purpose of profit-making by sale, and there is no operation of the provisions to deem him in any event to have acquired for profit-making by sale, any profit on the sale of the property by the taxpayer will be determined without the operation of any function of the Commissioner.

[3.109] The operation of the provisions in a claimed loss situation is to a degree in parallel. The Commissioner is given a function, by s. 52(2), to determine the amount of a loss on the sale of property by a taxpayer who has acquired under a transfer in the prescribed manner, and this whether or not the taxpayer actually acquired for the purpose of profit-making by sale. Unless the Commissioner exercises his function, no loss will be allowable. This is the consequence of s. 52(3). In this respect there is no parallel with the provisions in regard to a profit, which, at least in theory, leave the determination of a profit on sale to general principles where the Commissioner has not exercised his function. And there is another way in which the loss provisions fail to parallel the profit provisions: a sale in the prescribed manner by a taxpayer who has actually acquired for the purpose of profit-making by sale, but is not deemed to have acquired for the purpose of profit-making by sale, cannot give rise to a loss deduction. Express provision is made to this effect in s. 52(5)(a). Section 52(5)(a), it should be noted, does not exclude the Commissioner’s function, where a sale is in the prescribed manner, to allow a loss if the taxpayer is deemed under s. 25A(5) to have acquired for the purpose of profit-making by sale.

[3.110] The provisions applicable to Transaction (II) are not only complex but involve a circuitry that might be expected of a lawyer draftsman, but of which an electronics engineer might feel ashamed. It may fairly be asked why the elaborate circuitry was necessary. The background of the provisions is of course the decision of the Full High Court in N. F. Williams (1972) 127 C.L.R. 226. A taxpayer could abort the operation of the first limb of s. 26(a) by making a gift to his wife of property he had acquired for the purpose of profit-making by sale where the property had increased in value. The first limb would have no application to the wife on her subsequent sale of the property, since she could not be said to have acquired “purposively”, that is, for the purpose of profit-making by sale. If it was thought that N. F. Williams showed that the law did not accord with its policy, there were precedents for reform in s. 36 in relation to trading stock, and in s. 26AAA(4) in relation to short-term purchases and sales, that might have been followed. Such provisions prevent the abortion of a transaction that would otherwise have given rise to a profit that was income. Their method is to deem a disposal that is not in the ordinary course of a trading transaction, or in the ordinary course of a purchase and sale, to be a sale at market value. The person who acquires under the disposal is deemed to have acquired at that value. It is true that the method would not, without more, enable the taxing of a further increase in the value of the property that may be realised by the person who took under the disposal. But reform to enable the taxing of that further gain might have been directed to some modification of the principle requiring purposive acquisition, such that a taxpayer might be taken to have acquired for the purpose of profit-making if he accepts a gift inter vivos and his subsequent actions thereafter do not contradict a presumption that he acquired for profit-making by sale.

[3.111] Chart A has attempted to trace the operation of the provisions applicable to Transaction (II) over a series of transfers of property, and some comment is now offered.

[3.112] In column (1) it is assumed that A has acquired under a transfer in the prescribed manner from X, a person who actually acquired for the purpose of profit-making by sale. The consequence is that the exercise of the Commissioner’s function under s. 25A(9), referred to in column (2), must conform with s. 25A(10)(b), and this, presumably, whether or not X is also a person who is deemed to have acquired for the purpose of profit-making by sale: he may have acquired with an actual purpose of profit-making by sale, though under a transfer in the prescribed manner.

[3.113] In columns (2) and (4) it is assumed that the transfers are by way of sale, so as to raise questions as to the arising of a profit that is income or a loss that is deductible. If A does not sell to B, or B does not sell to C, but transfers in the prescribed manner by way of a gift inter vivos, or as a private company or private trust estate (defined in paras (b) and (c) of s. 25A(12)) making a distribution to a shareholder or beneficiary, there can be no profit or loss by A or B that is income or deductible. However B or C will be deemed to acquire for profit-making by sale: s. 25A(5). And the circumstances of the deemed acquisition by B or C will be relevant to the determination of any profit made by B or C that is income, or of any loss that is deductible by B or C, if there is a subsequent sale by B or C.

[3.114] Column (2) distinguishes the situation of a sale other than in the prescribed manner from the situation of a sale in the prescribed manner. In both situations the Commissioner’s function to determine the profit is attracted. It will be noted that if the sale in column (2) is not in the prescribed manner—it is a sale between persons at arm’s length and for full value—a following sale by B to C will not attract the Commissioner’s function to determine the profit in relation to that sale. At this point the operation of s. 25A in bringing in a profit is an operation of the first limb of s. 25A(1) unaided by any of the further provisions of s. 25A. There will however be an operation of s. 52(5)(a) in relation to the bringing in of a loss if the sale by B to C is a sale in the prescribed manner. It is a mark of the defective circuitry of the new provisions that a loss may be deductible under s. 52(2) where there has been a sale in the prescribed manner if the taxpayer, because of an acquisition in the prescribed manner, is deemed to have acquired for profit-making by sale, but not where the taxpayer has acquired for full value.

[3.115] The determination by the Commissioner of the amount of a profit in a column (2) situation is subject to a direction to him by s. 25A(10)(b) to have regard to a number of matters. The direction is however confined to circumstances where the taxpayer (A in the chart) has acquired the relevant property from a person (X in the chart) who actually acquired for the purpose of profit-making by sale. If X in the chart is a person who is deemed to have acquired for the purpose of profit-making by sale, and did not also actually acquire for profit-making by sale, s. 25A(10)(b) has no application, and the Commissioner has power to determine the profit uninhibited by the direction that provision gives. The reason for limiting s. 25A(10)(b) to a situation where X in the chart actually acquired for the purpose of profit-making by sale is not apparent, unless it was intended to select a circumstances where X may be taken to have paid full value for the item of property so that it is not inappropriate to have a calculation of profit based on his actual costs, as the provision may be thought to require. But X may have actually acquired for the purpose of profit-making by sale in a transfer to him at less than the value of the property.

[3.116] Alternatively the intention may have been that the s. 25A(10)(b) direction should be available only where X has actually acquired for profit-making by sale, and is not a person deemed by any provision of s. 25A to have acquired for profit-making by sale. Even then it may not be appropriate to base a calculation of profit on X’s costs: he may have actually acquired for profit-making in a purchase at less than full value from a person who did not acquire, actually or by deeming, for profit-making by sale.

[3.117] The operation of the direction on the transfers to which it applies poses further problems. The Commissioner is directed to have regard to the extent to which the amount “that would have been included in the assessable income of the transferor” (X in the chart) “if [he] had sold the relevant property at the time when it was sold by the taxpayer” (A in the chart) “for an amount of consideration equal to the amount of the consideration received or receivable by the taxpayer in respect of the sale of the relevant property by the taxpayer, exceeds the sum of” certain specified amounts. The reference to the inclusion of an amount in the assessable income of the transferor is to an inclusion of a profit which would require the subtraction of the transferor’s costs. There is no direction as to the identification of those costs though it is likely that actual costs only were intended. Yet if s. 25A (10)(b) extends to situations where the transferor acquired in circumstances where there was both an actual and a deemed purpose of profit-making by sale, the costs should in fairness include any element of gift received by the transferor in his acquisition of the property. Fairness has the support of the decisions in Bernard Elsey Pty Ltd (1969) 121 C.L.R. 119 and Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355. And it has the support of the principle that might be thought to stem from those cases, and asserted by Gibbs J. in Curran (1974) 131 C.L.R. 409, though, it is submitted with respect, misapplied by him in that case.

[3.118] There are other problems in regard to the operation of the direction. The subtractions from the profit that the transferor (X in the chart) would have made, in determining the profit that is income of the taxpayer (A in the chart) include “(i) any expenditure incurred by the taxpayer in respect of the relevant property, not including—(A) any consideration given by the taxpayer in respect of the transfer of the relevant property to the taxpayer; or (B) expenditure to which subpara. (ii) applies …”. The exclusion in (A) is clearly necessary, because of the subtraction allowed by subpara. (iii) of subs. (10)(b) of “the amount of any profit included in the assessable income of the transferor (X in the chart) in respect of the transfer of the relevant property to the taxpayer” (A in the chart). The object, it would seem, is to tax to the taxpayer the balance of the profit the transferor would have made beyond that amount of the profit already taxed to the transferor.

