The Commissioner of Taxation of the Commonwealth of Australia v ANZ Bank Ltd M44/1997 [1997] HCATrans 383 (14 November 1997)

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Melbourne Nos M44 and M45 of 1997

B e t w e e n -

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Applicant

and

AUSTRALIA AND NEW ZEALAND SAVINGS BANK LIMITED

Respondent

Applications for special leave to appeal

GAUDRON J

McHUGH J

GUMMOW J

TRANSCRIPT OF PROCEEDINGS

AT MELBOURNE ON FRIDAY, 14 NOVEMBER 1997, AT 9.37 AM

Copyright in the High Court of Australia

MR N.J. YOUNG, QC: May it please the Court, in each matter I appear with my learned friends, MR G.T. PAGONE, QC, and MR G.P. HARRIS, for the applicant. (instructed by the Australian Government Solicitor)

MR D.H. BLOOM, QC: May it please the Court, I appear with my learned friend, MR B.J. SULLIVAN, for the respondent. (instructed by Freehill Hollingdale & Page)

MR YOUNG: May it please the Court, this application raises, in our submission, issues of general importance concerning sections 97 and 51(1) of the Income Tax Assessment Act, both provisions of central importance to the Act. All of the provisions - - -

McHUGH J: It cannot be of much importance, can it? Section 97, the particular issue that you are dealing with, has never been dealt with in 60 years, has it?

MR YOUNG: It has not been dealt with by any court, your Honour, but that does not mean that the construction applied to it by the Full Court does not raise matters of general importance.

McHUGH J: Why should not the matter rest with the Full Court of the Federal Court? This Court has said on a number occasions that, prima facie, tax matters end in the Full Court of the Federal Court.

MR YOUNG: Firstly, there are powerful reasons why the Full Court's decision is wrong, both in relation to section 97 and section 51. Secondly, the Full Court's construction of those provisions will affect every trust situation where there is a derivation of both assessable income and exempt income.

McHUGH J: The Income Tax Assessment Act is amended at least yearly. Why cannot the Commissioner fix it up if he really complains?

MR YOUNG: Your Honour, these provisions have been in the form they are in and as dealt with in this Act for very many years. They are still in that form. The concluding words of section 97 interlink with the carry-forward loss provisions and the only area where exempt income is specifically provided to be offset in some fashion is in those provisions. That has been a core element of the carry-forward loss provisions right through the 1980s. It is still the position now in the 1997 Act.

GAUDRON J: Is there not an anterior question in this case, namely whether, in fact, it is exempt income - whether the capital portion is exempt income?

MR YOUNG: It has been decided that it was, both by the trial judge and the Full Court.

GAUDRON J: Yes, I know it has been decided but, surely, there is a question which arises in this matter on that issue.

MR YOUNG: It will arise, according to the submissions of the respondent of this application, if they are given leave to raise that matter before this Court. It does not arise on this application for special leave.

McHUGH J: You are content with the findings below.

MR YOUNG: Yes, we are, but it may arise if special leave is granted and the other side are permitted to raise the anterior questions on appeal to the High Court. We take the judgments on those points as we find them. We are content with them. We contest the finding in relation to - - -

GAUDRON J: You say you are content with them, but are you not perhaps asking us to proceed on a false premise if there is an issue about that?

MR YOUNG: No, with respect. We are not asking the Court to proceed on a false premise. We say the Full Court decision was correct in that respect.

GUMMOW J: In what respect?

MR YOUNG: In relation to the deductible amount being exempt income.

McHUGH J: On common law principles or - - -

MR YOUNG: On both, but it is effectively because of the analysis that the Full Court went through of Charles' Case.

GAUDRON J: But it is not necessarily against your interests if it is capital, is it?

MR YOUNG: No, it is not. That would have implications for the operation of section 51 and so forth.

