National Bank of A/asia Ltd v Commissioner of Taxation (Cth) [1969] HCA 11

High Court of Australia Kitto J. National Bank of A/asia Ltd v Commissioner of Taxation (Cth) [1969] HCA 11

ORDER Appeal allowed with costs. Order that the assessment be amended by excluding from the appellant's assessable income the profit derived in the relevant year of income from the sale of the shares held by the appellant in the capital of Queensland Pastoral Co. Limited.

Cur. adv. vult.

1969, Mar. 28 Kitto J. delivered the following written judgment:—

During the year of income ended 30th June 1963, the appellant (which I shall call the National Bank) sold all the shares it owned in the capital of Queensland National Pastoral Co. Limited (which I shall call the pastoral company) namely 46,720 fully paid preference shares of £1 each and 1,454,138 fully paid ordinary shares of 2s. 6d. each. The sale price was £685,461, and as the cost had been only £157,836 a profit of £527,625 was made. In assessing the National Bank's income tax the Commissioner treated this amount of profit as assessable income, and the question to be decided is whether he was right in so doing. He was right if the National Bank had acquired the shares for the purpose of profit-making by sale, or if the sale was the carrying out of a profit-making scheme, or if the profit is properly to be considered a product of the carrying on of the National Bank's general profit-making undertaking which consisted of the business of banking. Otherwise, as it seems to me, the Commissioner's treatment of the amount was erroneous, for no other ground than those mentioned appears to exist, by virtue of any provision of the Act or any business concept applicable under s. 25, for attributing to the profit the character of income or deeming it to be assessable income for the purposes of the Act.

The National Bank acquired the preference shares and 540,189 of the ordinary shares on 30th June 1948, from the liquidator of the Queensland National Bank Limited (which I shall call the Queensland National Bank), that company being then in voluntary liquidation pursuant to an agreement for a merger of the two banks. The price was the current market value, producing in total the amount which has been mentioned of £157, 836. In 1960 the pastoral company made a bonus issue which yielded the National Bank 913,949 ordinary shares, so that the number of ordinary shares held by it rose to 1,454,138 without further cost and without altering the National Bank's percentage of the voting power in the pastoral company, namely thirty-five per cent. I shall refer to all the shares which the National Bank held in the pastoral company from that time until 1963 as "the shares", and it will be convenient, and only formally inaccurate, to speak of them as if they were identical with the shares which had been bought from the liquidator in 1948.

The circumstances in which the Queensland National Bank had come to own the shares must be noticed. In 1915 the Queensland National Bank had on its books a "bad debt" of £539,451 which had arisen in respect of loans on the security of certain pastoral properties in Queensland in consequence of the financial difficulties of the 1890s. It had accepted the properties in satisfaction of the mortgagors' indebtedness and decided to form a company to take them over. The pastoral company was formed for this purpose and the Queensland National Bank took up all the issued capital in that company, namely 250,000 preference shares and 600,000 ordinary shares, all of £1 each. The amount of the unpaid mortgage debt, though discharged (or perhaps, because this would seem more likely, only so much of it as exceeded the assumed value of the properties) continued to be recorded in the Queensland National Bank's books as a "bad debt", and it was reduced thereafter by sales of shares in the pastoral company to members of the public. Some 263,091 shares were sold between 1915 and 1927, producing £285, 002. In 1932, losses on the running of the pastoral properties led the pastoral company to reduce its share capital by the cancellation of paid-up capital to the extent of 17s. 6d. upon each issued ordinary share. By 1948 the residue of the "bad debt" was £254,449, and in that year the sale of the Queensland National Bank's remaining shares to the National Bank reduced it to £96,613.

Thus it seems that the Queensland National Bank always treated the shares as property the proceeds of sale of which, as and when made, should be applied in reduction of the "bad debt". It is a fact that after 1927 the Queensland National Bank made no effort to sell them; but one must remember that almost immediately there occurred the financial depression which lasted until well into the 1930s, and that not long after it was over the second world war broke out. One may therefore wonder whether the retention until 1948 of the shares which remained unsold at the end of 1927, notwithstanding that some offers were received, may not have been due to a lack of opportunity to effect sales at satisfactory prices. I think that that was the main reason; indeed I understood Sir Douglas Forbes to assent to that view when he accepted a suggestion in cross-examination that from 1927 until the merger of the two banks there was no occasion when it was "economic" to sell any further parcel of shares in the pastoral company. (Sir Douglas was at all material times a senior executive of the Queensland National Bank, and from 1937 onwards was its managing director.) But I also think that the Queensland National Bank's idea of a satisfactory price came to be greatly affected by its appreciation of some important advantages which its banking business might expect to gain from the retention of a large interest in the pastoral company. Sir Douglas Forbes summed the position up when he said in evidence:

