69 ATC 229
JL Burke Ch
RC Smith M
RE O'Neill M
No. 1 Board of Review
Judgment date: 18 July 1969.
JL. Burke (Chairman) and RC. Smith QC. and RE. O'Neill (Members): During the year ended 30 June 1966 the Spares Staff Provident Fund derived gross income totalling $7,078, made up of interest $2,074 and dividends $5,004. The dividends were received from two associated private companies: $4,820 from ``Spares'' Pty. Ltd., in which the Fund held an 18 per cent interest and $184 from ``Distributor'' Pty. Ltd., in which the Fund held a 2 per cent interest. The Commissioner was not of the opinion in terms of sec. 23F(16) that it would be reasonable to exempt either of the two dividends and, accordingly, he assessed the Fund under sec. 121CA on a taxable income of $5,004. The trustees of the Fund now seek to have the Board exercise its power under sec. 193(1) to substitute for the Commissioner's decision on the objection a decision that it would be reasonable to exempt the dividends from tax.
2. Sub-sections (15) and (16) of sec. 23F are as follows-
``(15.) Subject to the next three succeeding sub-sections, the income derived during the year of income by a superannuation fund to which this section applies in relation to the year of income is exempt from income tax.
(16.) A dividend paid to a superannuation fund by a company that is a private company in relation to the year of income of the company in which the dividend was paid is not exempt from income tax by virtue of the last preceding sub-section unless the Commissioner is of the opinion that it would be reasonable to exempt the dividend from income tax, having regard to-
- (a) the paid-up value of the shares in that company that are assets of the fund;
- (b) the cost to the fund of the shares on which the dividend was paid by the company;
- (c) the rate of the dividend paid to the fund by the company on the shares in the company that are assets of the fund;
- (d) whether the company has paid a dividend on other shares in the company and, if so, the rate of that dividend;
- (e) whether any shares have been issued by the company to the fund in satisfaction of, or of a part of, a dividend paid by the company and, if so, the circumstances of the issue of those shares; and
- (f) any other matters that the Commissioner considers relevant.''
3. Spares Pty. Ltd. was incorporated in January 1955 when it took over a business of retailing motor vehicle spare parts which A had begun as a sole trader in 1952. At the end of April 1957 the issued capital comprised 90 shares of $2 each allotted at par and held as follows: 30 by A, 30 by his wife, 15 by first son, and 15 by second son.
4. In June 1957 Distributor Pty. Ltd. was incorporated with an issued capital of 90 shares of $2 each allotted at par and held as follows: 20 by A, 20 by his wife, 15 by first son, 15 by second son, and 20 by the trustees of the Fund which had been constituted by a deed of 1 June 1957. The Fund's 20 shares were redeemable at par at any time before June 2007 upon one month's notice but otherwise had rights pari passu with the other issued shares. Thus the Fund may fairly be said to have held a 22 per cent interest in Distributor which began business in June 1957, its function being to act as the exclusive retailer for Spares Pty. Ltd., which was to sell exclusively to it at a discount off the retail price.
5. In June 1958 Spares Pty. Ltd. allotted 5,500 shares of $2 each at par as follows: 1,500 to A, 1,500 to his wife, 750 to first son, 750 to second son, and 1,000 to the Fund's trustees. After that issue the net tangible assets backing for the 5,590 issued shares (which were all of the same class) was $5.56 per $2 share. In the result the Fund
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acquired for $2,000 an 18 per cent interest worth $5,560 on a net assets basis.
6. In April 1960 Distributor Pty. Ltd. allotted to Spares Pty. Ltd. 1,000 shares of $2 at par. Distributor's issued and paid up capital was then 1,090 shares of which Spares Pty. Ltd. held 92 per cent. As a result of that issue to Spares, the Fund's interest in Distributor dropped from 22 per cent to 2 per cent. The Fund still, however, held its 18 per cent interest in Spares which now held 92 per cent of Distributor's shares.
7. In June 1960 a third company, ``Trading'' Pty. Ltd., was incorporated. Of its issued capital of 1,002 shares of $2 each, Spares held 1,000 shares. The new company stepped into the shoes of Spares in that it now did the buying which Spares had theretofore done and, like Spares had done, it sold exclusively to Distributor. In the result Spares virtually ceased trading and derived its income in the form of dividends from both Distributor and Trading and from rents paid by those companies for their business premises which Spares owned.
