McClelland v. Federal Commissioner of Taxation.
70 ATC 4115
Judgment date: Judgment delivered 2 November 1970.
Judgment of majority (Lord Donovan, Viscount Dilhorne and Lord Wilberforce) delivered by Lord Donovan: The appellant, jointly with her brother, became entitled under the will of her uncle and pursuant to the assent of his Executors to land in Western Australia. She wished to retain the land unsold. Her brother did not. She managed to purchase his interest, but only by selling off part of the land. She still retains the rest. The respondent estimated that on the part she sold the appellant made a profit of £56,951, and assessed her to income tax in this sum. The appellant objected, on the ground that the whole of the sale price she received was capital and that no part of it constituted assessable income. At the hearing of this objection before a single Judge of the High Court of Australia (Windeyer J.) she won her case. The assessment was set aside and the respondent ordered to pay costs. Upon his appealing to the Full Court (Barwick C.J., Kitto, Menzies and Owen JJ.) the appellant lost (Barwick C.J. dissenting) and was herself ordered to pay the respondent's costs. Subsequently special leave was granted to the appellant to appeal to the Board.
The detailed narrative begins with the will and codicil thereto of Henry John Spaven who died on 27 September 1958. He gave his residuary estate to his trustees (who were also his executors) upon trust to sell, with power to postpone the sale; to set aside out of the proceeds of sale two sums of £15,000 and £10,000, in which he gave a life interest to Miss Hoult and a Mrs. Burns respectively: and subject thereto the capital and income of the residue was given to the appellant and her brother as ``tenants in common in equal shares''. The appellant and her brother -
70 ATC 4117
Reginald Spaven-were respectively the niece and nephew of the testator.
Pursuant to this last provision the appellant and her brother were each entitled to onehalf of the proceeds of sale of certain land at Rockingham south of Fremantle. Or, if they wished to have the land instead and hold it as tenants in common they could do so if the Executors assented. It was not necessary for the purposes of the administration of the estate that the land should be sold.
Reginald, the brother, however wanted the land sold as soon as possible, and in 1962 told one of the Executors that he had been offered £40,000 for his half-share and that the same buyer would pay another £40,000 for the appellant's share. She, however, did not wish to sell, believing that over the years the land would appreciate in value. It comprised some 3,600 acres with development potential. Accordingly she asked her brother to grant her an option to buy his half-share for the £40,000 he said he had been offered. He agreed, and granted it. This was on 26 July 1962. The option was to expire on 15 September 1962.
The appellant did not have £40,000 at her disposal. Accordingly she decided to sell part of the land in order to raise it. Acting on advice she prepared a plan dividing the land into three portions, known as portions 4, 5 and 6. The plan was submitted to and approved by the local Town Planning Board. Portions 4 and 6 being nearest to the beach were the portions which the appellant particularly wished to keep as being more likely to appreciate in value. These two portions comprised 525 acres. Portion 5 comprised 3,073 acres but on the other hand most of it was back land away from the beach.
Eventually after declining a number of less attractive offers the appellant on 5 October 1962 with the assent of the Executors accepted an offer of £150,000 for portion 5, the purchasers agreeing to pay a deposit of £50,000 on the execution of the contract and the balance upon acceptance for registration of a transfer of the land at the Land Titles Office Perth.
The Executors' assent was made conditional upon the appellant and her brother each depositing £10,000 as further security for the above mentioned settled legacies of £15,000 and £10,000; the executors being uncertain whether the investments they had set aside for these would prove sufficient.
With some foreknowledge of the terms of the eventual contract of sale the appellant had on 10 September 1962 exercised her option to buy for £40,000 her brother's half-share in the whole of portions 4, 5 and 6.
The sale went through as planned. Out of the deposit of £50,000 the appellant paid her brother £40,000 lodged the balance of £10,000 with the Executors as required, and was left with the balance of the purchase price plus the sole ownership of portions 4 and 6 which were duly transferred to her by the Executors with her brother's assent.
The respondent estimated that the appellant had made a profit of £56,951 from the foregoing transaction; and in August 1966 made an adjusted assessment to income tax upon her in respect of this profit for the year ended 30 June 1963. He declined a request by her Solicitors to state how he arrived at his figure, but did so at the trial before Windeyer J. who was critical of the computation. The result of the trial and of the subsequent appeal have already been narrated.
The question obviously suggests itself-why did the appellant have to sell land worth £150,000 simply in order to get £40,000 to pay her brother? The answer is that the appellant was advised that in order to get a good price for portion No. 5 she would have to include in that part some of the more valuable land.
The respondent made the adjusted assessment upon the appellant pursuant to the terms of sec. 26(a) of the Income Tax Assessment Act 1936-1965 of the Commonwealth of Australia. This reads-
``The assessable income of a taxpayer shall include
(a) profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme.''