[3.119] The provisions of s. 25A (10)(b)(i)(B) are a drafting measure to prevent any double subtraction of amounts that would in effect be within both subparas (i) and (ii). Subparagraph (ii) allows the subtraction of “so much of the consideration received or receivable by the taxpayer” (A in the chart) “in respect of the sale of the relevant property by the taxpayer as exceeds the amount that, in the opinion of the Commissioner, would have been the consideration received or receivable by the taxpayer if the taxpayer had not incurred” certain capital expenditure. The capital expenditure referred to is “expenditure of a capital nature in respect of the relevant property otherwise than—(A) in acquiring property for the purpose of profit-making by sale; or (B) as part of a profit-making undertaking or scheme”. The intention of para. (ii) is to deal with circumstances where the taxpayer (A in the chart) has, for example, erected a house on land that he is deemed to have acquired for the purpose of profit-making by sale, intending to make the house his home. Subparagraph (ii) contemplates the exclusion from the profit subject to tax, of that element which reflects an increase in the value of the house over its cost. In the result, there may be a profit that is less than the profit that would have been income if there had been an actual acquisition of land for the purpose of profit-making by sale, and no deemed acquisition for that purpose, and the taxpayer, following a change of mind, had built a home on the land and thereafter sold the land and home. It is arguable that general principles of the calculation of profit that is income under the first limb of s. 25A(1) would include the element of profit attributable to the increase in value of the home. A taxpayer may thus find advantage in the deeming that he acquired for the purpose of profit-making by sale.

[3.120] There is a question left by subpara. (ii) as to whether expenses in acquiring property for the purpose of profit-making or as part of a profit-making undertaking or scheme are subtractable by the Commissioner in following the direction given by subs. (10). The pattern of drafting is confusing but the interpretation is open that these expenses are subtractable under subpara. (i) as “expenditure incurred by the taxpayer in respect of the relevant property”. But the reference to expenditure incurred “as part of a profit-making undertaking or scheme” poses a question of the correctness of the view taken above that none of the provisions of subss (2)–(12) of s. 25A has any application where the circumstances involve a profit-making undertaking or scheme within the second limb of s. 25A(1). Subparagraph (ii) contemplates expenditure in a scheme which commenced after the acquisition of the relevant property, for example a scheme to build houses for sale on land acquired for the purpose of profit-making by sale. A rigid separation of the operations of the first and second limbs of s. 25A(1) would require a distinct calculation of the profit from the scheme, a calculation that does not draw on subss (2)–(12) of s. 25A and no subtraction of the expediture in determining the profit from the first limb transaction. There would need to be some apportionment of the proceeds of sale to determine the amounts referable respectively to the first limb and to the second limb transactions. Indeed, there should in theory be a separation of the first limb transaction that began with the acquisition of the land and the first limb transaction that began with the acquisition of the house. The transaction that began with the acquisition of the house would not attract a deeming of acquisition for profit-making by sale, though the transaction that began with the acquisition of the land has done so.

[3.121] Two final observations on s. 25A(10)(b) may be appropriate. The calculation of the profit that would have been made by the transferor (X in the chart) if he had sold at the time of sale by the taxpayer (A in the chart) assumes a method of accounting that would bring in the consideration received and the consideration receivable by the taxpayer. The language used contrasts with the language in other paragraphs of s. 25A(10). In para. (a) the reference is to “proceeds of sale”. And it contrasts with the general provision, in subs. (9), which also refers to “proceeds of sale”. The phrase “proceeds of sale” admits of a method of accounting that would be designated profit-emerging. But para. (b) of s. 25A(10) does not.

[3.122] The second observation concerns the operation of subpara. (iii) which provides for the subtraction of any profit taxed to the transferor in determining the profit to be taxed to the taxpayer. The profit taxed to the transferor may be a profit that is assessable income of the transferor under s. 26AAA if purchase and sale by the transferor occurred within 12 months. The operation of s. 25A does not preclude the operation of s. 26AAA and the transferor’s profit will be calculated by reference to a sale price determined by s. 26AAA(4). Where the Commissioner is satisfied that transferor and the taxpayer were not dealing with each other at arm’s length, the transferor is deemed to have sold for an amount that in the opinion of the Commissioner was the value of the property. The taxpayer is deemed to have acquired for a consideration equal to that amount. The deemed consideration provided for in s. 26AAA(4) will not be relevant where s. 25A(10)(b) operates but the deemed proceeds of sale by the transferor raises the possibility that the resulting profit to the transferor may exceed the proceeds of sale by the taxpayer that remain after other subtractions. There is no provision whereby that excess may be treated as mitigating the profit that may arise on a subsequent sale by the person (B in the chart) who took from the taxpayer. The deemed consideration provided for in s. 26AAA(4) will not be relevant where the Commissioner must determine the taxpayer’s profit under s. 25A(9), s. 25A (10)(b) being inapplicable. The deeming is only for the purposes of s. 26AAA, and could be relevant only if there is another operation of s. 26AAA arising from B’s sale of his property within 12 months.

[3.123] Paragraph (b) of s. 25A(10), it has been noted, has an operation limited by the condition that the transferor (X in the chart) has actually acquired the property for the purpose of profit-making by sale. Where para. (b) is not applicable, the calculation of profit on sale by a taxpayer who is deemed to have acquired for the purpose of profit-making by sale will be made by the Commissioner under the general provision in s. 25A(9). Presumably, the Commissioner will not consider it appropriate to allow as a cost the value of the property taken by the taxpayer in the transfer to him in the prescribed manner. To allow that value as a cost would be to defeat a principal purpose of the enactment of subs. (5) of s. 25A. Yet a refusal to allow the value as a cost would be to depart from the general principle in Bernard Elsey Pty Ltd (1969) 121 C.L.R. 119, Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 and the principle asserted by Gibbs J. in Curran (1974) 131 C.L.R. 409.

[3.124] The policy the Commissioner will assert is that so much of the increase in value that has not been taxed to the transferor (X in the chart) should be brought to tax on A’s sale of the property. If the increase in value had been brought to tax on X’s transfer in the prescribed manner, A is entitled to be allowed a cost of the value of the property at the time of the transfer to him. Such a policy is reflected in the words of the definition of a transfer in the prescribed manner in subs. (11) of s. 25A. A transfer in the prescribed manner does not include a transfer by way of distribution of property of a private company or private trust estate to the transferee in his capacity as a shareholder in the company or a beneficiary of the trust estate, if the property transferred is excepted property defined in subs. (12). The items of expected property are trading stock, and plant or articles within the meaning of s. 54 purchased for use for the purpose of producing assessable income. In regard to these instances of excepted property there are provisions in s. 36 and s. 59 whereby the Commissioner may tax the transferor in a way that reflects the increase in value.

[3.125] The Commissioner must find a further policy when the question is whether he should bring to the computation of the profit the whole of the proceeds of sale by the taxpayer (A in the chart). Where the taxpayer is deemed to have acquired for profit-making by sale, but did not actually acquire for that purpose, there is room to argue that the policy of the new provisions is to bring to the calculation of profit only so much of the proceeds as will ensure that the profit that is income of A will include so much of the increase in value of the property in the hands of X as has not been brought to tax on the transfer by X to A. It may be expected, however, that the Commissioner will adopt as a further policy that a person who takes under a transfer in the prescribed manner ought to be taxed on any increase in value of the property during the time he holds the property. There may be some justification for such a policy where transferor and transferee (X and A in the chart) are persons who share income. It is hard to see the justification where they are not. None the less the Commissioner may claim that the policy he asserts is reflected in the specific provisions of s. 25A(10)(b) which do not contemplate any adjustment to the amount received by the transferee when he sells, such as would limit the amount taxed to him to the amount of the increase in value in the hands of the transferor that has not been taxed to the transferor.

[3.126] The determination by the Commissioner of a profit on sale will need to be made though the sale by taxpayer A is made in the prescribed manner, that is, in a non-arm’s length transaction for a consideration less than the value of the property. In such circumstances there is unlikely to be any question of the Commissioner excluding some of the proceeds of sale from the calculation of the profit, though in theory the issues that have been canvassed in previous paragraphs again arise.