We had no desire to forsake what we thought was a good revenue and money-spinner I did not want the money, therefore I was not much interested in the sale of it, because we would have lost a sphere of influence. The Queensland National Bank had an extensive banking business in Queensland and had built up its goodwill largely by associating itself with the pastoral industry and other rural activities in that State. It had numerous branches in country towns and had pursued a lending policy which recognized the desirability of assisting the development of rural areas and rural industries. It did not invest in shares as a general rule: in fact apart from the pastoral company's shares it seems never to have held any shares except about 2,000 in the Milliquin Sugar Co. Limited which it acquired in somewhat similar circumstances.

But the retention of the shares in the pastoral company which it still held after 1927 offered considerable advantages over and above the prospect of higher prices at a future time and possibly good dividends in the meantime. In the first place it would secure for the Queensland National Bank the very substantial amount of banking business connected directly with the pastoral properties themselves which, taken together, formed one of the largest pastoral enterprises in the State. A second result would be that commercial concerns desiring to do business with the pastoral company—for example, provedoring companies, wool brokers, stock agents, insurance companies—would be likely to see the advantages of reciprocity and give their banking business to the Queensland National Bank. And thirdly there was an advantage of a more intangible kind in that a substantial holding in a large pastoral company would tend to consolidate the reputation which the Queensland National Bank was anxious to maintain in the minds of the public and of governmental and other public authorities that it was and intended to remain closely identified with the rural interests of Queensland. In the twenty-one years for which the Queensland National Bank continued thereafter to hold the shares these advantages were gained to an extent that it considered important, and in consequence the holding in the pastoral company came to be regarded by the Queensland National Bank as an adjunct of its banking business, albeit an adjunct not indispensable and not necessarily permanent. Its city office was on the top floor of the Queensland National Bank's head office building and it was run almost as a department of that bank. But there is no evidence to suggest that a time ever came when the shares ceased to be regarded by the Queensland National Bank as assets the proceeds of sale of which, if and when a sale should be made, ought properly to be set in its accounts against the "bad debt", that is to say ought to be considered as making good the unrecovered capital and interest in place of which the pastoral properties had been accepted. I conclude that the shares were always held as a potential source for the recovery (by their sale) of the loan moneys and interest which otherwise would have had to be accounted as finally irrecoverable, and that the realization of them was postponed only because the Queensland National Bank considered that for the time being the interests of its banking business would be better served by obtaining the advantages that have been mentioned than by getting in the cash.

But by the time of the merger with the National Bank the collateral advantages had largely diminished in importance. Sir Douglas Forbes in his cross-examination agreed that by then the association with the pastoral company had ceased to produce any substantial volume of business for the Queensland National Bank. The custom that had been attracted through the holding of the shares in the intervening years was pretty firmly held, and not much expansion was going on among the types of business from which the Queensland National Bank could hope to get substantial custom because of its connexion with the pastoral company. But the holding of the pastoral company shares gave added strength to the relation between the Queensland National Bank and many of its existing customers and business expansion of relevant kinds might well occur in Queensland with better seasons and other economic changes. Sir Douglas at least still thought of the shares as "one of the best bulwarks we had for attracting business". His view was, if I have gathered it correctly, that the shares had long been a good source of influence for the Queensland National Bank, that given good seasons they would be the same again, and that they ought to be retained for that reason, as well as for the sake of the dividends they might produce, unless a very attractive offer to purchase should be received.

Sir Douglas's evidence on these matters is important because on the merger he became a member of the board of the National Bank, and although the state of his mind is not to be attributed necessarily to the whole board it provides some of the material from which an inference may be drawn as to the purpose of the National Bank in acquiring the shares in the pastoral company. But before proceeding with that topic it is convenient to state how the acquisition came about. It was not specifically required by the terms of the merger agreement, but it was plainly contemplated by the parties; indeed there was a provision that for a period of five years the National Bank should support the re-appointment of any of the directors of the Queensland National Bank and its general manager who were directors of any of three named companies including the pastoral company who should retire by rotation and seek and be eligible for re-election. Moreover the importance of the collateral advantages of the shareholding was brought strongly to the National Bank's attention, the suggestion being made in a letter of 13th October 1947 that if a sale were desired not only should a high price, £150,000, be asked but the condition should be imposed that Vesteys (the envisaged purchaser) should do all its Queensland business with the National Bank "or make some other favourable gesture".