In addition he contends that the profit made by the appellant was income and not capital according to the commonly accepted notions of what income is, since she had engaged in an adventure in the nature of trade.
Windeyer J. held that neither limb of sec. 26(a) applied to the present case. The appellant had not acquired property for the purpose of profit-making by sale. She acquired
70 ATC 4118
an undivided half-share through the bounty of the testator. She acquired the other half-share by purchase from her brother but her dominant purpose in doing this was to ensure that, as far as she could do so, the land would not be sold until some time in the future. The appellant-so far as she had been obliged to sell-had done no more than realise a capital asset.
On appeal by the respondent to the Full Court Barwick C.J. agreed with the foregoing conclusions. He took the view that the ``realisation of an inheritance, even though carried out systematically and in a business-like way to obtain the greatest sum of money it will produce does not... make the proceeds either profit or income for the purposes of the Act''. It would be different if the inheritance had been adventured as the capital of a business, for example, land jobbing or development, but no such thing had been done here.
Kitto J. was of the opinion that liability to income tax had been established. He considered, for reasons which will presently be specified that the profit made by the appellant was caught by the second limb of sec. 26(a) and was also income as being the result of an adventure in the nature of trade.
Menzies J. and Owen J. concurred with Kitto J. delivering no separate judgments.
This division of opinion reflects the difficulty in deciding when an isolated transaction involving the acquisition, whether by purchase or otherwise, of an asset, and its resale at a profit, yields to the seller a profit in the nature of income or, instead, an accretion to capital. Judicial decisions, whether in the Commonwealth, or in the United Kingdom, yield no touchstone by which all cases may be easily resolved. In the United Kingdom the test is whether the transaction is ``an adventure in the nature of trade''-see the definition of trade in sec. 526 of the Income Tax Act 1952. Although there is no similar provision in the Australian Income Tax Act, the respondent invokes the same test in his argument that the profit accruing to the appellant was income according to ordinary concepts ``because (she) was engaged in an adventure in the nature of trade'' (see paragraph 5 of his Reasons). But his primary contention is that the appellant is liable under the express provisions of sec. 26(a) and this contention their Lordships now examine.
The first question is whether the appellant acquired property for the purpose of profit-making by sale. Windeyer J. held that she had not. She had, he said, acquired an undivided share in the land by the bounty of the testator. ``This was given to her. It was not acquired by her for the purpose of profit-making''. She acquired the other half-share by purchase but ``so that she might realise her plan of retaining her interest under her uncle's will as far as possible in the form of land''.
The statement that an undivided share in the land came to the appellant by the bounty of the testator was challenged by the Solicitor-General on behalf of the respondent. What the appellant was entitled to under the will was, he said, not a half-share in land but a half-share in the proceeds of the sale of the land which the testator directed his trustees to effect. She acquired the land by agreement between herself and her brother and the Executors, and did so at a time when she had already formed her plan for sale and had received an offer which would yield a profit. So that within the words of sec. 26 she acquired land for the purpose of profit-making by sale.
If one looks no further than the terms of the residuary gift it is true that the appellant was entitled to a share of the proceeds of sale. There was no specific devise of the land. But she and her brother were the sole beneficiaries in respect of the land; and if the state of administration allowed it, they could have called for the transfer of the land to them. In fact specific power enabling the Trustees to do this is contained in Clause 8(iii) of the will. Not only did the state of administration allow such a transfer (subject to the above mentioned deposits as additional security for the settled legacies) but the evidence strongly suggests that not only the appellant but her brother wanted the land transferred to them in specie. Thus Mr. Medcalf one of the Executors said that about May 1962 the appellant ``and her brother discussed the purchase by one of the other's share, and Mr. Spaven said he had a buyer at £40,000 for his half-share''. And the option given by him to the appellant begins ``I hereby agree to give you an option to purchase my ½ share in Rockingham land of the estate of the late H. J. Spaven....'' It is clear therefore that rather than let the trust for sale be executed according to the will both beneficiaries wanted the land in specie as soon as the Executors
70 ATC 4119
could properly transfer it: and that being so it is not inaccurate to describe sister and brother as acquiring the land through the bounty of the testator. On that footing it would be quite inappropriate to say of the appellant that she acquired land through the bounty of the testator ``for the purpose of profit-making by sale''. This may well explain why there is no separate mention in the majority judgment in the High Court of any argument based on the first limb of sec. 26 though your Lordships were assured that one was advanced.
The second limb of the section poses the question whether the appellant derived profit from the ``carrying on or carrying out of any profit-making undertaking or scheme''. Kitto J. rested his affirmative answer on these grounds:
- (i) The appellant purchased her brother's half interest in the Rockingham land for the purpose of enabling her to sell the fee simple in those lands.