[3.127] Whether or not the sale by taxpayer A is in the prescribed manner, there is the prospect of the allowance of a loss by the Commissioner under s. 52(2). There will be no loss allowable under s. 52(1)—it is precluded by s. 52(3). In theory, a loss may be allowed by the Commissioner though the sale was in the prescribed manner, so that the proceeds of sale are less than the value of the property sold. Section 52(5)(a) does not preclude the allowance of the loss in these circumstances—it is confined to an allowance of a loss under s. 52(1). The Commissioner is however unlikely to allow the loss. If he does, and s. 25A(10)(b) is applicable, there will be problems in the operation of that paragraph when B later sells the property. An appropriate determination of profit would need to add to the proceeds of sale by B the amount of the loss allowed to A. On the other hand, if s. 25A(10)(b) is not applicable—the view expressed above is that it is not—and the Commissioner acts only under s. 25A(9), it would be inappropriate, if he has not allowed A a loss, to calculate the profit derived by B by reference to the actual price paid by B to A.

[3.128] Section 52(2)(c) directs the Commissioner to have regard in all circumstances to the price paid by the person from whom the taxpayer acquired the property. In Chart A where B is the taxpayer, this would be the price paid by A to X. There is in the result some want of coherence with s. 25A(10)(b) which, in calculating a profit made by B, requires reference to the price paid by A only when A has actually acquired for the purpose of profit-making by sale. One is again left with an uneasy feeling that the circuitry of s. 25A and s. 52 is defective, and that both loss and profit depend on an unpredictable manual interference by the Commissioner.

[3.129] Paragraph (b) of s. 52(2) imposes a limitation on the Commissioner’s power to allow a loss. The limitation is that he must be satisfied that the property has not been held or used by the taxpayer in a manner inconsistent with the purpose of profit-making by sale that s. 25A(5) deems the taxpayer to have. The policy of para. (b) has some kinship with the policy reflected in s. 25A(10)(b)(ii). The policy of the latter provision is that a taxpayer should not be taxed on a profit attributable to improvements he may have effected to property unrelated to any profit purpose. That provision will also allow the Commissioner in effect to deny an element of loss in relation to the improvements. He would do this by setting the amount that would in his opinion have been the consideration received or receivable if the taxpayer had not incurred the expenditure, at a figure less than the amount of the expenditure. Paragraph (b) of s. 52(2) does not attempt any refinement in its operation. If there has been any use of the property which is inconsistent with the deemed purpose, the taxpayer is simply denied a loss, and this notwithstanding that at least some of his loss would none the less have been incurred if he had not made any inconsistent use of the property.

Disposition of an interest in property acquired for the purpose of profit-making by sale or a disposition of property in which an interest acquired for the purpose of profit-making by sale has merged: Transactions (III) and (IV)

[3.130] The relevant provisions are subss (6), (8), (9), (10)(c), (11) and (12) of s. 25A, and subss (2), (3), (4) and (5)(a) of s. 52. They may be described as the identity doctrine amendments, and the identity doctrine and N. F. Williams amendments.

[3.131] Transactions (III) and (IV) may be considered together. They are dealt with in Chart B. The background of the provisions dealing with these transactions is a development, in the cases interpreting the first limb of s. 26(a), of a doctrine that required an identity between the property acquired and the property sold. If there was no such identity, the first limb of s. 26(a) could have no operation.

[3.132] The first indications of an identity doctrine appear in the judgments of Windeyer J. at first instance in White (1968) 120 C.L.R. 191 at 208 and in the joint judgment of Taylor and Owen JJ. in the Full Court (at 218). Taylor and Owen JJ. said:

[3.133] The identity doctrine takes on more definition in the judgment of Windeyer J. in McClelland (1969) 118 C.L.R. 353 at 359:

A number of situations are identified in the passage quoted as situations to which s. 26(a) first limb did apply, the identity requirement being satisfied. There is identity where the taxpayer acquires property and sells part of it to another, for example on a subdivision of the property. There may however be a difference between selling the whole undivided interest in a part of property and selling a part of the undivided interest in the whole of the property. An example of the latter would involve a taxpayer who acquires property and sells a half undivided interest as tenant in common to another. The requirement of identity is satisfied where a taxpayer acquires the undivided half interest of two tenants in common, in each case for the purpose of profit-making by sale, and then sells the whole interest in the property. The requirement of identity in this case is satisfied even though there has been a merger of the undivided interests. The requirement of identity will not however be met where a taxpayer holds an undivided half interest as tenant in common, acquired in circumstances where there was no purpose of profit-making by sale, and then acquires the other undivided half interest for the purpose of profit-making by sale. Thereafter he sells the whole interest in the property. The doctrine requiring identity received the support of Barwick C.J. in A. L. Hamblin Equipment Pty Ltd (1974) 131 C.L.R. 570 at 575, where he treated it as not satisfied where the hirer under a hire-purchase agreement has an interest not acquired for the purpose of profit-making by sale, and thereafter acquires the remaining interest in the property from the owner for the purpose of profit-making by sale. He also treated it as not satisfied where a lessee has an interest not acquired for profit-making by sale, and subsequently acquires the reversion for the purpose of profit-making by sale. Mason J. agreed with Barwick C.J. on statements of the identity doctrine, disagreeing only on the view to be taken of the facts. Mason J. did however offer a statement in relation to the identity doctrine in which neither Windeyer J. nor Barwick C.J. might have agreed. He considered that the requirement of identity is satisfied where property is acquired for the purpose of profit-making by sale and newly created strata titles to parts of the property are sold.

[3.134] Section 25A(6) is directed against the defeat of the operation of the first limb of s. 25A that the requirements of identity might involve. It will operate within its terms to deem the taxpayer (A in Chart B) to have acquired the property he sells for the purpose of profit-making by sale, and will thus satisfy the identity requirement in a number of circumstances where it would otherwise defeat the operation of the first limb: The consequence that the Commissioner has a function to determine under s. 25A(9) the profit arising from the sale is attracted. In this regard the provisions of s. 25A(10)(c) will be relevant. Section 25A(6) may however have a wider operation. Its terms may cover circumstances in which the identity requirement is satisfied. It will none the less bring about a deemed acquisition by the taxpayer of the property sold for the purpose of profit-making by sale, and the Commissioner’s function to determine the profit will be attracted. In this aspect, s. 25A(6) does not prevent the defeat of the first limb of s. 25A(1). No defeat is threatened. It makes a significant change however in the operation of the first limb, so as to substitute for principles of profit determination a function in the Commissioner, a function whose policy will not, in this instance, be readily apparent.

[3.135] The scope of s. 25A(6) in preventing the defeat of the first limb might first be considered. It may be thought that s. 25A(6) will not operate in the circumstances of McClelland, as they are described by Windeyer J. in the quotation in [3.133] above, if there is no merger of the brother’s interest with the already subsisting interest of the taxpayer. The terms of s. 25A(6), in para. (b)(ii), require that the property sold should be property “in which was merged an interest in property, being an interest acquired by the taxpayer for the purpose of profit-making by sale”. It may be, of course, that where there is no merger the identity requirement is satisfied. None of the statements of the doctrine is definitive in this respect. And there is a question of how a merger can be prevented. Section 10 of the Conveyancing Act 1919 (N.S.W.) provides that “there shall not … be held or deemed to be any merger by operation of law only of any estate, the beneficial interest in which would not be deemed to be merged or extinguished in equity …”. The Equity Court will have regard to the intention of the parties in deciding whether a merger has occurred. The possibility is thus open that a provision in the contract by which a tenancy in common is acquired, or a provision in the conveyance of the interest, may be sufficient to prevent a merger and exclude the operation of s. 25A(6). This is to assume that the word “merger” in the provision will receive a technical construction, so that the word will be given the meaning it has as a term of legal art.

