TAXPAYER and COMMISSIONER OF TAXATION
[2012] AATA 142
•7 March 2012
[2012] AATA 142
Division TAXATION APPEALS DIVISION File Number(s)
2011/2356
Re
TAXPAYER
APPLICANT
And
COMMISSIONER OF TAXATION
RESPONDENT
DECISION
Tribunal The Hon. Brian Tamberlin QC, Deputy President
Date 7 March 2012 Place Sydney The decision under review is set aside and the objection is allowed in full on the basis that the relevant date was 1 July 2003 for the purposes of s 139B of the Income Tax Assessment Act 1936. Consequently, the Applicant is not liable to pay penalty for shortfall.
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The Hon. Brian Tamberlin QC, Deputy President
CATCHWORDS
TAXATION AND REVENUE – assessment of income – grant of options – date of acquisition – decision under review set aside
LEGISLATION
Income Tax Assessment Act 1936 (Cth) ss 139B, 139C, 139CC, 139CD, 139E, 139G
CASES
Agricultural and Rural Finances Pty Ltd v Gardiner [2008] HCA 57
Franklins Pty Ltd v Metcash Trading Limited (2009) 264 ALR 15
Re Willis and Commissioner of Taxation (2010) 79 ATR 287
SECONDARY MATERIALS
Lewison, K and Hughes, D, The Interpretation of Contracts in Australia (Lawbook Co., 2012)
REASONS FOR DECISION
The Hon. Brian Tamberlin QC, Deputy President
7 March 2012
The taxpayer seeks review of a decision of the Commissioner of 28 March 2011 dismissing an objection by him to an amended assessment by which the Commissioner included an additional $443,500.00 in the taxable income of the taxpayer for the income year ended 30 June 2004 and imposed a tax shortfall penalty of five per cent.
The Commissioner concluded that the taxpayer adopted the wrong date as the date on which he acquired certain options to purchase shares in a public company (the Company), and hence the date at which the “discount” included in his assessable income ought to be calculated under s 139CC of Division 13A of the Income Tax Assessment Act 1936 (ITAA). The taxpayer’s position is that the relevant date was 1 July 2003, whereas the Commissioner considered the correct date was 22 December 2003 or alternatively 28 November 2003. The additional tax was attributable to a movement in the share price of the Company between the date asserted as the date of acquisition by the taxpayer and the date adopted by the Commissioner.
BACKGROUND FACTS
The essential background facts can be summarised as follows.
In about May 2003 the taxpayer, then a partner at a prominent law firm, was approached by Mr G, a director of the Company, who proposed to him that he accept employment with the Company. Discussions and negotiations with Mr G, and later Mr S, occurred on 8 and 9 May 2003. One of the subjects of discussion was the taxpayer being granted options in the Company as one of the components of his remuneration as an employee of the Company.
On 9 May 2003 the taxpayer sent an email to Mr G recording the proposed terms of the contract of employment between himself and the Company. In relation to the question of the grant of options to the taxpayer, the email stated:
Re … options I have requested 1 million at $5 strike price (up from your ½ million offer), ½ million at strike price of $5 and ½ million at $7 million [sic] strike price but obviously I would accept more.
On 13 May 2003 the taxpayer sent a further email to Mr G, after a telephone conversation with Mr G and Mr S to confirm “everything was agreed”. He asked whether Mr G was going to send him a letter or email or whether he could “take it that everything is settled”. The taxpayer asked for “details of the vesting etc of the options”.
On 13 May 2003 Mr G replied to the taxpayer’s email of earlier that day and said “yes we are settled”. He commented that “[y]our options [are] starting to look good after today’s move”.
On 15 May 2003 the Company announced the taxpayer’s appointment as a Commercial Director. That same day Mr G emailed to the taxpayer a draft contract of employment with the Company (the draft contract). By clause 3(c) of the draft contract the Company agreed to provide “those further benefits specified in Item 8 of the Schedule”. Item 8 of the Schedule to the draft provided as follows:
Subject to approval by the … Board (and any shareholder approvals that may be necessary) [the Company] will provide you with the following benefits:
…
B. participation in a company share option scheme as set out in the annexure to this Agreement marked “Annexure”. [Emphasis added]
The Annexure provided as follows:
It is proposed that the Company issue 2,000,000 share options to [the taxpayer], Commercial Director. The Company will seek shareholder approval for the issue of options, and subsequent share issues on exercise, in accordance with Australian Stock Exchange Listing Rules 7.1 and 10.11. If shareholder approval is obtained, it is proposed that the options will be issued no later than one month following the Annual General Meeting.
