Newton v Federal Commissioner of Taxation [1958] 2 All ER 758(PC)

Newton was a typical case of conversion, where profits were converted into capital. Three motor car retail companies entered into similar arrangements with a company (P Limited) owned and operated by their accountant. Similar features but for simplicity purposes arrangement of one company explained below:

1 Declared dividend to 80,000 ordinary shares of $1 each amounting to $460k
2 Sold these 80,000 ordinary shares to P Ltd for $460k
3 P Ltd received the dividend of $460k
4. P Ltd sold these 80,000 shares to their subsidary company for $80k (loss of $360k)
5. P Ltd took 400,000 preference shares for $1 each @ 5% p.a

Above arrangement provided them two benefits:
1. For motor car company profit of $460k was converted into a capital of $480k ($80k ordinary shares and $400k preference shares)
2. For P Ltd taxable income was only $80k , $460k (dividend) offset by loss on sale of shares $360k

At that time, under Australian law these company profits were liable for heavy tax but by doing such a kind of arrangement they could avail the benefit of lower tax rate. These arrangements enabled the shareholders to receive large sum without paying tax on it.
Lord Denning said
“Looking at the whole of this arrangement, their Lordships have no doubt that it was an arrangement which is caught by s 260. The whole of the transactions show that there was concerted action to an end - and that one of the ends sought to be achieved was the avoidance of liability for tax.”
Lord Denning developed the following principles in Newton case:
1. An arrangement can be partly oral and partly written and can be inferred from the circumstances
2. In applying the section one should look at what the arrangement effects, what it does irrespective of the motives of the parties.
3. Purpose is judged by what the arrangement intended to effect and is discerned from an examination of the terms of the arrangement.
4. In order to apply the section, one must be able to predicate from the overt acts by which the arrangement was implemented that it was implemented in that particular way so as to avoid tax.