73 ATC 442
AM Donovan Ch
GR Thompson M
RK Todd M
No. 2 Board of Review
Judgment date: 12 December 1973.
A.M. Donovan (Chairman); G.R. Thompson and R.K. Todd (Members): In respect of the years ended 30 June 1965, to 30 June 1969 inclusive, the Commissioner issued assessments on the income derived by the trustees of a superannuation fund in so far as it represented dividends received from D Pty. Ltd., which for the purposes of the Income Tax Assessment Act is a private company. On behalf of the trustees it is contended that the Board, standing in the place of the Commissioner, should form the opinion, as it is empowered to do under the relevant legislation, that it is reasonable to exempt the dividends from tax.
2. After considerable deliberation and with some hesitation, we have come to the conclusion that it is necessary to refer to one aspect only of the matters canvassed in evidence and argument. This conclusion avoids a quite lengthy statement of facts and reference to numerous submissions put by the representative of the trustees.
3. The superannuation fund, or scheme as it may more conveniently be called, was established by deed executed on 27 June 1955, on behalf of D Pty. Ltd. for the benefit of persons in its employ. That company was incorporated on 16 March 1954, and at the date of execution of the deed D was stated to be its only shareholder. Subsequently further shares were issued, and by the beginning of the period under review the issued capital (expressed in its subsequent equivalent) was 12,000 fully paid shares of $1 each of which D, C Pty. Ltd. (which was D's family company) and the trustees of the superannuation scheme held 1,000, 9,000 and 2,000 shares respectively. Those held by C Pty. Ltd. had been allotted at par but a premium of $3 had been charged for each share acquired by the trustees of the scheme, so that their total shareholding had cost $8,000.
4. At all material times D and his accountant N were directors of D Pty. Ltd. and C Pty. Ltd. and were both trustees and members of the superannuation scheme.
5. The deed constituting the scheme contemplated that it would be divided into three separate parts comprising a general, a provident and a disablement fund, of which only the first two seem to have been established. The deed also provided for three different classes of members, but again only two categories appear to have been utilised. Class 2 comprised those who made personal contributions to the scheme, and only D and his wife seem to have been within this group. All other members (being persons who made no personal contributions to the scheme) must be taken to have been in Class 3. D Pty. Ltd. made contributions in respect of all members.
6. The general fund of the scheme consisted of all contributions made by or in respect of members and included, of course,
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the income arising from that fund's investments. Within this fund individual accounts were opened in the names of all members, to which contributions made by the employer were credited. The personal contributions by D and his wife were credited to separate individual accounts. Each year the income of the fund was allocated pro rata to all members' accounts.
7. It is not necessary to explain what benefits the scheme was intended to provide. It is sufficient to say that if a member, not having attained retiring age, ceased to be employed by D Pty. Ltd. for any reason other than death, he was entitled only to a return of his own contributions, if any. The balance then standing in his account or accounts in the general fund was required to be transferred to the provident fund. These transfers were the only monies in the latter fund apart from the income which its investments produced. No person was entitled to this fund, but the whole or any part of it could be used to augment the benefits of any continuing member, that is to say the whole or any part of it could be transferred to the account of any member in the general fund.
8. There had been such transfers to members' individual accounts in the general fund prior to the years with which the Board is concerned. The first occurred during the year ended 30 June 1961, when $12,600 was so transferred. Of this amount, $10,000 was credited to D's account and sums of $200 were taken to the accounts of 13 other members. The following year there was a further transfer of forfeited benefits to D's account amounting to $2,000. During the year ended 30 June 1965, $5,200 was so transferred, of which sum $1,600 went to D's account and the balance was divided between 10 other members. There were transfers in the remaining years under review but they were not on a basis which discriminated in favour of D to any marked extent.
9. The effect of the transfers of the forfeited benefits in favour of D meant that at 30 June 1964, his interest in the general fund (apart from that arising from his own contributions) stood at $21,464. Of this amount, $3,600 represented contributions directly made by D Pty. Ltd. for his benefit, $12,000 represented forfeited benefits of other members allocated to him and the balance represented the pro rata allocation of the income to his account.