"It is quite feasible", Sir Douglas wrote, "for the (National Bank) to sell the (Queensland National) Bank's holding in this (the pastoral) company to one of the larger pastoral houses who are large rural land holders. People like the A.M.L. & F., Australian Estates, Australian Pastoral Co., Scottish Australian Investment Co. may buy, and the (National) Bank should be able to quit at the face value of the shares, which are presently selling at a premium on change." The National Bank's response to this was that "having regard to the old association and the goodwill attaching thereto" it would be the intention to retain the shareholding. This was consistent with, and indeed a part of, the general attitude of both sides, that the merger should have the character of a union, a "marriage" as Sir Douglas came to call it. This attitude was exemplified by the National Bank's willingness that although the name of "The National Bank of Australasia Limited" should be kept, in practice there should be added the statement "united with The Queensland National Bank Limited", because, as the National Bank itself said in a letter, "our view is that goodwill reasons alone will demand the preservation of the Queensland National's name, more particularly in Queensland, for at least a generation".

The formal agreement for the merger was entered into on 26th March 1947, the National Bank agreeing to acquire all the issued shares of the Queensland National Bank. The latter was then placed in voluntary liquidation, and the National Bank bought from the liquidator the shares in the pastoral company together with the bulk of the other assets.

I do not think that the purpose of the purchase of the shares is fully described by simply reciting the three kinds of collateral advantage above mentioned and adding that there was optimism about future dividends. The true view of the matter clearly appears, I think, from the evidence of Mr. Roscoe (who had been the Queensland National Bank's head office accountant, went over to the service of the National Bank, and for a time was the liquidator of the Queensland National Bank), and of Mr. B. O'Keefe (whose evidence as to the policy that was pursued within the National Bank's own organization in connexion with the merger is, I think on reflexion, admissible as showing what manifestations of purpose there were). I am satisfied that the governing consideration in the view of the National Bank was the importance of its moving into the place the Queensland National Bank had occupied in Queensland, and doing so as completely and with as little disturbance of existing relations with the public and public authorities as possible and as little apparent break as possible in the continuity of operations. There was a very clear realization of the importance of ensuring by every available means that the take-over should not look like the swallowing of a Queensland bank by a larger bank from the South, and that people to whom the Queensland National Bank had been a familiar institution of known practices and attitudes should not feel that it had vanished and that there was no more reason to regard the National Bank as the logical inheritor of their custom than there was to transfer their allegiance elsewhere. Consequently the National Bank purchased not only the shares, but all other assets of the Queensland National Bank (except some long term local government loans which it seemed better to allow to mature than to take over at a heavy cost in stamp duty), and took its staff over as well.

Thus the prospect of deriving the collateral advantages which the pastoral company shares were likely to bring with them was but a part of the contribution which the acquisition of the shares made to this end. That, I think, is the explanation of the fact that Sir Douglas Forbes (in, for example, a memorandum to the board of the Queensland National Bank headed "Points on which a union might be considered") wrote of the collateral advantages in less emphatic terms than those he was to use in evidence in the present appeal, saying only that the pastoral company's association with the Queensland National Bank wielded "a certain amount of influence in diverting business to the Bank" and that it would be left to the National Bank to decide whether the shares should be retained. The collateral advantages, I say, were but a part of a larger benefit the National Bank aimed to derive from taking the shares, namely the benefit of being known to have moved into the same relationship with the pastoral company as the Queensland National Bank had maintained—as it proceeded to make clear to the world not only by ensuring that the pastoral company's managing director was thenceforth a National Bank executive but by moving the pastoral company's head office to the building which housed the National Bank's central office in Brisbane.

Whether and when, after a time, probably years, the shares should be sold, and whether their sale would result in a profit or a loss were questions that were left for the future to answer. At the moment they were not important. Certainly the purchase of the shares was not dictated, and I do not think it was even influenced, by the hope of a profit to be gained by their ultimate sale. Sale was not ruled out as a possibility; no doubt all that would be needed at any time would be a sufficiently tempting offer. Even Sir Douglas, alive though he always was to the practical value of the collateral advantages likely to flow from the retention of the shares, would have been inclined (as he conceded in evidence) to sell them in 1947 if he had received the offer that was received and accepted in 1963. But I am satisfied that profit-making by sale was not a purpose for which the National Bank acquired the shares in 1948.