GAUDRON J: Yes, that is why I say maybe there is an anterior question before we get to the questions that you seek to advance as important questions in - - -

MR YOUNG: The way we would put it, your Honour, is that there is or may be another question if the matter comes before this Court on appeal. There is no anterior question in the special leave application. We say the Full Court decision was correct in that regard and we see no coherent arguments, really, as to why it was incorrect. The argument essentially was that the provisions of the trust deed providing for the redemption of units meant that that portion of the receipt to the investors was alleged to be capital and the answer the Full Court gave was that is not the way Division 6 operates. The taxability of that amount depends upon the interest which the beneficiary had in the trust. That is governed by section 97. Hence, you get into the division of section 97 of the beneficial share in the trust estate into either assessable income or exempt income: paragraphs (a) and (b) of section 97(1).

GUMMOW J: What is your point about the last words to 97(1)?

MR YOUNG: Our point is this, your Honour - - -

GUMMOW J: When it says, "except to the extent.....was taken into account"? Do you fix on that?

MR YOUNG: Yes. We make several points. First, the Full Court's construction deprives the whole of paragraph (b) of any operative effect. The reason is this: if "taken into account" is given as wide a meaning as the Full Court gave it, in every situation in which a trust derives assessable income and exempt income, you necessarily must separate the two. It is a definitional requirement. The mere act of separating the two will mean there is a taking into account and, hence, the beneficiary is to be regarded as having no present entitlement to that portion of the trust income which was exempt income of the trust. Hence, paragraph (b) can never apply.

A subset of that argument is to focus on the words "to the extent that" in the excepting words. If the mere separation of exempt income or the recognition of the exempt status of that income triggers the exception, it will always be an "all or nothing" situation. There will be no scope for the operation of the words "to the extent that". You will never have exempt income.

McHUGH J: It is "to the extent to which", is it not?

MR YOUNG: Or, "to the extent to which", yes. You will never have those words applying because the exempt income will either be wholly taken into account or not taken into account.

GAUDRON J: Yes, thank you, Mr Young. We think we might be advantaged by hearing from Mr Bloom at this point.

MR BLOOM: Yes, thank you, your Honours. Your Honours, we would respectfully submit that special leave should be refused for these reasons: we say the application raises no point of fundamental principle. The issue is one of statutory interpretation and - - -

GUMMOW J: It is always going to be statutory interpretation. It is the Income Tax Act.

MR BLOOM: But if I just might go one step further, your Honour: in the context where the Income Tax Assessment Act is in the process of being rewritten. Now, section 51(1) itself has been rewritten. All of the loss company provisions, not only have they been rewritten in the existing 1936 Act, but they have been rewritten in the 1997 rewrite Act and the trust provisions are yet to be - - -

GUMMOW J: What is the stage of this rewrite? The legislative stage?

MR BLOOM: It is being enacted progressively, so as parts are rewritten, then there is an Act released. So, so far there is a 1997 Act which took effect from 1 July this year. Now, the trust provisions are yet to be rewritten, and it is quite clear that it is open, as it always is, to the legislature to redo any provision of the Act in the course of that rewrite. The trust provisions have been singled out by the Treasurer as something upon which attention is to be focused in the course of doing just that. So, if it is said there is some problem that flows, then the redress, in our respectful submission, is legislative and that can be done as part of the current rewrite.

Also, what is said to be the section 51(1) point of principle was not raised below before the Full Court or, indeed, before the trial judge in the Federal Court and, in any case, its relevance must be limited to the facts of this case, namely where - - -

GUMMOW J: But it is a pure question of law, is it not? There is no prejudice in a factual or evidentiary sense.

MR BLOOM: No, there is not but it is not the practice of this Court, as we understand it, to grant special leave in relation to an issue not raised below and raised for the first time in a special leave application. Again, the relevance is limited to the facts of this case where a beneficiary of a trust borrows to fund his investment in a trust and the trust then acquires, by purchase, an annuity. It is limited to those factual situations.

Your Honours, we say, further, the decision of the Full Court was clearly correct. In Australia, unlike in the United Kingdom, annuities have always received preferential tax treatment and thus an amount equivalent to their purchase price, which is now called the deductable amount, has always been treated as non-taxable, representing, as the High Court has said from time to time, as the treasurers have said from time to time, a return of the capital invested in acquiring the annuity.

Now, before Justice Jenkinson and before the Full Court, the applicant here argued that having regard to the definition of "exempt income" there were only two kinds of income: exempt and assessable, and he said this was exempt and it was not assessable. The definition, indeed, says - it is at page 35 of the application book, set out in the judgment of Justice Sunberg who delivered the judgment - - -

GUMMOW J: The definition of "exempt income"?

