Tax Brief
14 May 2003
The Textured Issue of Beneficial
Ownership
In the decision of Commissioner of Taxation v Linter Textiles Australia Ltd (in liq
[2003] FCAFC 63 (14 April 2003), the full Court of the Federal Court upheld the
decision of Hely J at first instance in Linter Textiles Australia Ltd (in liq) v
Commissioner of Taxation [2002] FCA 1089. While this unanimous decision
provides a useful discussion of the term ‘beneficial ownership’, it stops short of
eliminating any lingering ambiguity in the ownership of assets held by a company
subject to a winding up order.
Background
(a)Facts
The relevant facts in this case were not disputed on appeal. Briefly, Linter Textiles
Australia Ltd (in liq) ("LTAL") was a wholly owned subsidiary of Linter Group Ltd
(in liq) ("LGL"). The companies were wound up in 1992 and 1991 respectively,
and a liquidator was appointed for each.
For the year ending 30 June 1992, LTAL derived assessable income of
approximately $10m. The company sought to offset the entirety of this income by
applying prior year losses under s79E of the Income Tax Assessment Act 1936
("ITAA36"). A sizeable portion of these losses were deemed to have been
incurred by LTAL as the result of a transfer from LGL.
The Commissioner argued that the upon the creation of the winding up orders,
LGL ceased to be the beneficial owner of its shareholding in LTAL. Accordingly,
prior year losses could not be utilised by virtue of s80A(1). This provision
operated to prevent a loss from being used as a deduction under 79E, unless a
company was able to establish:
"that, at all times during the year of income, shares in the company carry
between them 
List bullet the right to exercise more than one-half of the voting
power in the company;

the right to receive more than one half of any dividends that may
be paid by the company;

the right to receive more than one-half of any distribution of
capital of the company, were beneficially owned by persons, who
at all times during the year in which the loss was incurred,
beneficially owned shares in the company carrying between them
rights of those kinds."
(b)The Decision at First Instance
At first instance, Hely J sought to determine the meaning of ‘beneficial ownership’
as it is used in the context of s80A(1). His Honour focussed upon the mischief of
this provision - to prevent the trafficking of companies with accumulated losses by
requiring a continuity of ownership. His Honour conceded that while beneficial
ownership may be suspended in some contexts, the purpose of s80A(1) would
not be furthered by denying LGL beneficial ownership of its shareholding in LTAL.
His Honour also considered that LGL was still entitled to dividends, capital
distributions and voting rights notwithstanding that they were unable to exercise
these rights. Therefore, the criteria under Section 80A(1)(a)-(c) were met, and the
losses could be utilised to offset assessable income.
Issues
On appeal, the issues in this case were refined to two fundamental questions:
Did LGL beneficially own the shares in LTAL for the purposes of Section 80A(1)?
If question (a) is answered in the affirmative, did the shareholding entitle LGL to
the voting rights, dividends and capital as required under (c), (d) & (e)?
Decision
(a)Did LGL Beneficially Own the Shares?
Prior to engaging in a discussion of the meaning of beneficial ownership in the
context of s80A(1), the Court examined the company law consequences of a
winding up order. Their Honours noted that the making of a winding up order
does not amount to the creation of a trust in favour of creditors. Instead, a
liquidator is merely required to apply the assets of a company subject to the
relevant statutory requirements.
The Court then addressed relevant English authorities. In particular, their
Honours examined the decisions of In re Oriental Inland Steam Company [18731874] LR 9 Ch App 557 and Inland Revenue Commissioners v Olive Mill Limited
(in liq) [1963] 1 WLR 712, which both ostensibly stand for the proposition that
upon the making of a winding up order, a company’s assets are held on trust for
the benefit of creditors. Their Honours considered that perhaps the Court of
Appeal in Re Oriental Steam may have applied the principles of trust law by way
of analogy. Therefore the ratio of these cases may not have been intended to
suggest that a trust in the strict sense is created. Their Honours cited the
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The Textured Issue of Beneficial Ownership
judgement of Menzies J in Franklins Selfserve Pty Ltd v Federal Commissioner of
Taxation (1970) 125 CLR 52, in which his Honour stated:
"Even if a company, being insolvent, goes into liquidation, I find difficulty in
regarding the company itself as trustee for anybody, notwithstanding that it
can no longer employ its assets in its business nor dispose of them.”
Having confirmed that a trust is not created upon the making of a winding up
order, their Honours examined the application of the House of Lords decision in
Ayerst (Inspector of Taxes) v C & K (Construction) Limited [1976] AC 167. In this
case, the House of Lords seemed to leave open the possibility that the term
‘beneficial ownership’ may have acquired a unique meaning from the context of
the Finance Act 1927 (UK) in which this term was initially used. Arguably, this
concept of ‘beneficial ownership’ is broader than the technical equitable meaning,
and may have been tacitly adopted by the English legislature through repeated
use in revenue statutes.
Their Honours explained that the potentially expanded notion of "beneficial
ownership" refers to the capacity of a shareholder to enjoy the ‘fruits’ of a
shareholding. Where a winding up order is made, because the assets of company
have to be applied in accordance with statutory requirements for the ultimate
benefit of creditors, a shareholder will lose this ability. Beneficial ownership in the
non-technical sense will be lost, even though a trust is not strictly created.