[3.136] There is a number of circumstances where s. 25A(6) will operate though the circumstances are such that the requirement of identity is satisfied. In these circumstances the provision brings about a change in the operation of the first limb of s. 25A(1), by letting in a Commissioner’s function to determine the profit from the transaction. It is enough that the property sold was “an interest in property, being property acquired by the taxpayer for the purpose of profit-making by sale”. The word “interest” in this context may be given a meaning that is wide enough to cover the sale of the whole interest in part of property acquired for profit-making by sale. It would thus cover the acquisition of property and sales of it in subdivision. And it would cover the acquisition of property and sales of newly created strata titles to parts of the property, a circumstance where, in the view of Mason J. in Moruben Gardens Pty Ltd (1972) 46 A.L.J.R. 559, the requirement of identity is satisfied.

[3.137] In McClelland (1969) 118 C.L.R. 353 Windeyer J. expressed the view that the identity requirement is satisfied where a taxpayer purchases the interests of two tenants in common in property and thereafter sells the property. Those circumstances are none the less covered by the words of s. 25A(6)(b)(ii), which will apply notwithstanding that both of the interests which merge the one in the other were acquired for the purpose of profit-making by sale.

[3.138] The consequences of a deeming under s. 25A(6) are the letting in of the Commissioner’s power to determine the profit under s. 25A(9) on the sale of the property, guided by the direction in s. 25A(10)(c), and the Commissioner’s power to adjust the amount of a loss under s. 52(4) in the situation where the deemed acquisition for the purpose of profit-making by sale depends on the operation of s. 25A(6)(b)(ii)—the merger situation there described.

[3.139] The direction given by s. 25A(10)(c) is presumably intended to ensure that the Commissioner will exclude from the profit brought to tax, so much as may be regarded as arising from that interest in the property sold that was not actually acquired for the purpose of profit-making by sale. The direction is framed in the vaguest of terms, but the suggested intention is at least a rational explanation. In Chart B the determination of the profit by the Commissioner on the sale by A, will, in a s. 25A(6)(ii) situation where only one of the interests that have merged was acquired for the purpose of profit-making by sale, exclude so much as is attributable to the interest that was not acquired by A for the purpose of profit-making by sale. Thus in the circumstances of McClelland, assuming that the taxpayer does not acquire the inherited interest for the purpose of profit-making by sale, profit on the sale of that interest when merged with the interest acquired for profit-making by sale should have excluded from it the element that is attributable to the inherited interest.

[3.140] A method of exclusion would be to apportion the proceeds of sale between the two interests by reference to the values of the two interests before their merger. A method that would apportion by reference to the costs of the two interests would have an unfair operation. Any method adopted by the Commissioner is likely to seek to bring to tax the element of increase in value of the interest actually acquired for profit-making by sale, that arises on its merger with the other interest. A method that seeks to exclude that element of increase in value would need to identify so much of the proceeds of sale as would have been the proceeds if only an interest equivalent to the interest acquired for profit-making by sale had been sold. That would involve an exercise in reconstruction that might be thought to be outside the Commissioner’s function. It is of course an exercise in reconstruction on which he would not easily be persuaded to engage.

[3.141] One might expect that the method the Commissioner adopts for separating out and excluding an element of profit attributable to the interest not acquired for profit-making by sale, will also be adopted in separating out the element of any loss that is attributable to that interest when the Commissioner exercises his function under s. 52(4).

[3.142] Where the sale in Chart B by A to B is made in the prescribed manner, problems of the method of profit determination to give effect to the direction in s. 25A(10)(c) arise, but all problems in regard to the method of loss determination are excluded by s. 52(5)(a): no loss is allowable.

[3.143] Such a sale in the prescribed manner will attract the operation of s. 25A(8), whose purpose parallels the purpose of s. 25A(5). The person who takes under the sale in the prescribed manner (B in Chart B) is deemed to have acquired the property for the purpose of profit-making by sale. Where the property is the result of a merger with other property, the deeming extends to the whole of the property acquired. If B sells to C, the profit will be determined by the Commissioner in accordance with the direction in s. 25A(10)(c). The problems involved in finding a method of determining profit that will fairly reflect that direction, considered in [3.140] and [3.141] above, will again arise. And there will be problems of a kind considered in dealing with Transaction (II) in [3.115] and [3.125] above, as to the extent of the profit that it is the policy of the Act to include in B’s income. The question is whether the policy is only to include the residue of the profit that would have been made by A had he not sold in the prescribed manner. In that regard it may be appropriate to distinguish the case where B has taken only with a deemed purpose of profit-making by sale, from a case where he has an actual purpose of profit-making by sale.

[3.144] If B has taken with an actual purpose of profit-making by sale there will not be any room for the operation of the direction in s. 25A(10)(c): all the property sold will be property that has been acquired by some person for the purpose of profit-making by sale. Within the terms of s. 25A(10)(c) all the “property consists of, or is attributable to, the related property”. And there will be no room for the operation of s. 52(4) in determining a loss.

[3.145] Section 25A(8) parallels the purpose of s. 25A(5), but there is no attempt in s. 25A(10)(b) to extend that paragraph to the determination of a profit on the sale of a property deemed by s. 25A(8) to have been acquired for profit-making by sale. No doubt the draftsman was glad to be relieved of the need to design the circuitry that would have been necessary.

[3.146] Where the question is one of the allowing of a loss, s. 52(2) is applicable and in this respect the consequences of s. 25A(5) and (8) are in parallel. Thus, curiously it may be thought, a loss may be allowable to B on his sale in the prescribed manner to C, though a loss on a sale in the prescribed manner was not available to A. Section 52(5)(a) there denied the operation of s. 52(1), and s. 52(2) had no application.

A taxpayer actually acquires shares in a company for the purpose of profit-making by sale, or is deemed by the operation of any provisions of s. 25A to have acquired shares for that purpose, and the company makes a bonus issue or a rights issue to the taxpayer: Transaction (V)

[3.147] The transaction, extended so as to indicate the consequences of sales of the bonus shares or the rights, is outlined in Chart C. The key provisions are s. 25A(4) and s. 25A(10)(d) and (e). They might be described as the Miranda amendments.

[3.148] The background of these provisions is the decision of Rath J. in Miranda (1976) 76 A.T.C. 4180. Bonus shares and rights to shares issued by a company are items of property distinct from the shares in regard to which they are issued. A taxpayer who sells bonus shares or rights issued to him in respect of shares he has acquired, does not sell the original shares. It was therefore irrelevant, in determining the operation of s. 26(a) on the sale of the bonus shares or rights, that the original shares may have been acquired for the purpose of profit-making by sale. The bonus shares and rights are not in themselves property acquired for the purpose of profit-making by sale. There was no purposive acquisition, at least when the taxpayer who receives the shares or rights did not exercise any control of the directors of the company that made the issue.

[3.149] The effect of s. 25A(4) is to deem bonus shares and rights issued by a company to a taxpayer who acquired the shares to which the issues relate for the purpose of profit-making by sale, to have themselves been acquired by the taxpayer for the purpose of profit-making by sale. The deeming will give the Commissioner power to determine how much of the proceeds of sale should be treated as a profit arising from the sale of the bonus shares or rights. Where bonus shares are involved, s. 25A(10)(e) provides that the cost to the taxpayer is to be ascertained in accordance with s. 6BA. Where rights are involved, s. 25A(10)(d) provides that the rights shall be deemed to have been acquired by the taxpayer at no cost. Section 25A(4) is confined in its operation to bonus and rights issues, and in the latter respect to rights issued “by reason that the taxpayer was the owner of the shares” (s. 25A(4)(b)(ii)). It does not apply to rights issued to a taxpayer by reason of his ownership of options, debentures or securities.

[3.150] Section 25A(10)(e) specifically adopts s. 6BA in the determination of the cost of the bonus shares. Section 6BA will have the effect of transferring some of the cost of the original shares to the bonus shares, and will deny that any part of the moneys paid up on the bonus shares in the process of their issue is a cost to the taxpayer of the bonus shares. The denying of the cost will operate save where the moneys paid up have been or will be included in the assessable income of the taxpayer, and the taxpayer is not a resident treat the acquisition of the options as an acquisition at no cost notwithstanding that the taxpayer has paid a substantial sum on the exercise of the rights, in acquiring the options. At the same time it might be observed that the issue of rights to options requiring only a minimal payment on the exercise of the rights will be a way of defeating the purpose of s. 25A(4). There is of course the prospect that the options will in fact be purposively acquired and a profit company: s. 6BA(2) and (4). Section 6BA overcomes Curran (1974) 131 C.L.R. 409, in its possible application to bonus shares that are deemed to have been acquired for profit-making by sale.

