Condell v Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Federal Court of Australia (QUD 349 of 2006)
Judgment date: 28 March 2007
Date published: 20 March 2008
Decision outcome: Favourable. Appeal dismissed by majority (Kenny and Allsop JJ) with Gyles J dissenting

Summary of decision:
HP paid a dividend by way of an in specie distribution of shares in its subsidiary to its shareholders. The Full Court found that the dividend was paid wholly out of profits although the market value of the shares (approx $29 billion) exceeded the amount debited to HP's books of account (US$4.2 billion).

Overview of facts:
1. Hewlett-Packard Company (HP) was incorporated in the United States. The respondent was a shareholder. | 2. On 2 March 1999, HP announced its intention to effect a demerger of its test and measurement semiconductor products, chemical analysis and healthcare solutions businesses ("discontinued operations"). | 3. On 12 August 1999, HP entered into a Master Separation & Distribution Agreement ("Separation Agreement") with Agilent Technologies Inc (Agilent), then a wholly owned subsidiary of HP. | 4. On 1 November 1999, pursuant to the Separation Agreement HP transferred assets and liabilities of the discontinued operations to Agilent. | 5. On 18 November 1999, Agilent launched an initial public offering of 15.9% of its common stock (the "IPO"). Thereafter HP's shares in Agilent represented approximately 84.1% of Agilent's common stock. Pursuant to the Separation Agreement, Agilent transferred the net proceeds of the IPO to HP by way of a dividend distribution. | 6. On 7 April 2000, HP declared a stock dividend of substantially all of its shares in Agilent. The dividend was distributed on 2 June 2000 to HP shareholders on record as of 2 May 2000. 1327 shares in Agilent were distributed as a dividend by HP to the respondent. The market value of the respondent's shares, as at 2 June 2000, was $168,961, based on a market price for Agilent shares of US$77.0068 per share and an exchange rate of US$0.6048. | 7. The market value of the total distribution was approximately $29 billion which HP accounted for by eliminating the net assets of the discontinued operations and reducing retained earnings by $4.2 billion. | Issues decided by the court | The issue before the Court was whether the dividend, paid by HP to its shareholders by way of a distribution of in-specie shares in its subsidiary, Agilent, was paid wholly out of profits derived by HP in circumstances where the market value of the distribution greatly exceeded the amount debited to retained earnings. | The majority held the distribution was paid wholly out of profits. The correct perspective to determine the source of the distribution is from the point of view of HP: Slater Holdings . The source identified by HP was its retained earnings account. The "discrepancy [between the market value of the shares and the amount debited to the retained earnings account] did not represent any inadequacy, error or lack of truth and fairness in the accounts. Rather, the shares in Agilent and the assets that were transferred to Agilent had been carried in Hewlett Packard's accounts at less than current market value. That wholly unremarkable state of affairs did not alter the fact that from the point of view of Hewlett-Packard the distribution of the shares had its source in retained earnings. ... The shares were distributed out of a profit account. That was the complete explanation given by Hewlett-Packard for the distribution of the shares and the extent of the adjustment in the accounts does not, in our view, require a further explanation of the source of that additional value to understand what, from the company's perspective, is the source of the distribution of the shares."

Issues decided:
The issue before the Court was whether the dividend, paid by HP to its shareholders by way of a distribution of in-specie shares in its subsidiary, Agilent, was paid wholly out of profits derived by HP in circumstances where the market value of the distribution greatly exceeded the amount debited to retained earnings. The majority held the distribution was paid wholly out of profits. The correct perspective to determine the source of the distribution is from the point of view of HP: Slater Holdings . The source identified by HP was its retained earnings account. The "discrepancy [between the market value of the shares and the amount debited to the retained earnings account] did not represent any inadequacy, error or lack of truth and fairness in the accounts. Rather, the shares in Agilent and the assets that were transferred to Agilent had been carried in Hewlett Packard's accounts at less than current market value. That wholly unremarkable state of affairs did not alter the fact that from the point of view of Hewlett-Packard the distribution of the shares had its source in retained earnings. ... The shares were distributed out of a profit account. That was the complete explanation given by Hewlett-Packard for the distribution of the shares and the extent of the adjustment in the accounts does not, in our view, require a further explanation of the source of that additional value to understand what, from the company's perspective, is the source of the distribution of the shares."

ATO view of decision:
The majority judgment aligns with the Commissioner's view, explained in TR 2003/8 , that the money value of property paid to a resident shareholder by way of a dividend will be included in the shareholder's assessable income if it is sourced out of profits derived by the company. For these purposes there need not be a correspondence between the amount debited to the company's books of accounts and the value of the distribution in the hands of the shareholder. Where a company properly keeps its accounts on a basis that does not record its assets at current market value, there will often be a discrepancy between the amount debited to the account of profits and the value of the assets distributed. It will not be necessary for the additional value of the assets accounting for that discrepancy to be recognised in the accounts as a profit and debited on the distribution for the distribution of the assets to be seen as sourced entirely in profits. That is to say, where distributed assets representing profits are identified by the company as a distribution of profits the requirements of section 44 are satisfied, and it is not necessary for the company to take the further step of identifying the value of the assets as the amount of the profit distributed. | Different considerations may arise where the company's accounts are not kept properly. | The decision does not deal with the case where a distribution of assets is debited to an account of share capital and the value of the assets distributed exceeds the amount debited to share capital. The Commissioner considers that in such a case there will generally be a distribution out of profits; the provisions of subsection 44(1B) may also be relevant.

Administrative treatment:
Implications on current Public Rulings & Determinations | Decision confirmed correctness of TR 2003/8 and ATO ID 2002/639

Legislative references: Income Tax Assessment Act 1936 (ITAA36) 6 44(1) Income Tax Assessment Act 1997 (ITAA97) 6-5
Case references: McFarlane v FC of T (1986) 13 FCR 356 86 ATC 4477 17 ATR 808 FC of T v Slater Holdings Ltd (1984) 156 CLR 447 84 ATC 4883 15 ATR 1299 Davis Investments Pty Ltd v Commissioner of Stamp Duties (NSW) (1958) 100 CLR 392 Commissioner of Taxation v Condell [2006] FCA 1047 Birdseye v Australian Securities and Investments Commission [2003] FCAFC 232 Australian Securities and Investments Commission v Saxby Bridge Financial Planning Pty Ltd (2003) 133 FCR 290 Australia Telecommunications Corporation v Lambroglou (1990) 12 AAR 515 Comcare v Etheridge (2006) 149 FCR 522 Coulton v Holcombe (1986) 162 CLR 1 Dismin Investments Pty Ltd v FC of T (2001) 183 ALR 565 2001 ATC 4377 47 ATR 292 Ergon Energy Corporation Ltd v Commissioner of Taxation (2006) 153 FCR 551 64 ATR 130 [2006] FCAFC 125 Evans v DFC of T for Sth Aust (1936) 55 CLR 80 FC of T v Sun Alliance Investments Pty Ltd (in liq) (2005) 222 ALR 286 2005 ATC 4955 60 ATR 560
Subject references: Income tax assessable income in-specie distribution of shares dividend whether paid wholly out of profits derived
Other references: ATO ID 2002/639: Shares received as result of a company split - treated as dividend