MR BLOOM: Yes. At about line 12:

The expression "exempt income" is defined as -

and if one puts in the word "meaning" because the word is in the definition -

meaning "income which is exempt from income tax and includes income which is not assessable income".

So, the argument for the Commissioner, accepted below, was that the deductible amount was exempt income and that was exempt income derived by the trust. But the question for the court then was whether any exempt income was derived by the beneficiary, and that is why the case concerned 97(1)(b) and only 97(1)(b).

Now section 97, your Honours, which is set out at application book, page 40, about line 8:

Where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate -

that has been held to be the trust law concept of income, then his assessable income includes that share or that proportion of the net income of the trust estate and his exempt income includes any individual interest he has in exempt income "except to the extent", et cetera, in the proviso.

GAUDRON J: Why would it be taken into account if the beneficiaries are all presently entitled?

MR BLOOM: Present entitlement is a concept that applies only to the trust law income. So one looks at three different things in working out section 97. One looks to whether there is a present entitlement to a share of trust law income and then, having worked out that there is, say, assume here, 100 per cent - - -

GAUDRON J: To a share of the income, yes.

MR BLOOM: That is trust law income. Then you apply - your Honour, let me explain it this way: sometimes trust law income and tax law income are quite different.

GUMMOW J: Yes, we know that. It is one of the curiosities of life but there it is.

GAUDRON J: But if everyone - if all beneficiaries are presently entitled, why would anybody bother to calculate the net income of the trust - why would anyone take into account whether it was net income or exempt income?

MR BLOOM: For the reason I just gave, your Honour, because there could be a difference. I mean, the tax law income could include a capital gain but the trust law income would not. So, if a beneficiary is entitled to, say, 50 per cent of the trust law income, then his assessable income will include 50 per cent of the assumed different tax law income. So, if, to take a very simple example, a trust derived $100 in assessable income according to ordinary concepts and $100 capital gain, a beneficiary entitled to 50 per cent of the trust law income would have to bring in to his - - -

GAUDRON J: Yes, but we are only concerned, in that section, with Tax Act income, are we not?

MR BLOOM: No. We start off with trust law income and - because, in order to tax beneficiaries under a trust, the concept is, firstly, to see what interest they have, if any, and sometimes it is nil, in the trust law income. If the trust law income - - -

GAUDRON J: But if they are all presently entitled?

MR BLOOM: Yes, but the trust law income could be zero and the tax law income a positive amount.

GUMMOW J: In turns on this phrase "the income of a trust estate", does it not?

MR BLOOM: Yes, net income; "net income of a trust estate".

GUMMOW J: Yes, which is defined.

MR BLOOM: "Net income" is but "income" is not.

GUMMOW J: No, "of the trust estate", is that not defined?

MR BLOOM: No. "Income of the trust estate" has been held by the courts to mean income, according to ordinary concepts; trust law income, in other words, and not to include such things as capital gains or profits under section 26(a) as it used to be or that sort of thing.

Probably the best way to illustrate it is two examples were given by Justice Sunberg at page 46 of the application book. We have actually reduced those examples to writing. If I might hand them to your Honours. These were actually handed up to the court below. Now, if your Honours keep those in front of you I will read from Justice Sunberg's reasons. The first of them, your Honours see, is "Exempt Income Taken Into Account In Calculating Allowable Deductions" of trust estates. Your Honours recall that net income of trust estate equals assessable income less allowable deductions, and "exempt income" is separately defined.

Now, the Commissioner accepted below that this correctly represented the exception of the operation of section 97(1)(b). So, his Honour said:

assuming a loss carried forward of $3,639,902 and exempt income of $2,793,750, the permissible loss deduction -

to the trust -

pursuant to s80(2) is the difference between those figures. The permissible loss is deducted from the assessable income to produce the net income of the estate. The exempt income is thus taken into account in calculating the allowable deductions integer of the net income, and thus in calculating the net income.

Now, more importantly, that example stems from what is said in Ratcliffe and McGrath, written in 1938 on the 1936 Act, and referred to again by the trial judge below.