10. In spite of the transfers mentioned, the provident fund stood at $9,904 at 30 June 1964, and was only reduced to $7,190 at the end of the period under review. The figures mentioned are an indication of the extent to which benefits under the scheme were forfeited by members upon their leaving the employ of D Pty. Ltd. The constitutent deed provided that membership of the scheme would depend upon selection by the company but that, except in special circumstances, no employee with less than two years service would be eligible for admission. Nevertheless, at the time of admission, seven employees had been working for D Pty. Ltd. for less than one month, 21 for periods between one month and six months, 16 for periods between six months and one year, while 11 others had service extending beyond one but less than two years. Only three people at the time of admission had been employees for more than two years. In circumstances which were not explained to the Board, a contribution was made at 30 June 1961, in respect of a person who did not commence employment with D Pty. Ltd. until some two months later. In his evidence, N said that the early admissions to the scheme were arranged in an endeavour to stabilise the employer's work force. It is not necessary to comment on this evidence beyond saying that it must have been clear to all concerned that benefits provided for many of these employees would sooner or later become forfeited and fall to be dealt with as part of the provident fund. But even if this had been the purpose of the early admissions, neither that nor the discriminatory allocation of forfeited benefits in favour of D was in any way precluded by the deed.
11. In the early years of the scheme it can be taken its income was not subject to tax by reason of sec. 23(j)(i) of the Act, which provided exemption of -
``the incomes of the following funds, provided that the particular fund is being applied for the purpose for which it was established -
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(i) a provident, benefit or superannuation fund established for the benefit of employees.''
The deed was so drawn and the scheme so administered that this exemption was not jeopardised. In particular it should be mentioned that the forfeiture of benefits and the manner in which a substantial part of those benefits was allocated to D was not contrary to sec. 23(j)(i) or any other provision of the Act as it then stood.
12. Commencing with the first year under review there was a substantial change in the relevant legislation. In relation to the year ended 30 June 1965, the general exemption provided by sec. 23(j)(i) was continued, but sec. 46(3) of Act No. 110 of 1964 nevertheless specifically subjected to tax dividends received by a superannuation fund from a private company and it was pursuant to this provision that the first assessment before the Board was raised. Subsequently sec. 23(j)(i) was deleted and its place was taken by sec. 23F. The new section provides exemption from tax for the income of a superannuation fund of the type referred to in the repealed section only if a number of stringent requirements is met. In particular it imposes conditions on the way in which forfeited benefits are to be dealt with if exemption from tax of the fund's income is not to be lost. With the introduction of sec. 23F some minor amendments were effected to the deed of 27 June 1955, but thereafter the scheme was constituted conformably with the section. It was likewise administered in a manner consistent with the requirements of the section, including the way in which forfeited benefits were allocated during the year ended 30 June 1966, and subsequent years. Thus the general income of the scheme was exempt, but notwithstanding this exemption private company dividends were specifically made subject to tax by sec. 23F(16), and it was pursuant to this provisions that the later assessments were made.
13. Liability of private company dividends to tax in any year under review was however not absolute. The terms of sec. 46(3) of Act No. 110 of 1964 which relates to the year ended 30 June 1965, and sec. 23F(16) of the Act which relates to the subsequent assessments, can be treated as identical for present purposes. It is convenient to regard the last mentioned section as having application to all assessments. It provides -
``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.''
14. As we have already indicated, we propose to deal only with one aspect of the arguments addressed to the Board. Within this context, the submission made by the representative of the trustees was that the Board, standing in place of the Commissioner, should form the opinion that it would be reasonable to exempt the dividends in question from tax. His submission was, firstly, that sec. 23F(16)(a) to (e) dealt only with matters pertaining to investment, and cl. (f), in spite of its wide terms, should be restricted to an investigation of the ``circumstances which
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throw light on the conduct of the fund in its role as an investor''. He argued that if cl. (f) is so construed, the relevant facts approximate those which have been accepted by Boards as justifying the formation of an opinion that it would be reasonable to exempt private company dividends from tax.