The draft was never executed by either party.
On 1 July 2003 the taxpayer commenced employment in the position of Commercial Director. On 7 July 2003 the taxpayer sent to Mr G an email asking him:
Can I trouble you please to now email contracts(s) as my wife’s computer has been on [the] blink? Sorry have not even looked at them but I am sure they are fine. [Emphasis added]
On 3 September 2003 the taxpayer was appointed a director of the Company.
On 11 September 2003 the Company Secretary lodged with the Australian Stock Exchange Limited (ASX) a form entitled “Appendix 3X Initial Director’s Interest Notice”. Pursuant to that notice, the Company gave to the ASX certain information concerning the taxpayer’s interest in securities of and contracts with the Company. That information was given “as agent for the director for the purposes of section 205G of the Corporations Act”. Part 3 of that document was entitled “Director’s interests in contracts”. The “Nature of interest” was recorded as follows:
Right, conditional on shareholders approval, to be granted options over un-issued shares in [the Company]. [Emphasis added]
The document went on to state the strike price of the options and said:
The grant of these options is subject to the approval of ordinary shareholders in general meeting. [Emphasis added]
On 28 October 2003 the Company issued a Notice of Annual General Meeting. Under the heading “Special Business”. The Notice included the following proposal:
To consider and, if thought fit, pass the following resolution as an ordinary resolution:
‘That the Company approve for all purposes acquisition by [the taxpayer] of up to 2,000,000 options and, in consequence of exercise of those options, fully paid ordinary shares in the Company, on the basis described in the Explanatory Notes, which accompany this Notice of Annual General Meeting.’
The Explanatory Notes to the Notice of Annual General Meeting contained the following:
It is proposed that the Company issue … 2,000,000 share options to [the taxpayer], Executive Director. Shareholder approval is required under ASX Listing Rules for the issue of options to Directors of the Company, and the subsequent issue of ordinary shares in the capital of the Company (“Shares”) on exercise of those options.
The options will be issued immediately following the Annual General Meeting and, in any event, no later than one month after the Annual General Meeting, if approved. … There is no option issue fee …
… The terms of the options for [the taxpayer] were agreed on 9 May 2003, the date of his appointment, when the Company’s share price was $4.37. [Emphasis added]
On 18 November 2003 a further draft contract for the taxpayer’s employment was brought into existence. That contract did not refer to the options. It was never executed by the taxpayer.
On 28 November 2003, the Annual General Meeting of the shareholders of the Company passed the resolution approving the issue of the options for the taxpayer.
On 22 December 2003 the taxpayer and the Company executed an Option Deed. Clause 1 of the Option Deed provided as follows:
1 Grant of Options
1.1 Number of Options
The Company grants the Optionholder 2,000,000 Options on the terms of this deed. There is no option issue fee.
1.2 Issue Date
The issue date of the Options will be 22 December 2003.
Clause 3 of the Option Deed made provision for the options to vest in three tranches: 1 million on 9 May 2004 if certain conditions as to the Company’s share price were satisfied; 500,000 on 9 May 2005, again, if certain conditions as to its share price were satisfied; and 500,000 on 9 May 2006, once more, if certain conditions as to its share price were satisfied.
On 7 October 2005 the taxpayer made elections under s 139E of Division 13A of the 1936 Act to the effect that s 139B(2) was to apply to the options for the year of income ending 30 June 2004. Each election related to a different tranche of the three separate tranches of the options.
STATUTORY PROVISIONS
Division 13A of the 1936 Act brings to tax discounts on the market price for shares or rights issued under employee share schemes. The key provisions of Division 13A of the 1936 Act are as follows:
139B Discount to be included in assessable income
(1)If a taxpayer has acquired a share or right under an employee share scheme, the assessable income of the taxpayer includes the discount given in relation to the share or right.
…
(2)Unless subsection (3) applies, the discount is included in the taxpayer’s assessable income of the year of income in which the share or right is acquired.
…
(3)If the share or right is a qualifying share or right and the taxpayer has not made an election under section 139E for the year of income in which the share or right is acquired, the discount is included in the taxpayer’s assessable income of the year of income in which the cessation time (see sections 139CA and 139CB) occurs.