McHUGH J: And by the Full Court.

MR BLOOM: I am sorry, by the Full Court, yes, thank you. Now, if I could ask your Honours to look at page 657 at the third paragraph or the second full paragraph on that page. Your Honours, 97(2) is equivalent to 97(1)(b) in this instance.

Where a trust estate derives exempt income the beneficiary's share in such exempt income is transferred to his individual return, and is taken into consideration in the making of his assessment in any case where a loss incurred by him in a previous year is being carried forward, or where a loss incurred by him in the year of income is to be carried forward to a later year. This does not apply in those cases in which the exempt income is taken into account in calculating the net income of the trust estate (s. 97(2)). This latter position would arise in the case in which exempt income had been derived by a trust estate in a year in which losses of previous years were allowable as a deduction -

Now, the Commissioner accepted as he was bound below that if you took the exempt income into account in calculating the allowable deductions integer, then it had been taken into account in calculating the net income.

Now, the reverse side of that coin is our case, and if your Honours turn to the next example, using the same figures which actually come from the application book, and I will read to your Honours, as your Honours look at that, from Justice Sunberg:

the annuity payment received on 1 November 1986 was $3,639,902 and the deductible amount (exempt income) was $2,793,750. The second figure was deducted from the first to give $846,152 as the amount included in the assessable income. The exempt income was thus taken into account in determining the assessable income integer of the net income, and thus in determining the net income.

Now, what his Honour then said is you cannot, obviously, read the same words as applying - read them in a different way, applying them according to whether it is taken into account the allowable deductions integer - losses - or in relation to the assessable income integer. These are the only circumstances, with respect to my learned friend, where this sort of situation under 97(1)(b) as it now is is going to arise. It is not right to say that wherever exempt income is ascertained, that it has been taken into account in calculating the net income. Because if your Honours go to section 95 - and I think that has been supplied to your Honours as separate materials:

"exempt income", in relation to a trust estate, means the exempt income of the trust estate calculated as if the trustee were a taxpayer -

so that is one thing -

"net income", in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer.....less all allowable deductions -

so, they are two different things. There will be very limited circumstances - the Ratcliffe and McGrath example is one example - - -

GUMMOW J: It says, "total assessable income of the trust estate".

MR BLOOM: Yes.

GUMMOW J: Well, that is not a trust law expression.

MR BLOOM: No.

GUMMOW J: That is what I was saying.

MR BLOOM: But that is net income and net income is a different concept to, as your Honour knows, pure income. So, the only circumstances, with respect to our learned friends who seek to erect it as a point of principle, in which this sort of thing will be taken into account is the loss example given and the annuity example given and nowhere in the last 60 years has any other example arisen where it could be said that the exempt income is taken into account in calculating the net income. They are treated quite separately for all other purposes of the trust provisions.

GUMMOW J: Now, just explain to me, Mr Bloom: these appeals arise out of two years of income, do they not? 1986 and l987, is it?

MR BLOOM: That is correct, your Honour.

GUMMOW J: And there was a claim for deductions under section 51?

MR BLOOM: It has a rather longer history and part of it went to the High Court, as your Honour may have seen. Actually, the claim for deductions was initially allowed by the Commissioner and he treated the annuity as assessable - - -

GUMMOW J: But the ultimate result of this appeal would be to restore a claim for a deduction, would it not?

MR BLOOM: Yes, your Honour, quite.

GUMMOW J: Now, step by step, how does that work, to give you the deduction?

MR BLOOM: The taxpayer was a member of a partnership which borrowed moneys at interest and used those to subscribe for redeemable units in a unit trust. The unit trust then used the moneys to purchase annuities. The effect of the decision of the court below is that the partnership beneficiary under the trust derived assessable income and that was the only income which the partnership derived. The only argument put against us below was that the partnership had also derived exempt income and the court held that having regard to the 97(1)(b) proviso, that was simply not the case.

Now, your Honours, for those reasons it is our submission that special leave should not be granted but, particularly, I remind your Honours that there is this rewrite going on at the moment; that the Treasurer has announced that trusts are to be especially looked at; that if there is some injustice perceived by the Commissioner, that can be easily redressed by the courts. Importantly, he has been unable to point to any situation where the effect of the courts' conclusion, other than this case, has some adverse effect to him. If your Honours pleases.