The sale of the shares in 1963 was apparently under discussion for some eighteen months with the company which ultimately became the purchaser, but I find nothing to support the notion that the sale was the carrying out of a profit-making scheme. Under this head I need do little more than repeat that the plan with respect to the shares was primarily one for holding them, not necessarily for ever but indefinitely, and not for the sake of getting a profit by sale of them, although the purpose of retaining them was never so absolute that a high price might not induce its abandonment. The sale in 1963 was for a price which Sir Douglas not unnaturally described as excellent, amounting to £685,000 for shares which had cost £157,836. But it was the excellence of the price, not the profit as such, that was a factor in inducing the National Bank to sell. Moreover even that was not the only factor. The offer was made to all shareholders in the pastoral company and was conditional upon acceptance by the holders of ninety per cent of the shares. More than 3,000,000 shares were held in small parcels by members of the public, and Sir Douglas's opinion, which I do not doubt was shared by his fellow directors, was that if the National Bank had rejected the offer in respect of its own holding, and had thereby prevented the other shareholders from benefiting by the favourable price they were being offered, it would have incurred great odium in Queensland.

The question remains whether the profit which the sale in fact produced should be considered of an income character, as having arisen from the carrying on of the National Bank's banking business. The loss the Queensland National Bank made, namely the amount by which the sale price to the National Bank had fallen short of recouping the old "bad debt", had been treated by Queensland National Bank as a trading loss and had been allowed under s. 51 as a deduction for income tax purposes. It was no doubt correctly so allowed, for the original advances in satisfaction of which the pastoral properties had been accepted were advances in the course of the banking business; they were advances of circulating capital, and therefore the shares into which the properties were converted were investments of circulating capital; so that what was recovered through the sale of the shares was circulating capital, and what ultimately was not recovered was a loss on revenue account just as any excess would have been an income profit: cf. Punjab Co-operative Bank Ltd., Amritsar v. Income Tax Commissioner, Lahore [1] ; Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation [1] ; Australasian Catholic Assurance Co. Ltd. v. Federal Commissioner of Taxation [2] ; Commissioner of Taxation v. Commercial Banking Co. of Sydney [3] . But it does not at all follow that the National Bank should be considered to have taken over the Queensland National Bank's assets in the same character as that in which the Queensland National Bank had held them. Their character in the hands of the National Bank must depend on the nature of the purchase transaction: was it a transaction on capital account—for the purpose of adding to the profit-making structure of the National Bank—or was it a transaction forming part of the profit-earning activities within the structure. I have no doubt that it was the former. The National Bank when buying all the premises in which the Queensland National Bank had carried on its business must have had in mind that some would be likely to prove redundant sooner or later and would need to be sold, but they had to be bought at the time if the goal of stepping into the Queensland National Bank's shoes was to be pursued. In exactly the same way the shares had to be bought, even if ultimately they should be sold as no longer required, for otherwise the desired appearance of complete continuity of business, as well as the collateral advantages, would have to be foregone. Both that appearance and those advantages may be subsumed under the general head of goodwill, for their nature was of that kind. The purchase of the shares bore no resemblance to an investment of banking funds, made to earn income pending a need for their deployment in the making of advances and the like; it bore no resemblance to an investment by way of erecting a second or third line of defence against a time of stringency or emergency. It was an acquisition, not of the kind that might be repeated in the course of the profit-earning process, but made once and for all for the sake of enhancing, even if only for the time being, the profit-earning potential of the enterprise as a whole. Of course the shares would probably produce income directly; but dividends on them would form part of the National Bank's assessable income not as being profit from the carrying on of the banking business but simply as dividends, as income in their own right, just as rents from superfluous premises bought from the liquidator of the Queensland National Bank would be income in their own right. For the Commissioner some emphasis was placed upon the fact that during the period in which the shares were held by the National Bank that bank held shares in other companies also. In most cases, however, the acquisition was a result of sub-underwriting contracts; some of the companies were subsidiaries of the National Bank; some acquisitions reflected modern tendencies for banks to reach into wider financial activities than banking, e.g. into the hire-purchase business; and one shareholding (in the Western Queensland Pastoral Co. Ltd.) had come to the National Bank in circumstances resembling those in which the Queensland National Bank had acquired the shares in the pastoral company. The evidence about these holdings does not indicate to my mind that the National Bank was engaged in an undertaking of such a kind as to give the colour of income to the profit that was made on the pastoral company shares. The acquisition of those shares did not follow any pattern of investment that the National Bank had followed; it is to be accounted for solely as part and parcel of the take-over of the Queensland National Bank's whole undertaking, so that in respect of purpose it was, as I have suggested, akin to a purchase of goodwill rather than a purchase of property to be turned over in the course of business. As the purchase of the shares stood outside the course of the banking business, the sale of them likewise stands outside it. The profit from the sale was in my opinion a capital profit according to ordinary business concepts.

1. [1940] A.C. 1055, at p. 1072. 2. (1946) 73 C.L.R. 604, at pp. 608, 614. 3. (1959) 100 C.L.R. 502. 4. (1927) 27 S.R. (N.S.W.) 231.

Accordingly I must allow the appeal and order that the assessment be amended by excluding the profit from the appellant's assessable income.