- (ii) She had no other purpose than to sell the entirety of those lands, part of them immediately and the rest at a future time.
- (iii) She wished to do this in a way which would bring in the best price.
- (iv) These premises involve the conclusion that the plan the appellant adopted was a plan for the making of profit.
- (v) This profit answered the description of profit in the second limb of sec. 26(a).
- (vi) It would also be income according to ordinary concepts since it would be the net proceeds of an adventure in the nature of trade.
- (vii) Windeyer J. had not given due weight to the point that the appellant's purpose was one of profit-making by uniting both half-interests in the lands in her own hands and then selling the resulting entirety in sub-division over a period for more than the entirety had cost her.
It is not easy to reconcile with the evidence the learned Judge's assertion that the appellant had no other purpose than to sell the entirety of the land, part immediately and the rest at a later date. The relevant testimony is that of the appellant herself, and the nearest she gets to the purpose so ascribed to her is in one answer which she gave in examination in chief. After saying that she had wanted to retain the Rockingham land because in time it would become very valuable she was asked ``How would it be realised?'' To which she replied ``Later on I thought it could be subdivided: it was near the beach and beach cottages could be built on it.''
Their Lordships would hesitate to draw from this single answer the conclusion that the appellant's sole purpose in 1962 was the sale of the whole land. She reiterated constantly in her evidence that she wanted to keep it unsold: and at one stage implied that this would be for the benefit of her family. Moreover if the implication be read into the evidence that it was the appellant herself who would build the cottages, or cause them to be built, she said nothing which proved her intention to sell them, rather than to let them and retain them as investments. It is fair to say that the learned Judge did not rest his conclusion in favour of the respondent solely on his assumption regarding the intentions of the appellant. Nor could he have done so consistently with a considerable body of judicial authority, to the effect that a landowner may develop and realise his land without making a profit which partakes of the character of income: even though he goes about the realisation in an enterprising way so as to secure the best price. Looking at Australian authorities alone one need only instance
Scottish Australian Mining Co. Ltd. v. F.C. of T. (1950) 81 C.L.R. 188, and
White v. F.C. of T. (1969) 43 A.L.J.R. 26 at p. 28. What clearly helped to tip the scales in favour of the respondent was the further fact which Kitto J. describes as ``a process which involved bringing both that'' (i.e. the brother's) ``half interest and her own to an end by uniting them in her own hands etc.''
The process thus described, if spelt out in more detail, comes to this: the appellant found herself in a position where, desiring to retain the land, she had a prospective tenant in common with herself who desired to sell. To avoid becoming tenant in common with a stranger she decided to try and acquire her brother's interest. She accordingly obtained the option. When she exercised it she became in equity the owner of the fee simple, owing her brother £40,000. At this point as Barwick C.J. points out she made a profit in the sense that the fee simple was much more valuable than the sum of the former interests in common: but this profit, being unrealised appreciation, was not a taxable profit in her hands. She then had to pay her brother, and to enable her to do so she had to sell part of the land.
70 ATC 4120
Do these facts disclose a ``profit-making undertaking or scheme'' within the meaning of sec. 26(a)? It is clear in the first place that not all such undertakings or schemes are caught by the section. Otherwise every successful wager would be within it. So also would the purchase of investments bought by a private investor as a hedge against inflation and sold-perhaps long afterwards-at more than the purchase price. The participator in a lottery would also be liable if he drew the winning ticket. The undertaking or scheme, if it is to fall within sec. 26(a) must be a scheme producing assessable income, not a capital gain. What criterion is to be applied to determine whether a single transaction produces assessable income rather than a capital accretion? It seems to their Lordships that an ``undertaking or scheme'' to produce this result must-at any rate where the transaction is one of acquisition and re-sale-exhibit feature which give it the character of a business deal. It is true that the word ``business'' does not appear in the section; but given the premise that the profit produced has to be income in its character their Lordships think the notion of business is implicit in the words ``undertaking or scheme''. They are reinforced in their view by the opinion expressed by the respondent in paragraph 19 of his case. Referring to the fact that he did not submit in the High Court that the appellant had engaged in an adventure in the nature of trade, he nevertheless asked to be allowed to raise this contention before the Board on the ground that ``it is only an alternative way of presenting the respondent's case under sec. 26(a)''.
Did the appellant engage in such an undertaking or scheme? One must look at all the facts to decide. She obtained her share in the land through the bounty of her uncle. She desired to keep it and not to sell it. Her cobeneficiary had the opposite desire. She was thus faced with the prospect of a tenant in common who was a stranger with all the difficulties which that situation might produce. There were two possible solutions: to sell her share also as her brother suggested, or to buy him out. She chose the latter course as the one which would enable her to salvage as much as possible of her original purpose.