GAUDRON J: Yes, Mr Young.

MR YOUNG: As to the rewrite, we submit as follows: the law is being rewritten as part of a simplification process. The intention - - -

GUMMOW J: Yes. That may be a vain hope.

MR YOUNG: Yes, it is, your Honour, but the intention is not to change the law. Section 51 has already been addressed and, in substance, it is unchanged. The carry-forward loss provisions have already been addressed and no change has been made to them. The basic principle remains that it is only in the context of carry forward loss that exempt income is offset for two purposes: first, to define what is the loss that can be carried forward - it is the loss less exempt income - and, secondly, to ascertain when you claim your carry-forward loss what is the amount of the claimed deduction. You must first apply the carry-forward loss against exempt income of that year before you offset it against assessable income. That principle remains unchanged in the simplification process.

It has not yet dealt with trusts but, consistent with what has been done thus far, there is now reason to assume that a basic tenet such as section 97 is going to be altered. Indeed, it is the whole concept of Division 6, that wherever possible the Act looks through the trust and taxes the beneficiary and especially where he is presently entitled.

Now, can I deal with this example because it makes our point as well. On the first page the Court will note that it is an application of section 80(1) and (2). Exempt income is offset against a carry-forward loss producing an available deduction of $846,152. That available deduction would be applied in the year in which it is claimed, first against exempt income, and then against any assessable income. As a consequence, the offsetting of exempt income against the carry-forward loss necessarily alters the quantum of the net income of the trust estate. But for the offsetting of exempt income, the net income of the trust estate would be reduced by a carry-forward loss of some $3.6 million. Because of the offsetting of exempt income, it is only to be reduced by $846,000. That is a true example of taking into account in calculating the net income of the trust estate because the offsetting of exempt income alters the quantum of the trust estate and it alters it over and above the way in which it would be altered by the mere segregation of exempt income from assessable income and recognition of its exempt status. Moving to the second page - - -

GUMMOW J: Now, Mr Bloom says the second page is just the flip side of the first.

MR YOUNG: Well, it is not, your Honour. The figures taken confound the comparison because the $3.6 million here is the annuity payment, on the first page. It is not the income of the year, it is the carry-forward loss.

All that happens on the second page is the exempt status of the exempt income is recognised. It is separated from the assessable income. That is all. There is no taking into account other than recognising that exempt income is exempt income. So, you separate it and all that you take into account for the purposes of calculating in that year - there being no carry-forward losses, you simply take into account the assessable income as per the definition of the net income of the trust estate. So, it is not taken into account in calculating the net income of the trust estate at all.

To make the two examples comparable, you would have another line in the first page of the example. You would not only have loss carry-forward exempt income, you would have a line for assessable income which we would adopt from the second page of $846,152. You offset the permissible carry-forward loss and there is no net income of the trust estate on the first page, and there is a net income in the trust estate of $846,000 on the second page. That proves our point as to what a distortion this construction imposes upon Division 6. Making those examples comparable demonstrates the point.

What it demonstrates is the taking into account, in our submission, means more than simply recognising that it is exempt. It means factoring in pursuant to some provisions the exempt income in such a way as to alter the quantum of the net income of the trust estate and, in our submission, that is the proper construction of those excepting words.

Can I make one other point, if the Court pleases.

GAUDRON J: It may not be necessary to do that. There will be a grant of special leave in these matters, Mr Young.

MR YOUNG: If the Court pleases.

GAUDRON J: But before you resume your seat, could you please ensure that when the matter does come before the Court, the Court is provided with provisions of the Act as they stood at the relevant times, namely 1986 and 1987, together with a detailed account of legislative changes since that date so that at least we know where we are.

MR YOUNG: Yes. We are conscious of that, your Honour, and we, indeed, had prepared it over night but we did not want to unnecessarily trouble the Court with it.

GAUDRON J: Thank you. Well, there will be a grant of special leave in both matters.

AT 10.07 AM THE MATTER WAS CONCLUDED