The Court noted that the ratio in Ayerst has not yet been subject to rigorous
judicial scrutiny in this country. The only comment thus far has come from
decisions before a single judge, including Franklins Self Serve Pty Ltd v Federal
Commissioner of Taxation. In this decision, Menzies J was required to determine
whether a company in liquidation beneficially owned shares for the purpose of
deducting prior year losses. His Honour held that the focus of the relevant
legislation was upon a continuity of ownership in the year of loss and the year of
income, and that this was not lost simply because a company was placed into
liquidation. Implicit in this argument, is the notion that a trust is not created in
favour of creditors where a winding up order is made.
Their Honours also cited the later decision of FC of T v St Hubert’s Island Pty Ltd
(1977-1978) 138 CLR 210, in which Mason J acknowledged an apparent conflict
between the approach adopted by Menzies J and the ratio of Ayerst. Their
Honours also referred to a passage by Meagher, Gummow and Lehane
contained in Equity: Doctrines and Remedies explaining the different approaches:
"The position thus is reached that both Lord Diplock (in Ayerst) and
Menzies J agree that the company in liquidation is not a trustee of its
assets, in the ordinary sense, but they differ as to the next step. To
Menzies J, this is that the company has not been deprived of its beneficial
interest; to Lord Diplock, the company has by force of the legislation been
so deprived but not so as to vest beneficial interest in any other group or
individual and Livingston’s case indicates that the result is not an
anomalous ‘gap’ or lacuna in the title to the assets in question."
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The Textured Issue of Beneficial Ownership
Having acknowledged the complexities and tensions created by previous
authority, the Court declined to reach a concluded view upon the precise interest
that a company retains in their assets upon the making of winding up order.
Instead, their Honours sought to interpret the meaning of ‘beneficial ownership’ by
reference to the mischief of s80A(1) only. Their Honours noted that a
consideration of the context of statute must be the first task of statutory
interpretation. They agreed with the analysis at first instance that the predominant
purpose lying behind this provision was to prevent the ‘hawking’ of entities with
large accumulated losses by requiring a continuity of ownership. Their Honours
held that this purpose would not be furthered by disallowing the deduction of
losses simply because a company may have gone into liquidation. On this basis,
the Court upheld the conclusion of Hely J at first instance that LGL was the
beneficial owner of the shares for the purpose of s80A(1).
(b)Was LGL Entitled to Dividends, Capital and Voting Rights?
Having determined that LGL was the beneficial owner of their shareholding, the
Court then examined the second issue - whether LGL were entitled to dividends,
capital and voting rights notwithstanding that LTAL were subject to a winding up
order. In a brief analysis, the Court argued that the answer to this question is to
be found by examining the articles of association of LTAL. At para 64 the Court
stated:
"There is no change in the rights attaching to the shares merely because
the company has gone into liquidation. The shares continue to carry the
same rights. In our view the question can only be answered by looking at
the rights which, in accordance with the articles of association of LTAL
attach to the relevant shares. Those rights are such that at all times in the
year of income there was the necessary continuity of rights as existed in
the year of loss."
On this basis, the Court concluded that the requirements under s80A(1) were
satisfied, and LGL was entitled to deduct the transferred in losses.
Conclusion
By its nature, the concept of beneficial ownership is amorphous and difficult to
describe with precision. Because this term is not defined in the taxation statutes,
it is the responsibility of the Courts to provide adequately reasoned, and
appropriately detailed explanations of its meaning and application.
It is submitted that the decision of the Full Court in Commissioner of Taxation v
Linter Textiles Australia Ltd represents an opportunity lost. While the Court does
give a useful discussion of the ambiguity associated with the use of ‘beneficial
ownership’, they leave open the fundamental issues raised by this case. The
Court declines to provide an authoritative assessment of the precise nature of the
interest held by the shareholders of a company subject to a winding up order.
Beyond stating that no trust in a strict sense is created in favour of creditors, the
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The Textured Issue of Beneficial Ownership
Court declines to reach a concluded view as to the effect of holding property
subject to the statutory order of distribution, or the appropriateness of applying
the label ‘trustee.’ Even though answers to these questions would have only been
collateral to an interpretation of s80A(1), they would have gone a long way to
resolving much of the ambiguity which exists at present.
It would seem that the concept of beneficial ownership will continue to be an
integral component of many provisions of the tax legislation. It is still used as a
touchstone of the continuity of ownership test, which is presently set out under
subdiv165-D of the Income Tax Assessment Act 1997 ("ITAA97"). It also used in
the same business test, and is incorporated by reference in the rules relating to
the transfer and utilisation of losses within a consolidated group (Div 707 of the
ITAA97). Outside of the loss rules, ‘beneficial ownership’ or variants such as
‘beneficial entitlement’ arise in the capital gains provisions and are central to the
deemed shareholding of s24D(2) of the ITAA36. While it is a pity that the Court
was not prepared to provide more conclusive guidance, there is at least some
comfort in knowing that the meaning should be considered in the context of the
particular rules and the mischief to which they are directed.
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The Textured Issue of Beneficial Ownership
This article written by Stephen Banfield appeared in the June 2003 edition Vol 37
(11) of Taxation In Australia, the journal of the Taxation Institute of Australia.
These notes are in summary form designed to alert clients to tax developments of general
interest. They are not comprehensive, they are not offered as advice and should not be
used to formulate business or other fiscal decisions.
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The Textured Issue of Beneficial Ownership