Like Barwick C.J. and Windeyer J. their Lordships cannot think that this is the kind of undertaking or scheme caught by sec. 26(a). It is true that the appellant set about selling sufficient land in an enterprising way. But in argument the Solicitor-General on behalf of the respondent rightly admitted that this was inconclusive. What he strongly relied upon was the prior purchase of the brother's interest and its inclusion in the sale. Their Lordships take the view that the facts bring out clearly that this was simply a means to an end, i.e. the retention of the more valuable land.
The final contention of the respondent is that the profit which arose to the appellant is income according to ordinary concepts, since it arose from an adventure in the nature of trade. Whilst this claim is quite independent of sec. 26(a) it seems to their Lordships to introduce no new element into the problem such as would lead to some different conclusion. The whole of the facts have still to be considered; the same criteria have to be applied; the question to be asked and answered is still whether the facts reveal a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the appellant went beyond this and engaged in a trade of dealing in land albeit on one occasion only. To this question their Lordships think that, as in the case of the question arising under sec. 26(a) the answer should be in the negative.
As in most cases of this kind a wealth of authorities was cited, ranging from
Californian Copper Syndicate Ltd. v. Harris (1904) 5 T.C. 159 down to
White v. F.C. of T. (1968) 43 A.L.J.R. 26. No useful purpose would be served by examining them all. The governing principle is clear: it is the application of it to cases exhibiting a wide variety of circumstance that constitutes the difficulty. In Californian Copper Syndicate v. Harris the Lord Justice Clerk formulated the question which must be asked in cases like the present. ``Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?''
So far as sec. 26(a) is concerned, the Solicitor-General pointed out that the words ``an operation of business'' do not occur therein. Their Lordships' view, already stated, is that in a case where the profit is made by the acquisition and sale of some asset a similar notion must be implied if the profit is to partake of the character of assessable income.
70 ATC 4121
So far as concerns the claim that the appellant's profit is income according to ordinary usages and concepts it is common ground that this can be established only if what the appellant did was an adventure in the nature of trade.
Applying these tests it must be a question of fact in each case whether liability to income tax has been incurred or not.
A word should be said however about two cases strongly relied upon by the respondent, one is
Official Receiver v. F.C. of T. (Fox's case) (1956) 96 C.L.R. 370. In that case the Official Receiver as administrator in bankruptcy of the estate of one Fox (also known as Rankin) carried on after an interval a business which Fox had conducted during his lifetime. This was to reclaim land in Queensland, top dress the reclaimed soil, construct drains and water channels, make roads and then sell the land in plots. In one year the Official Receiver sold 32 plots so reclaimed and developed by him. In the second year he sold 66 such plots: and still had on hand 235 more waiting to be sold after the necessary expenditure had been laid out upon them. It was held that although the Official Receiver's duty was to realise the estate for the benefit of creditors he had adopted a set plan to do so and the profit was assessable under sec. 26(a). It was also held, however, that the basis of computation of the profit adopted by the Commissioner was wrong, and the report does not indicate whether his victory was a pyrrhic one or not. But although he succeeded in principle the facts are so different from the present case that the decision does not really help.
The other case is
Iswera v. Ceylon Commr. of I.R. (1965) 1 W.L.R. 663. This was an appeal heard by the Board from a decision of the Supreme Court of Ceylon. The appellant wishing to live near a school which her daughters were attending, bought a site of 2½ acres in the locality. It was more than she wanted but the vendor would sell only the whole. The appellant divided the land into 12 lots selling 9 to sub-purchasers, reconveying one to the vendor, and keeping one for herself. She made a profit and was assessed to Ceylon income tax upon it as being profit from an adventure in the nature of trade. The Board of Review in Ceylon on appeal to them by the appellant found that her dominant motive was to divide the land and to sell the surplus lots so as to make a profit, and obtain a lot for herself below market value. They therefore upheld the asessment. An appeal lies to the Supreme Court of Ceylon from the Board of Review only on a point of law. The Supreme Court held that no error of law had been made. On appeal to the Judicial Committee the same view was taken, Lord Reid however indicating that it was a borderline case, and that the Board of Review might properly have taken a different view of some of the evidence.
The case illustrates the difficulty of applying the accepted tests. It differs sharply from the present case since Mrs. Iswera intended from the first to divide and sell off the greater part of the land. Mrs. McClelland wanted to keep it, but circumstances forced a sale upon her.
Having carefully considered the evidence and the arguments their Lordships have reached the conclusion that the decision of Windeyer J. and Barwick C.J. ought to prevail: and in the circumstances they do not need to consider the validity of the respondent's method of calculating the figure of £56,951. They will humbly advise Her Majesty that this appeal should be allowed. The respondent must pay the costs here and below.