…
139CC Calculation of Discount
…
(2)If subsection 139B(2) applies to the discount, the discount is the market value of the share or right at the time when it was acquired by the taxpayer less any consideration paid or given by the taxpayer as consideration for the acquisition of the share or right.
…
139CD Meaning of qualifying shares and qualifying rights
(1) For the purposes of this Division:
…
(b)a right to acquire a share in a company is a qualifying right if the first, second, third, fifth and sixth of the 6 conditions below are satisfied.
…
(4)The third condition is that all the shares available for acquisition under the scheme are ordinary shares and all the rights available for acquisition under the scheme are rights to acquire ordinary shares.
…
139E Taxpayer may make election
(1)A taxpayer may make an election under this section that subsection 139B(2) applies for a year of income. The election covers each qualifying share or qualifying right acquired in that year by the taxpayer.
…
139G Meaning of acquiring or providing a share or right
A person acquires a share or right if:
…
(c) in the case of a right – another person creates the right in that person;
…
LEGAL PRINCIPLES
Agreements between commercial parties should be given a businesslike and commercial construction in accordance with the practical expectations of the business community. Consideration should be given to the objective aims and purpose of an agreement as part of the relevant surrounding circumstances considered in the context in which the agreement is made. The surrounding circumstances are those which exist at the time the contract is made and which are known by the parties. In construing an agreement the Court will proceed on the basis of an objective consideration, and will normally not have regard to the subjective expectations or intentions of the parties: see the summary of the relevant law in Franklins Pty Ltd v Metcash Trading Limited (2009) 264 ALR 15.
Regard must be paid to the meaning of the words used, read as a whole in the above context. However, subsequent conduct and actions can be taken into account for purposes other than the interpretation of the terms of the agreement. For example, in order to ascertain what is included in the terms of the agreement; to determine whether the agreement is a sham; or to determine whether an agreement has been reached between the parties or whether there was an objective intent to create legal relations. The law as to the use of subsequent conduct of the parties in order to interpret the meaning of terms in the contract was confirmed by the High Court in Agricultural and Rural Finance Pty Ltd v Gardiner (2008) 238 CLR 570 at [35]. See also Lewison, K and Hughes, D, The Interpretation of Contracts in Australia, (Lawbook Co., 2012) at [3.15].
The question whether it was a term of an agreement, in the present case, that it was not to operate until a condition had been satisfied, raises a question as to what the terms of the contract comprised and not merely a question as to the meaning of terms in the contract. Accordingly, regard can be had to subsequent conduct and events in determining this question in the present case. The Tribunal does not accept the submission that no regard can be paid to the subsequent events, conduct or communications between the parties in the present circumstances where the contract in relation to options is, to say the least, very succinct in its formulation.
The objective facts in the instant case are consistent with the conclusion that the parties intended in May-June 2003, to enter into binding legal relations whereby the taxpayer would resign from a partnership in a major legal firm in order to take up the new position as a result of which he acquired the options. Indeed, the Commissioner does not contend there was no legal right to the options as at that date, but rather seeks to characterise the right acquired as “anterior” to that referred to in s 139B. There is no doubt that the options were on any objective approach an important ingredient in the taxpayer’s remuneration, and this reinforces the conclusion that the exchange of emails and the discussions conferred an immediate binding legal right on the taxpayer to the acquisition of shares upon exercise of the options. It would be contrary to reasonable commercial expectations that the taxpayer, in the circumstances of taking up employment for a three-year period, after careful negotiations to secure the options in a quantity and at the strike price he wanted, would have entered into the employment arrangement in the absence of having such an immediate legally enforceable entitlement. In the event that steps were taken to obtain a declaration as to his entitlement on 1 July 2003, the Tribunal accepts that his entitlement to then acquire the options and the shares would have been recognised by a declaration of right or an order for specific performance.
ISSUES
There are two primary issues between the parties and these are:
(a)Were the taxpayer’s rights acquired on 1 July 2003 or some other date.
(b)Whether any penalty should be imposed and if so, whether it should be remitted.
First Issue – Date of Acquisition
The Commissioner submits that the taxpayer did not acquire a relevant right for the purpose of s 139B until 28 November 2003 when the Annual General Meeting of the Company approved the issue of options to the taxpayer or, alternatively, 22 December 2003, when the options were actually created and granted to the taxpayer by the Option Deed of that date.