[3.151] A suggestion might be raised that the operation of s. 25A(4) can be avoided if the bonus issue is not made “in satisfaction of a dividend … payable to the taxpayer in respect of the shares”—the words of s. 25A(4). But the issue of bonus shares without any expressed intermediate stage of dividend and application of that dividend in paying up the shares, raises the prospect that the shareholder has received a dividend on which he is subject to tax. Indeed even if the bonus shares are expressed to be in satisfaction of a dividend, they will only escape tax as a dividend if the dividend is wholly and exclusively out of profits arising from the sale or revaluation of assets not acquired for the purpose of resale at a profit (s. 44(2)).

[3.152] An attempt to make a bonus issue without a dividend in satisfaction of which the shares are issued may involve one of two consequences. The bonus issue will be construed as the declaration of a dividend to be applied in paying up the bonus shares. In which event s. 25A(4) has not been avoided, and the shareholder may find that he has both acquired a taxable dividend and is deemed to have acquired for the purpose of profit-making by sale. The construction may not extend to treating the dividend as wholly and exclusively out of capital profits. The other possible consequence is that the shareholder may be treated as holding shares that are subject to call of the amount to which they are expressed to be paid up. In the latter event, s. 25A(4) has been avoided, but there is a prospect that in accepting a liability to make payment for the shares the taxpayer will be held to have acquired for the purpose of profit-making by sale.

[3.153] Rights issued in respect of the shares acquired for profit-making by sale will be deemed to have been issued at nil cost: s. 25A(10)(d). There is no provision that will transfer cost from the original shares to the rights in the way in which some part of the cost of the original shares will be transferred by s. 6BA to bonus shares. Section 52A is inapplicable. It applies only when shares are acquired as trading stock, or in the carrying on or carrying out of a profit-making undertaking or scheme. In the result the effect of a rights issue will continue to create an opportunity for the taxpayer to sell the original shares at a loss for tax purposes, though the fall in value of the original shares is effectively recouped to the taxpayer by the rights issue. There is a question whether s. 25A(4) extends to options to acquire shares issued by a company to the owner of shares, following the exercise by him of rights to acquire options issued to him by the company. Presumably it does not. The issue to the taxpayer of the options is not made to the taxpayer by reason that has was the owner of the shares but by reason that he was the owner of the rights. If the subsection did extend to the options, s. 25A(10)(d) would have rogue operation. It would treat the acquisition of the options as an acquisition at no cost notwithstanding that the taxpayer has paid a substantial sum on the exercise of the rights, in acquiring the options. At the same time it might be observed that the issue of rights to options requiring only a minimal payment on the exercise of the rights will be a way of defeating the purpose of s. 25A(4). There is of course the prospect that the options will in fact be purposively acquired and a profit on the sale of the options will be income. But in the determination of that profit the value of the rights at the time of exercise will be a cost of the options.

[3.154] The power in the Commissioner to determine a profit on the sale of the bonus shares, a power given him by s. 25A(9), is qualified by s. 25A (10)(e). The Commissioner’s power is confined to the exercise of the functions given him by s. 6BA. Equally the Commissioner’s power to determine a profit on the sale of the rights issued to the taxpayer in respect of the original shares is confined by s. 25A(10)(d). In effect he has no function to perform. The gross proceeds of sale of the rights will be the profit that is income.

[3.155] The fact that the sale of the bonus shares is made in the prescribed manner will not give the Commissioner any special power to determine the profit. A power to determine how much of the proceeds of sale it is appropriate to treat as a profit, is not a power to increase the proceeds of sale so that they represent a market price. A sale of the bonus shares in the prescribed manner may not however give rise to a loss. Section 52(5)(a) precludes the allowance of a loss.

[3.156] A sale of the bonus shares or of the rights in the prescribed manner (by A to B in Chart C) will however give rise to a deeming that B has acquired for the purpose of profit-making by sale. Section 25A(5) will give rise to this deeming, though A did not actually acquire the bonus shares or rights for profit-making by sale. Problems of determining the profit that is income on sales by B have already been explored in other contexts. A curiosity already noted is evident also here. A sale by A in the prescribed manner cannot give rise to a loss, but a sale by B may do so.

[3.157] The consequences of s. 25A(4) and s. 25A(10)(d) if the taxpayer does not sell the rights, but exercises them, and subsequently sells the shares, call for some examination. The sale of the shares is not a sale of the rights, and it may be doubted that s. 25A(6) will require that the shares be deemed to have been acquired for the purpose of profit-making by sale. The shares are not property in which the rights have merged.

[3.158] The acquisition of the shares might be seen as a two stage acquisition —the acquisition of the rights and the exercise of the rights. But tax consequences on the sale of the shares will require, in the exercise of the rights, at least an actual purpose of acquisition for profit-making by sale. And there will be a question whether the deemed purpose under s. 25A(4) in relation to the rights may be combined with an actual purpose on exercise, so as to give an actual purpose of profit-making by sale in the acquisition of the shares. If the deemed and the actual can be combined in this way there will be a further question as to the cost of the rights as an element in the cost of the shares. The deeming by s. 25A(10)(d) that rights have a nil cost does not appear to have any application. The deeming is expressed to be for “the purposes of the application of subs. (9)”, which is concerned with the determination of the profit on the sale of property that is deemed to have been acquired by the taxpayer for the purpose of profit-making by sale by virtue of any of the preceding provisions of the section. The shares acquired in the exercise of the rights are not deemed to have been so acquired. In the result the rights will have a cost equal to their value at the time of their exercise.

[3.159] If the acquisition of the shares is seen as a one-step acquisition in the exercise of the rights, as in Executor Trustee & Agency Co. of S.A. Ltd (Bristowe’s case) (1962) 36 A.L.J.R. 271, it is even clearer that s. 25A(10)(d) can have no application. The cost of the shares will include the value of the rights at the time of their exercise.

Section 26AAA: Gains from the Sale of Property within 12 months of Purchase

[3.160] Section 26AAA was added to the Assessment Act in 1973. Its effect is to extend the meaning of income in the Act to include gains which would not be income within the ordinary usage meaning of the word or s. 25A(1). Where purchase and sale of property are within a period of 12 months a resulting gain by a taxpayer will be income under s. 26AAA whether or not s. 25A is also attracted and, it seems, whether or not his actions also amount to an isolated business venture. Where, however, “the property [sold] was included in the assets of a business carried on by [a] taxpayer and, as a result of the sale, an amount will be included in the assessable income of the taxpayer under a provision of the [Assessment Act] other than [s. 26AAA]”, s. 26AAA has no operation to make any gain on the sale income of the taxpayer. This is the effect of s. 26AAA(5)(a). Presumably the reference to “business carried on” is a reference to continuing business operations.

[3.161] Attention is directed in [3.122] to possible consequences of the concurrent operations of s. 26AAA and the first limb of s. 25A(1).

[3.62] The effect of Mullins (1981) 81 A.T.C. 4643 is that a balancing charge arising, on the sale of land within 12 months of purchase, as a result of depreciation allowed in respect of fences on the land, will exclude the operation of s. 26AAA if the land is an asset of a business carried on by the taxpayer. There may in the result be the exclusion from income of a substantial sum at the price of what may be a relatively small balancing charge under s. 59. The exclusion is by the operation of s. 26AAA(5)(a), and not s. 26AAA(5)(b). The latter provision excludes the operation of s. 26AAA if “section 54 applied in relation to the property and, as a result of the sale, section 59 applies in relation to the property”. The relevant property is the land, and not the fixture that is the item of depreciable property.

[3.63] Another limitation on the operation of s. 26AAA is provided for in s. 26AAA(5)(c) where the sale is a sale of property used by the taxpayer as a sole or principal residence, or is a sale of shares which give a right of occupancy of a flat or home unit used by the taxpayer as his sole or principal residence. Section 26AAA will not apply if the sale took place as a result of a change in the place of employment, or place of business of the taxpayer. Section 26AAA(6) qualifies the limitation where only part of the land sold is occupied by a dwelling used by the taxpayer as a sole or principal residence.