15. Should the construction contended for be rejected, the argument was that the Board should not take into account in any way the discriminatory allocations of forfeited benefits in favour of D. Two reasons were advanced for this submission. The first was that the allocations to D did not operate to deny the exemption of the whole of the income of the scheme in the years in which they took place. The second was that under sec. 23F(2)(f) and (g), forfeited benefits are specifically dealt with and that being the case it is wrong as a matter of construction as well as of equity to take them into account again for the purposes of sec. 23F(16)(f).
16. Finally it was argued that if all these submissions are rejected, the discriminatory allocations of forfeited benefits to D did not provide a benefit for him which was inconsistent with the amount mentioned in Public Information Bulletin No. 6 issued by the Commissioner for the purposes of sec. 23F(2)(h).
17. We have given very careful consideration to the first submission and must confess that initially we were much attracted by it. There is a great deal of merit in the view that, since cl. (a) to (e) of sec. 23F(16) relate to matters of investment, cl. (f) should be restricted to similar matters. The reasons supporting such a view are obvious. Dividends from private companies may frequently represent more than a proper reward for capital invested. The flexibility provided by suitably drawn articles of association of a private company allows for the declaration of dividends by directors, rather than shareholders, for dividends to be attached to some only of the issued shares or for them to be paid in relation to issued, rather than paid-up, capital. These are but some of the matters which would permit an undue amount of company profits to be diverted to a superannuation fund. Such a practice is one which the Legislature could be expected to discourage even though it was prepared to exempt the other income of the fund. There are thus grounds for thinking that sec. 23F(16) in its entirety was intended to achieve this end and no other. If this were the first case of its kind to come up for consideration we would therefore be very inclined to adopt the submission made by the trustees' representative. However, the ambit of cl. (f) has been considered by Boards other than this on previous occasions (Case A38,
69 ATC 225, Case A39,
69 ATC 227, Case A40,
69 ATC 229, Case A41,
69 ATC 233, Case B15,
70 ATC 61 and Case B40,
70 ATC 202) and a wide interpretation of the provisions has been consistently adopted. It is far too late now for a more restrictive view to be adopted. Accordingly, we are of the opinion that we should follow the interpretation of the provision adopted by the other Boards.
18. It follows from what we have said that the discriminatory allocation of forfeited benefits to D is a matter to which regard may be paid. It is, we think, nothing in point that these allocations had no effect on the exemption of the scheme's income in prior years. Nor is it in point that in the current legislation the matter of forfeited benefits is specifically dealt with and that the trustees' current practice accords with the requirements of the section. What is material for present purposes is that the allocations previously made had the effect of augmenting D's entitlement under the scheme to an extent quite out of proportion to the benefits provided by the company's and his own contributions. In the result, in a scheme which at the end of the period with which we are concerned had 10 members, D had an entitlement of something in the vicintity of 50%. The prior allocations therefore have a continuing effect so that approximately that proportion of the general fund's income, including the dividends from D Pty. Ltd., are credited to D's accounts. The fact that such a high proportion of the dividends goes for D's benefit affords no reason at all for the conclusion that it would be reasonable to exempt the dividends from tax. On the contrary, it provides a reason for allowing sec. 23F(16) to operate to subject the dividends to tax.
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19. We have also given close consideration to the submission that the benefits provided for D are not excessive according to the formula expounded by the Commissioner in Public Information Bulletin No. 6. At first sight this argument appears to carry considerable weight. On more mature reflection, however, we have concluded that it should be rejected. Reasonableness of benefits provided for members of a fund is one of the matters upon which exemption of the general income of a fund depends. Section 23F clearly enough contemplates that, notwithstanding such exemption, private company dividends may be subject to tax. On construing the section as a whole the conclusion contended for is not open. Furthermore, if reasonableness of benefit were a matter to be taken into account for the purposes of sec. 23F(16), it would have been simple enough for the Legislature to have said so.
20. The position then is that sec. 23F specifically subjects the dividends here under consideration to tax unless the opinion is formed that it would be reasonable to treat them as exempt. In the light of the foregoing there is nothing to suggest that it would be reasonable to exempt the dividends. On the contrary, the continuing effect of the allocation of forfeited benefits to D provides a convincing reason for allowing the section to operate to make tax exigible on those dividends.
21. We would uphold the Commissioner's decisions on the objections.