The Commissioner submits that although a binding right was created in the taxpayer by 1 July 2003 to have the relevant options granted to him, nevertheless, this was not a relevant right for the purposes of s 139B, because that section contemplated a right, when exercised, would immediately give rise to the transfer or acquisition of shares. The Commissioner contends that the binding agreement reached between the taxpayer and the Company prior to late 2003, only gave rise to an “anterior” right to have options issued, which was not the right provided for in s 139B. The Tribunal does not accept this submission.
Section 139B(1) refers to the acquisition of a right not simply to the acquisition of a share. By s 139C the taxpayer acquires a right if a right is acquired by the taxpayer “in respect of, or for or in relation directly or indirectly to, any employment” (emphasis added). Under the agreement evidenced by the email exchanges and the oral evidence, the right to options is a “qualifying right” within s 139CD. This is because the right to the options is acquired under an employee share scheme, the Company is the employer of the taxpayer and the rights are rights to acquire ordinary shares (the first, second and third conditions). In the Tribunal’s view the reference to rights to acquire ordinary shares is sufficiently wide to include a right to be granted an option and is not restricted, as contended by the Commissioner. Immediately after the acquisition the taxpayer did not hold an interest in more than 5 per cent of the shares in the Company (the fifth condition). Nor could he control more than 5 per cent of the votes (the sixth condition).
On a proper analysis, the right to acquire ordinary shares includes a right to obtain options which, when exercised, result in the acquisition of ordinary shares. The Tribunal considers that the restrictions advanced by the Commissioner are not warranted by the language of the provisions of Division 13A.
The agreement reached by the parties was that the taxpayer would have the options at the specified strike prices on assuming office, and such a binding agreement was specifically enforceable. The evidence is that he was appointed as Commercial Director on or about 15 May 2003.
The above approach is consistent with commercial realities, having regard to the circumstances in which the taxpayer was placed in May 2003.
For the above reasons, the Tribunal accepts the submission that the right to obtain options is a relevant right within the meaning of s 139B, and is not a form of anterior entitlement which does not come within that provision. The expression “right” is not limited in its terms and should be given a practical operation.
In support of his decision the Commissioner relies on reasons for decision given by Senior Member Pascoe in Re Willis and Commissioner of Taxation (2010) 79 ATR 287 at [9] where he said:
… Again, the ITAA 1936 does not define “right” but it is clear from a reading of Div 13A that the right which is in issue here is a right to take up shares in a company. The resolution of 3 May 2004 did nothing more than approve in advance the allotment by the board of 1,000,000 options pursuant to the option plan. The resolution required such allotment to occur no later than 12 months from the date of the meeting. At its best it may be said that, on 3 May 2004, Mr Willis had a right to have the board issue the options under the plan within the next 12 months. I am unable to see that it can be said that Mr Willis acquired the right, being the options, at any time prior to the date when those options were created…
The above case is distinguishable. In Willis there was no contract for the taxpayer which gave him an immediate contractual right to obtain the options. There was also in fact an approval by the Annual General Meeting in advance of an allotment. Also in Willis the taxpayer was a director of the public company and authorisation was required. In the present case although as at July 2003 the taxpayer held a position as “Commercial Director”, he was not in fact on the board of the public company and therefore not a director for present purposes at the relevant time. Therefore it was not necessary to have shareholder approval for the grant of the right to the options.
In the present case the Tribunal concludes that there was an acquisition of options, pursuant to the discussions and emails of May 2003, whereby the taxpayer agreed to accept the options and this was agreed to by the Company.
The second submission by the Commissioner is that upon the proper construction of the contractual arrangements between the taxpayer and the Company, the grant of the right to the options was conditional upon shareholder approval, or the formalisation of the contract by the Option Deed of 22 December 2003.
The Commissioner relies on communications, documents and records subsequent to July 2003 to make good this proposition. The taxpayer contends that it is not permissible to take into account subsequent matters, events and communications, in order to determine whether it is conditional or not, except in exceptional circumstances such as whether the contract was a sham on the issue as to whether any contract had been made. The Commissioner relies on the observations in Agricultural and Rural Finance Pty Ltd v Gardiner (2008) 238 CLR 570 at [35] the effect that the general principle is that “it is not legitimate to use as an aid in the construction of [a] contract anything which the parties said or did after it was made.”
In the present case however, the Commissioner seeks to rely on the subsequent conduct not simply as aid to interpretation, but rather to put forward a contention that there was a condition in the arrangement that the grant of the rights would only be operative upon shareholder approval or under the formal deed, which in fact was entered into on 22 December 2003.