[3.164] The operative provision of s. 26AAA is s. 26AAA(2). The words of s. 26AAA(2) have meanings extended by the interpretations in subs. (1) and by the deeming provisions of subss (3), (4) and (7). The words of s. 26AAA and those extensions and deeming provisions do not appear to preclude the application to s. 26AAA of the identity requirement that was applicable to the first limb of s. 26(a). Section 26AAA(2), by its terms, covers a purchase of property and the sale of an interest in that property, but that was probably not a situation affected by the identity requirement of s. 26(a). The identity requirement, as it operated in McClelland and Hamblin, would appear to be applicable to s. 26AAA. Section 26AAA(1)(a) gives an extended interpretation to “property”, but does not seek to deal with an identity requirement.

[3.165] Where a bonus issue of shares is made attendant upon original shares that were purchased by the taxpayer within 12 months before the bonus issue, the bonus shares are deemed to have been purchased by the taxpayer at the time he purchased the original shares. Subsection (7) presumably deems the fact of purchase to have occurred, and fixes the time of that purchase. There are two deemings involved. The bonus shares are deemed to have been purchased, where they are issued within 12 months of the purchase of the original shares, and they are deemed to have been purchased at the time when the taxpayer purchased the shares in respect of which the dividend was payable. A bonus issue is presumably not purchased in other circumstances. An inference may be drawn from paras (d) and (e) of s. 26AAA(1) that the acquisition of property that comes into existence only as it is acquired is not a purchase of that property: the notion of purchase is confined, in the absence of some deeming, to an acquisition of property that existed before the purchase. It is possible that a bonus issue is a purchase as “the acquisition of … share[s] by way of a subscription of capital” which, by s. 26AAA(1)(d), is deemed to be a purchase. The subscription of capital, it might be argued, is the notional dividend involved in the bonus issue which is applied by the company in the paying up of the shares. If s. 26AAA(1)(d) does not supply the element of purchase, bonus shares issued more than 12 months from the time of purchase of the shares in respect of which they were issued cannot attract the operation of s. 26AAA. Where s. 26AAA does operate the determination of the cost of the bonus shares will be made by the Commissioner under s. 6BA(3), unless the operation of that provision is excluded by s. 6BA(4). It may be excluded, in the case of a taxpayer other than a company, if the bonus shares themselves involve a derivation of income, s. 44(2) being inapplicable. In which event, the cost for purposes of determination of a s. 26AAA profit is not expressly dealt with. On general principle the cost would be, in these circumstances, the amount of the dividend applied in paying up the bonus shares—the amount credited within the definition of “dividend” in s. 6, that is assessable income under s. 44(1). The general principle of tax accounting is that an item of property that is income arising in some process of derivation of income must be given a cost of the amount in which it is income. There will otherwise be double taxation of an income item.

[3.166] A bonus issue attendant upon shares which were themselves bonus shares does not appear to be covered by s. 26AAA(7). Section 26AAA(7) does not in its terms contemplate successive applications so as to deem the bonus shares to be shares purchased for purposes of para. (a). The second bonus issue would thus escape the operation of s. 26AAA, unless the interpretation provision in s. 26AAA(1)(d) is considered to be applicable. The application of subs. (1)(d) would require the characterisation of a bonus issue as “the acquisition of a share by way of a subscription of capital”.

[3.167] A rights issue is not made in any circumstances a purchase of the rights.

[3.168] Section 26AAA(1)(f) substantially extends the operation of s. 26AAA in a wide range of situations. A transfer by way of gift, either wholly so, or partly so because of inadequacy of consideration, is a deemed sale by the transferor and a deemed purchase by the transferee. There is a question of the cost to be allowed in determining the amount of the profit which is income of the purchaser if he sells within 12 months. Were it not for s. 26AAA(4) the principle asserted in [3.39]–[3.41] above in relation to the first limb of s. 25A(1) would be appropriate: the transferee would be deemed to have purchased at market value at the time of acquisition. The deeming provided for in the concluding words of s. 26AAA(4)(c) presents a difficulty. The need for a deeming that the donee has purchased at market value in a case where the donor is subject to the operation of s. 26AAA(4) may suggest that a donee in other circumstances is not entitled to market value as his cost. An inference of this kind would be unfortunate.

[3.169] In the last paragraph it was assumed that s. 26AAA(1)(f) deems that there is a purchase where money is paid for property but the amount is less than the market value of that property. It could be said that in these circumstances property is “transferred … in exchange for other property”. Such a situation may in any case be a sale and purchase without the assistance of any deeming. Whether there is a deemed or actual purchase, the principle supported in [3.39]–[3.41] above should apply.

[3.170] There are situations where the application of s. 26AAA(1)(f) may be considered doubtful. It may be asked whether the transfer of property to a beneficiary under a will is a transfer “without consideration”. It may be asked whether the transfer of property in specie to a shareholder by way of dividend, or in the liquidation of a company, is a transfer “without consideration”. In relation to both questions the reasoning in Archibald Howie Pty Ltd v. Commissioner of Stamp Duties (N.S.W.) (1948) 77 C.L.R. 143 would suggest a negative answer. If however, these situations are held to be within subs. (1)(f), the question of cost for purposes of computing the profit which is income of the transferee will be so much the more pervasive. It would be argued that the cost is the market value of the item at the time of its receipt by the transferee.

[3.171] It will be recalled that there can be no profit which is income under the first limb of s. 25A(1) unless there is a sale, and under both limbs any profit which is income must be calculated by reference to actual proceeds so that there can be no profit which is income if property is given away or disposed of for a consideration less than cost. A gift therefore is a way of aborting a s. 25A(1) transaction, though the character of a transaction as a s. 25A(1) first limb transaction, will generally be transferred, by s. 25A(5), to the transaction in which the donee acquires the property. Section 26AAA, in subs. (4), includes a provision which deems a sale in circumstances where the Commissioner is satisfied that the parties were not dealing with one another at arm’s length, to be a sale at a price which in the opinion of the Commissioner was the value of the property at the time of sale. Subsection (4) has a function akin to s. 36 in relation to trading stock disposed of otherwise than in the course of carrying on a business.

[3.172] Section 26AAA(3) deems a purchase and sale to be within the 12 months period, though the sale is made outside that period, if the sale was made in pursuance of an option or agreement granted or entered into during that period. In this case, if s. 26AAA(4) is applicable, the value of the property sold is determined not at the time of sale but at the time of the option or agreement.

[3.173] In [3.46] above attention was drawn to the implications of Hobart Bridge Co. Ltd (1951) 82 C.L.R. 372 in providing a way of escape from the operation of the first limb of s. 26(a). The provisions of subss (2) and (3) of s. 25A, in blocking off that way of escape, were considered in [3.85]–[3.102] above. The way of escape from s. 26(a) suggested by Hobart Bridge had its parallel in a way of escape from the operation of s. 26AAA which involved the purchase of property by a subsidiary company and the sale of shares in the holding company within 12 months of the purchase by the subsidiary. The taxpayer, in a typical set of circumstances, was the holding company of a subsidiary that had been formed to acquire shares in another company in a take-over bid. The subsidiary would acquire shares in the take-over target, not for the purpose of profit-making by sale but to hold them. If, however, the bid was unsuccessful, it would be anticipated that the taxpayer would sell its shares in the subsidiary at a profit reflecting an increase in value of the shares held by the subsidiary in the target company. That increase in value may have arisen from the pressure of another bid for shares in the target company made by the ultimately successful bidder. The sale of shares by the taxpayer would be made within 12 months of the acquisition of shares by the subsidiary. But the subsidiary, now the subsidiary of the successful bidder, would continue to hold the shares it had acquired in the course of the earlier bid at least until 12 months had expired from the acquisition of those shares.

[3.174] In 1982 subsections were added to s. 26AAA to prevent this way of escape. The relevant provisions are s. 26AAA(1)(h)-(m), (2A), (2B), (3A), (4)(a), (4)(c)(iii), (4)(c)(iv) and (10). At the same time provisions were added to prevent another way of escape from the operation of s. 26AAA. A company or trust holding property acquired within 12 months would make a distribution of that property to a shareholder or beneficiary. The distribution, it was considered, did not qualify as a sale despite the extended meaning given to the concept of sale by s. 26AAA(1)(f). The person taking in the distribution had not purchased the property, and could sell without attracting the operation of s. 26AAA. There would be no purposive acquisition to let in the operation of s. 26(a). The provisions directed to closing this way of escape are s. 26AAA (1)(h)-(m), (8), (9), (10) and (11).