8. To summarise: in 1966 the Fund held 1,000 shares in Spares, thus giving it an 18 per cent interest in that company which itself held 92 per cent of the shares in Distributor and 100 per cent of the shares in Trading; at the same time the Fund through its holding of 20 redeemable shares had a direct 2 per cent interest in the capital of Distributor; it had no direct interest in Trading. Apart from the shares held by the Fund all the issued capital of the three companies in the group was owned directly or indirectly by A, his wife, and his two sons.
9. The rules governing membership of the Fund constituted by a deed of 1 June 1957 provide that every employee of the group may ``with the consent of his employer'' become a member. Upon becoming a member the employee is liable to contribute at a rate nominated by him but not being more than 25 cents in the dollar of his wages. The employer company also undertakes to contribute the equivalent of the member's contribution. In addition the employer company may in its discretion make special payments to the Fund for the benefit of members specified by the company. The account of each member in the books of the Fund is credited with his own contributions and with his employer company's contributions (both ordinary and special) in respect of him. The net revenue derived by the Fund during a year ended 30 June is apportioned among the members in the proportion that the amount standing to his credit on such 30 June bears to the total amount standing to the credit of all members at that date exclusive of such revenue.
10. The first two members of the Fund were A and his wife who joined in June 1957. A became a member both as an employee of Spares Pty. Ltd. and as an employee of Distributor Pty. Ltd. In June 1958 the companies consented to all their employees at that date becoming members. A's two sons who were adults employed full time in the business thereupon joined, as did the two other employees. During the year ended 30 June 1962 two new employees were admitted and another was admitted in April 1963. None of the five last-mentioned was either a shareholder in the group or a relative of any shareholder. Two of these five resigned from their employment and ceased to be members, one in 1961 and another in 1964. During the year ended 30 June 1966 there were seven members: A, his wife and two sons, and three others. There was at that time only one other full-time employee, but he had declined an invitation to become a member. In every instance the members contributed at the rate of 5 per cent of their salary and their employer company made matching contributions.
11. By 30 June 1966 the Fund had grown to $58,840. The sources of that total sum were as follows-
Members' contributions $11,304
Companies' contributions --
Dividends from Spares
and Distributor 24,346
Less expenses and benefits paid 823
12. The special company contributions, with the exception of $200 made in 1966
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for the benefit of a non-shareholder employee, were all for the benefit of A, his wife and two sons, the amounts being $1,400 for A, $1,335 for his wife, $602 for one son, and $572 for the other son.
13. At 30 June 1966 the balances to the credit of the seven members of the Fund before the year's net income was apportioned among them were as follows-
His wife 11,925
1st son 6,092
2nd son 5,043 $45,727
E3 1,261 6,119
Net income to be
Spares dividend 4,820
Distributor dividend 184
Interest 1,990 6,994
14. Between them the three non-shareholder members were on the above figures entitled to 11.8 per cent of the net income of $6,994, that is, to $825. The rest of the net income went to the credit of the four shareholder members.
15. It was put as the principal submission for the Commissioner that para. (b), (c) and (d) of sub-sec. (16) when construed together direct attention to what was called the relative ``yield on cost'' of the Fund's shares and of other shareholders' shares. It was said that shareholders' funds in Spares at 30 June 1958 were $31,100 after the allotment at par to the Fund of 1,000 shares of $2 each. Hence, it was said, the cost to the Fund was $2,000, and the ``cost'' to other shareholders was $31,100 minus $2,000, that is, $29,100. The total dividend paid during the year ended 30 June 1966 by Spares was $26,944 (equal to a dividend rate of 241 per cent and being the amount of ``a sufficient distribution'' necessary to avoid Div. 7 tax, of which the Fund received $4,820 and the other shareholders $22,124. Accordingly, so it was said, the yield on cost of $2,000 to the Fund was 241 per cent whilst the yield on ``cost'' of $29,100 to the other shareholders was a relatively low 76 per cent. Such disparity in yield, it was said, must virtually preclude one from being of the opinion that it would be reasonable to exempt the dividend.