It is common ground that until 3 September 2003 the taxpayer was not a “director” of the Company and up to that time he simply held a position with the title of “Commercial Director”, and that there was therefore no requirement that shareholder approval was necessary in accordance with the Australian Stock Exchange Listing Rules.
The Commissioner relies on an unexecuted draft services agreement sent to the taxpayer on 15 May 2003, which refers to the Company seeking “shareholder approval for the issue of options, and subsequent share issues on exercise, in accordance with Australian Stock Exchange Listing Rules”. This statement is erroneous but the Commissioner relies on it as support for the view that the parties in fact contemplated shareholder approval. This agreement was never executed or implemented and does not support the existence of a condition requiring shareholder approval. As at 1 July 2003 there was, in the Tribunal’s view, a binding contractual agreement to grant the options and therefore an acquisition.
The next matter relied on is a Director’s Interest Notice sent by the Company to the Australian Stock Exchange on 11 September 2003, notifying that the taxpayer had an interest in a contract of employment describing the nature of the interest as being:
Right, conditional on shareholders approval, to be granted options over un-issued shares in [the Company]. [Emphasis added]
The reference to a “right, conditional on shareholders approval, to be granted options over un-issued shares in [the Company]” is stated to refer to the number of options and the strike price and states that the grant of the options is “subject to the approval of ordinary shareholders in general meeting.”
This document was sent to the Australian Stock Exchange by the Company Secretary and contains a statement that:
We (the entity) give ASX the following information under listing Rule 3.19A.1 and as agent for the director for the purposes of section 205G of the Corporations Act. [Emphasis added]
The evidence is that the taxpayer had not seen this notice until recently and that he had not authorised sending off the notice. The Tribunal does not consider that this notice supports the proposition that as at 1 July 2003 the agreement in relation to the options was conditional, and it is not persuaded that it can be taken to have been made “as agent” for the taxpayer.
A further document referred to by the Commissioner is the Notice of Annual General Meeting of the Company held on Friday, 28 November 2003 which refers to the proposed passing of a resolution to the effect that the Company approves the acquisition by the taxpayer of two million options. The taxpayer contends that, in the Tribunal’s view correctly, it was not necessary under the Listing Rules for such approval to be given, and accepts the evidence and submission that shareholders’ approval was obtained in the interest of transparency.
Finally, there is the formal Option Deed of 22 December 2003 pursuant to which there was a formal issue of the options at the specified option price and which spelled out the terms in detail.
The Commissioner relies on the above documents to show that the agreement in force as at 1 July 2003 was conditional, and did not satisfy the requirements of s 139B as being a relevant unconditional right for the acquisition of shares.
The Tribunal is not persuaded the agreement in force as at July was conditional upon approval or a formal deed or upon shareholder approval. In terms, the exchange of emails, together with the oral evidence from the taxpayer, establish that there was no reference in discussions or written reference to any such condition, and the Tribunal does not consider there was any such condition which could be implied in the email agreement of May 2003.
The emails make no reference to any such condition, and the draft agreement sent on 16 May 2003 is clearly in error referring to the need for shareholder approval.
Accordingly, for these reasons the Tribunal does not accept the agreement was conditional as submitted by the Commissioner.
CONCLUSION
The Tribunal considers that the relevant date of acquisition in this matter was 1 July 2003. The effect of this decision is that there is no tax shortfall amount so it is not necessary for the Tribunal to consider the issue of penalty.
The Tribunal therefore sets aside the objection decision of the Commissioner in respect to the Notice of Amended Assessment for the income year ended 30 June 2004 and allows the objection in full on the basis that the relevant date is 1 July 2003 for the purposes of s 139B. As a result of this decision the Applicant is not liable to pay penalty for shortfall.
The Tribunal notes that alternative arguments were made by the taxpayer relating to the capital gains provisions but as the result of its conclusion on the primary question as set out above it is not necessary to deal with this aspect of the case.
I certify that the preceding 50 (fifty) paragraphs are a true copy of the reasons for the decision herein of The Hon. Brian Tamberlin QC, Deputy President.
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Associate
Dated 7 March 2012
Date of hearing 30 January 2012 Counsel for the Applicant Dr A Bell SC Solicitors for the Applicant Munro Lawyers Counsel for the Respondent Mr M O'Maera Solicitors for the Respondent Australian Government Solicitor
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