[3.175] The provisions directed against the way of escape suggested by Hobart Bridge have as their core s. 26AAA(2A). There are obvious parallels with the s. 25A(2) provisions considered in [3.85]–[3.102] above. The provisions now considered were in fact the model for s. 25A(2).

[3.176] Section 26AAA(2A) is concerned with a sale of property that was acquired by a taxpayer more than 12 months before the sale. Where a sale relates to property that was acquired within 12 months of the sale, the relevant provision is s. 25AAA(2). That provision, it may be noted, has a narrower operation than s. 26AAA(2A) in one among other respects. It applies only where there has been a purchase. Section 26AAA(2A) requires only an acquisition. It is true that the meaning of purchase is extended for purposes of s. 26AAA(2) by a number of paragraphs of s. 26AAA(1). But the acquisition of an interest on entering into a partnership agreement, or the acquisition of an interest in a trust on the declaration of a trust, would not appear to be a purchase.

[3.177] The property must be shares in a private company (defined in s. 26AAA(1)(j) in the manner of the definition in s. 25A(12)); an interest in a partnership; or an interest in a private trust estate (defined in s. 26AAA (1)(k) in the manner of the definition in s. 25A(12)). The private company, partnership or trustee of a private trust estate will in the discussion that follows be identified as the primary intermediary.

[3.178] Where the property sold consists of shares in a primary intermediary that is a private company, or an interest in a primary intermediary that is a trust estate, it is enough to attract the operation of s. 26AAA(2A) that the assets of the private company or private trust estate immediately before the sale by the taxpayer included property purchased within 12 months preceding the date of the sale by the taxpayer, that was not excepted property. This property will be identified as underlying property. It will be noted that there is no mention of underlying property held by a partnership primary intermediary (s. 26AAA(2A)(c)(i)). The inference may be that the sale of a taxpayer’s interest in a partnership is to be seen as a sale of an interest in partnership assets, and s. 26AAA(2) will apply whenever the assets were acquired by the partnership less than 12 months before the sale of the interest in the partnership.

[1.179] Where the property sold consisted of shares in a private company, an interest in a partnership or an interest in a private trust estate, the operation of s. 26AAA(2A) will be attracted if the company, partnership or trustee of the trust estate held an interest in underlying property at a lower level, through one or more interposed companies, partnerships or trusts, in property that was purchased by another private company, partnership or trustee of a private trust estate within a period of 12 months immediately preceding the sale by the taxpayer, and this underlying property was not excepted property (s. 26AAA (2A)(c)(ii)). It will be noted that in this instance s. 26AAA applies to a sale by the taxpayer of an interest in a partnership. It will also be noted that the tracing of property from the primary intermediary to what may be called a sub-intermediary may be made through a company or trust estate that is not a private company or private trust estate.

[3.180] Whether the underlying property is held by a primary intermediary or a sub-intermediary, the operation of s. 26AAA(2A) is subject to a condition that immediately before the sale by the taxpayer of his shares in the private company, his interest in the partnership or his interest in the private trust estate, the value of the underlying property was not less than 75 per cent of the net worth of the company, partnership or trust estate that is the primary intermediary (s. 26AAA(2A)(d)).

[3.181] The operation of s. 26AAA(2A) is to include in the assessable income of the taxpayer so much of the consideration received or receivable by the taxpayer in respect of the sale as, in the opinion of the Commissioner, may reasonably be attributed to the amount (if any) by which the value of the underlying property immediately before the sale exceeds the sum of the consideration given or agreed to be given for underlying property by the primary intermediary or sub-intermediary, and so much of any other expenditure incurred in relation to the underlying property as, in the opinion of the Commissioner, is appropriate in the circumstances.

[3.182] Excepted property is defined in s. 26AAA(1)(m). It includes trading stock of the company, partnership or trustee, and property acquired by the company, partnership or trustee for the purpose of profit-making by sale or carrying on or carrying out any profit-making undertaking or scheme. In both aspects what is included in excepted property is qualified by s. 26AAA(2B). The qualification is not easily interpreted. It applies in relation to underlying property at any level but only in its terms to underlying property held by a company or trust estate. It has no application in its terms to property held by a partnership. The assumption behind s. 26AAA(2A)(c)(i) thus reappears, though, it will have been noted, it is not an assumption of s. 26AAA(2A)(c)(ii). The assumption is that assets of a partnership are assets of the partners. The qualification by s. 26AAA(2B) comes into operation where the Commissioner is satisfied that the consideration received or receivable by the taxpayer, in respect of the sale of shares or interest in the primary intermediary, was substantially more than the consideration that might reasonably be expected to have been received or receivable by the taxpayer if the taxpayer and the person who purchased the shares or interest from the taxpayer had expected that the underlying property would be disposed of by the intermediary immediately after the sale for its market value, and an amount would have been included in the assessable income of the intermediary. The reasoning behind the qualification would seem to be that in circumstances where it appears that it was not contemplated that there would be a sale of the trading stock or of the property acquired for profit-making by sale or carrying out of any profit-making undertaking or scheme, there is no reason for the qualification. The qualification is thus a partial anticipation of the provisions of s. 25A(2) introduced in 1984. Those provisions will cover the circumstances brought within s. 26AAA(2A) by the qualification to the exception, though they will of course have a wider operation. The operation of s. 26AAA(2A) requires that the acquisition by the intermediary should have been by way of purchase, and that the purchase should have been within 12 months before the sale of the shares or interest by the taxpayers. No such conditions apply to s. 25A(2). The operation of s. 26AAA(2A) requires that the shares or interest acquired by the taxpayer should have been acquired more than 12 months before the sale of the shares or interest. No such condition applies to s. 25A(2). The operation of s. 26AAA(2A) requires that the value of the underlying property should be not less than 75 per cent of the net worth of the primary intermediary. No such condition applies to s. 25A(2). Where both s. 26AAA(2A) and s. 25A(2) are applicable there will be income derived under two provisions, but there will not be double taxation. The Commissioner may however rely on the provision that will give rise to the greater amount of income. The general principles in this regard are considered in [12.220]ff. below.

[3.183] The determination of the amount of assessable income under s. 26AAA(2A) requires the exercise of a function by the Commissioner to determine how much of the consideration received or receivable on the sale by the taxpayer of his shares or interest, is attributable to the increase in value of the underlying property over the amount of the consideration given or agreed to be given for the underlying property. The effect is to treat as income derived by the taxpayer on the sale of his shares or interest an element of gain that is not yet, and may never be, income at the level of the intermediary.

[3.184] Some specific issues in relation to the operation of s. 26AAA(2A) require examination. In attributing the proceeds of sale of the shares or interest to the increase in value of the underlying property, the Commissioner could not properly make an attribution in respect of underlying property held by the primary intermediary, and at that same time make an attribution in respect of an increase in value of underlying property held by a sub-intermediary, where the latter increase in value will have been reflected in the increase in value of the underlying property held by the primary intermediary. A like point was made in [3.97] above in regard to the operation of s. 25A(2).

[3.185] There are difficulties in interpreting the condition imposed by s. 26AAA(2A)(d) that immediately before the sale of the shares or interest, the value of underlying property whose increase in value gives rise to assessable income found in the proceeds of the sale of the shares or interest, must be not less than 75 per cent of the net worth of the company partnership or trust in which the shares or interest are held. On one view the condition must be satisfied in relation to each individual item of underlying property. Such an interpretation would raise problems as to what is an individual item of property. Another interpretation would aggregate all items of property purchased by the primary or a sub-intermediary within 12 months before the sale of the shares or interest. That interpretation would be unacceptable in the respect that it involves what might be called double counting of the kind identified in [3.97] above. An acceptable interpretation would require an aggregation of all underlying property that may properly give rise to assessable income found in the proceeds of sale of the shares or interest.