16. In the first place we think that the assumption underlying the Commissioner's calculation of the ``cost'' to shareholders other than the Fund is false. The calculation treats as the ``cost'' to such other shareholders the excess of total shareholders' funds over the amount contributed by the Fund for its shares. That calculation fails to give weight to the fact that the other shareholders by virtue of their holding 4,590 of the 5,590 issued shares have between them an 82.2 per cent interest in Spares. The allotment of 1,000 shares at par of $2 each to the Fund had the effect of reducing the net asset value of each of the 4,590 shares held by individuals from $6.34 ($29,100 ÷ 4,590) to $5.564 ($31,100 ÷ 5,590). Accordingly, the value foregone by the other shareholders to the benefit of the Fund was $6.34 - $5.564 x 4,590 = $3,562. That value foregone might in some sense be said by some, though not by us, to be part of the ``cost'' of the 4,590 shares held by others than the Fund and which, for the purpose of comparing ``yield on cost'', should be added to the $9,180 they subscribed for their 4,590 shares. However, to do that seems to us to do no more than emphasize that the shares allotted to the Fund at par had a net asset backing in excess of par with the consequence that the Fund got its shares cheaply, which is a circumstance to which regard may be had pursuant to para. (b) of the sub-sec. (16).
17. In the next place the comparative yield on cost approach which the Commissioner seeks to have the Board endorse breaks down not only in the Distributor situation where the Fund subscribed on equal terms with others for shares in that newly incorporated company when it had neither assets nor any business, but also it breaks down in a case where a Fund is allotted shares at a proper premium in an established company. Thus if the Fund had been required to subscribe for its 1,000 shares in Spares $6.34 per share its dividend of $4,820 would show a yield of 76 per cent on cost of $6,340. By the same token the dividend of $22,124 paid to other shareholders on their 4,590 shares would show a yield of 241 per cent on their cost of $9,180.
18. Another grave weakness in the suggested
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approach is that the greater the share interest acquired by a Fund the lower becomes the yield on cost. For example if the Fund had been allotted only 100 shares in Spares representing a 2.1 per cent interest, its share of the dividend of $26,944 would have been $575, equal to a yield of 287 per cent on cost; but if it had been allotted 4,590 shares representing a 50 per cent interest, its dividend of $13,574 would equal a yield of 148 per cent on cost. If the Fund had subscribed either for the 100 shares or for the 4,590 shares $6.34 per share, then the relative yield on cost to the Fund and on ``issue'', cost to the other shareholders, viz., $2, would be in the ratio of 1: 3.17-hence in such a case the approach now advocated by the Commissioner could be readily adopted by trustees of superannuation funds seeking to have exempted from tax dividends paid to them by private companies.
19. It follows from what we have said that we consider that the suggested approach is not likely to prove useful as a guideline in deciding upon the reasonableness of exempting from tax private company dividends received by superannuation funds in general.
20. We turn now to the matters to which regard is to be had in terms of sub-sec. (16): under para. (a) and (b) we think that the fact that the Fund was allotted shares in Spares at par of $2 when their value was at least $6 tends against the claim that is made-but such an observation cannot be made in respect of the shares taken in Distributor; the matter of the rate of dividend to which para. (c) and (d) direct attention is in this case neutral as the same rate was paid on all the issued shares which were all of $2 each fully paid; the facts are such that there is nothing to have regard to in terms of para. (e).
21. It remains to consider under para. (f) any other matters that appear relevant. We think it is favourable to the claim that is made that all employees, whether shareholders or not, are members of the Fund and that all members must contribute to the Fund. However, weighing heavily against the claim is the size of the Fund's shareholding in light of the fact that all the other shareholders are members of the Fund and that 88 per cent of the dividends is apportioned to their credit in the Fund. The 1,000 shares of $2 each which the Fund holds in Spares give it a 17.8 per cent interest in the company. That interest which entitled the Fund to a dividend of $4,820 is, we think, in the circumstances of the case such that we do not consider that it would be reasonable to exempt that dividend from tax. On the other hand the 20 shares of $2 each which the Fund holds in Distributor is less than 2 per cent of the issued capital and in light of all the circumstances we think it would be reasonable to exempt from tax the dividend of $184 received in respect of those shares.
Claim allowed in part