[3.186] The value of the underlying property that enters the calculation required by s. 26AAA(2A)(c) must be not less than 75 per cent of the net worth of the primary intermediary. Net worth is defined in s. 26AAA(1)(h) as the total assets of the primary intermediary reduced by its total liabilities. Section 26AAA(10) is directed against action that might be taken to increase that net worth by discharging liabilities, or by the acquisition of assets, for the purpose of ensuring that the value of the underlying property that enters the calculation will be less than 75 per cent of net worth. If the Commissioner is satisfied that the purposes of discharge or acquisition included such a purpose, he may disregard the discharge or acquisition. An increase in the assets of the primary intermediary will not achieve the purpose if the assets are purchased at their market value within 12 months of the sale by the taxpayer of his shares
or interest in the primary intermediary. Indeed it will defeat that purpose. The cost of purchase will leave the net worth of the intermediary unaffected. But a raising of capital by the primary intermediary would achieve the purpose of diminishing the fraction that the underlying property that enters the calculation represents of the net worth of the primary intermediary. It may be noted that conversely a primary intermediary that relies heavily on loan capital, and has little share capital or reserves, will very easily cause the taxpayer to be caught by the condition that underlying property that enters the calculation is not less than 75 per cent of net worth.

[3.187] Action might be taken to diminish the value of an item of underlying property, for example by the issue of options or rights in respect of shares that are underlying property. The options or rights would not themselves be items of underlying property that are relevant to the operation of s. 26AAA(2A). They have not been purchased within the meaning of the word in s. 26AAA. Action of that kind might be within the general anti-avoidance provisions of Pt IVA, considered in Chapter 15 below.

[3.188] The field of operation of s. 26AAA(2A) is not affected by 26AAA(5). That subsection applies only to s. 26AAA(2). Moreover the concept of excepted property, relevant in regard to the holding of property by an intermediary, is not relevant to the taxpayer’s holding of shares or an interest in the intermediary. It follows that s. 26AAA(2A) is applicable where the taxpayer held shares or an interest acquired more than 12 months before their sale, even though he held the shares or interest as trading stock or as an asset acquired for the purpose of profit-making by sale, or in carrying out a profit-making undertaking or scheme, within the field of s. 25A(1). The Commissioner will no doubt ignore the possible operation of s. 26AAA(2A) in such circumstances if the operation of the law in regard to trading stock or s. 25A is likely to yield the higher amount of income. An examination of every sale of trading stock of a share trader in terms of the possible application of s. 26AAA(2A) would not be administratively feasible. There is no provision in s. 26AAA allowing the Commissioner to lift the operation of s. 26AAA(2A), in a way that might correspond with the provision in s. 25A(3).

[3.189] Reference was made, in [3.174] above, to another set of provisions added to s. 26AAA in 1982 to close another avenue of escape from the intended operation of s. 26AAA. The way of escape involved a distribution in specie by a company or trust estate of property purchased within 12 months of the distribution, and a sale of the property by the person who took the property in the distribution. The distribution in specie, it would be argued, is not a sale within the use of that word in s. 26AAA, and it would be argued that the receipt of the distribution is not a purchase within the meaning of that word in s. 26AAA. Section 26AAA(1)(f) would presumably not operate to treat the distribution as a sale and purchase. The transfer is not in exchange for other property. It is a transfer in satisfaction of rights of the transferee, not in exchange for those rights. It is not a transfer without consideration any more than a payment by a debtor to his creditor is a transfer without consideration. The consideration is an extinguishment of the transferor’s liability to pay. There is not in any case a receipt of proceeds of the sale from which the profit that is income may be determined, though that argument may be overcome by the operation of s. 26AAA(4) which, if there is a sale, will deem there to be a consideration of an amount that in the Commissioner’s opinion is the value of the property. Section 26AAA(4) is confined to a sale that the Commissioner is satisfied was made between persons not dealing with one another at arm’s length.

[3.190] Section 26AAA(8) applies to a distribution of property of a private company or a private trust estate that has been made to a taxpayer in his capacity as a shareholder in the company, or as a beneficiary of the trust estate. It applies whether the distribution was in the course of winding up of the company or trust estate or otherwise. The distribution must be a distribution of the whole or part of underlying property. Underlying property in this context is property purchased by the company or trust within 12 months immediately preceding the date of distribution, excluding property that is excepted property of the company or trust estate of the kind referred to in subparas (i) or (ii) of s. 26AAA(1)(m). Items within subparas (i) and (ii) of s. 26AAA(1)(m) are trading stock and property being plant or articles within the meaning of s. 54 purchased for use by the company or trust for the purpose of producing assessable income. Underlying property distributed to the taxpayer is referred to as prescribed property. There is a condition that the prescribed property immediately before the distribution of the whole or part of it was made, must have had a value not less than 75 per cent of the net worth of the company or trust estate. And there is a condition that the taxpayer would not, apart from s. 26AAA(8), be taken to have purchased the prescribed property.

[3.191] The last condition contemplates the possibility that the distribution could, in particular circumstances, amount to a purchase by the taxpayer. A company or trust may effect a distribution by selling property to a shareholder or beneficiary for less than its value. In which event, there would be successive operations of s. 26AAA(2) on the sale to the taxpayer and on his further sale of the property if it was made within 12 months following his taking of the distribution.

[3.192] If all these conditions are satisfied the taxpayer is deemed to have purchased the prescribed property, on the dates on which the prescribed property was purchased by the company or trustee of the trust estate, for an amount of consideration that the Commissioner considers appropriate having regard to two matters. The first matter is the amount of consideration given or agreed to be given by the company or the trustee in respect of the purchase of the prescribed property. The second matter is the nature and extent of the taxpayer’s shareholding in the company or his interest in the trust estate. The first matter contemplates that the profit that will be taxed to the taxpayer should include the increase in value between purchase by the company or trust and sale by the taxpayer. A rational explanation of the relevance of the second matter is not evident.

[3.193] Where the company or trustee of the trust estate incurred expenditure in relation to the prescribed property in addition to the consideration given or agreed to be given on or in respect of the purchase, the taxpayer is deemed to have incurred such amount of that expenditure as the Commissioner considers reasonable, having regard to the nature and extent of the taxpayer’s shareholding or the taxpayer’s interest in the trust estate. Again the relevance of the matter is not evident.

[3.194] The operation of s. 26AAA(8) is to deem a purchase by the taxpayer at the time of purchase by the company or trust estate, and to provide for the fixing of the cost on the deemed purchase. Whether any derivation of income results will depend on the fact of sale of the property by the taxpayer, and the time of that sale. The derivation of income will arise from the operation of s. 26AAA(2).

[3.195] Section 26AAA(9) seeks to cover a distribution that is made by the company or trust estate to the taxpayer through another trust estate in which the taxpayer is a beneficiary. It may be wide enough to cover a distribution through a number of trusts. There is no provision however that would cover a distribution to the taxpayer through another company or a series of companies.

[3.196] The distribution of property by the company or trust estate may give rise to assessable income derived by the taxpayer. The distribution though made in specie may yet be a dividend out of profits that is assessable income under s. 44. The distribution of property by the trust estate may be made in the exercise of a discretion, such that s. 101 will deem the beneficiary to be presently entitled to the amount of the distribution so that he is subject to tax under s. 97, or so that the distribution is subject to tax, immediately in the hands of the trustee, and ultimately in the hands of the beneficiary under s. 98 and s. 100, or s. 98 and s. 98A. In these circumstances the amount of assessable income arising under s. 26AAA is reduced by the amount of assessable income thus arising to the beneficiary by reason of the distribution. This is the effect of s. 26AAA(11). Where the distribution is made through an interposed trust there is a prospect of a levy of tax on the distribution as it moves through the interposed trust. The tax may have resulted from the operation of s. 97, s. 98, s. 99 or s. 99A. If in the opinion of the Commissioner the prescribed property or part of the prescribed property represents an amount included in assessable income of the taxpayer under s. 97, or represents an amount in respect of which the trustee of the interposed trust has been assessed and liable to pay tax in pursuance of ss 98, 99 or 99A, the amount of assessable income arising under s. 26AAA is reduced by that amount. The intention of s. 26AAA(11) is to prevent what would otherwise be thought to be double taxation—tax on the amount of the distribution that is the prescribed property and tax on the profit that is income on the sale of the prescribed property.