'VAN' and Commissioner of Taxation

[2002] AATA 1313

Administrative

Appeals

Tribunal

 

DECISION AND REASONS FOR DECISION [2002] AATA 1313

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No VT2002/12

TAXATION APPEALS  DIVISION		)
Re		‘VAN’

Applicant

And COMMISSIONER OF TAXATION

Respondent

DECISION

Tribunal Mr B. Pascoe, Senior Member

Date16 December 2002

PlaceMelbourne

Decision The Tribunal affirms the decision under review.

.........Sgd. Mr B. Pascoe..............

Senior Member

CATCHWORDS

Income Tax - capital gain - shares acquired under employee options - whether discount capital gain - whether shares acquired at date of grant of option or date of exercise of opinion - date contract entered into for acquisition of shares.

Income Tax Assessment Act 1997

Laybuff v Amoco Australia Pty Ltd (1974) 132 CLR 57

Sydney Futures Exchange v Australian Stock Exchange Ltd & Another (1995) 128 ALR 417

Elmslie & others v Federal Commissioner of Taxation 93 ATC 4964

Brooks and another v Federal Commission of Taxation 2000 ATC 4362

REASONS FOR DECISION

16 December 2002 Mr B. Pascoe, Senior Member     

1.      This is an application to review a decision of the respondent to disallow an objection against an amount of income tax based on the applicant’s income for the year ended 30 June 2000.  The objection was to the inclusion of the whole of the profit on sale of shares in assessable income and argued that 50% of the profit only should be so included.

2.      At the hearing, the applicant was represented by Mr T. Murphy of counsel and the respondent by M. P. Sest of counsel.  There was no dispute as to the facts of this case and the hearing involved submissions by the parties on the application of the income tax legislation to those facts.

3.      A summary of the relevant facts is:-

ithe applicant was a non-executive director of a publicly listed company.

iOn 12 August 1996 he was issued with options to subscribe for 500,000 shares in the company at $1.50 per share.

iThis applicant elected to include the value of options, $68,190, in his assessable income of that year.

iBetween 7 December 1999 and 2 March 2000 the applicant exercised his rights under the options to subscribe for 226,666 shares.

iBetween 8 December 1999 and 31 March 2000, the applicant sold 120,666 shares on the market for net proceeds of $569,637.

iThe applicant included a capital gain of $372,182 in his assessable income for the year ended 30 June 2000 calculated as follows:-

$                  $

Net proceeds from sale of shares  569,637

Cost base of shares

Exercise price  180,999

Market value of options on acquisition    16,456           197,455

372,182

ithe applicant objected to the notice of assessment for the year ended 30 June 2000 on the grounds that the date of acquisition of the shares was the date of the contract for the acquisition of the options, the shares were held for greater than 12 months prior to their disposal and he was entitled to reduce the capital gain by 50%.

4.      Section 109-10 of the Income Tax Assessment Act 1997 (“the 1997 Act”) states:-

“This table sets out some, specific rules for the circumstances in which, and the time at which, you acquire a CGT asset otherwise than as a result of a CGT event happening.

Acquisition rules (no CGT event)

Item     In these circumstances                    You acquire the asset at this time

….

2.A company issues or   when contract is entered into or if

allots equity interests in the               none, when equity interest issued

company to you  or allotted.

…..”

5.      The sole question in dispute was the date when the contract for the acquisition of the 120,666 shares disposed of in the year ended 30 June 2000 was entered into.  For the applicant it was contended that the contract was entered into when the options were acquired in August 1996.  For the respondent it was contended that the contract was entered into when the applicant exercised his options and shares were allotted in December 1999 and March 2000.  The significance is that, if the applicant is correct, he is entitled to a 50% discount on the assessable profit on sale of the shares.

6.      The option certificate issued to the applicant was in the following terms:-

“This is to certify that the abovenamed (hereinafter called the “Option Holder”) is the registered holder of the number of options set out above which expire not later than at 5.00pm on the final day of the Option period and is entitled to subscribe for and be allotted ordinary shares of 10 cents fully paid in the capital of the Company on the terms and conditions set out on the back hereof and the Memorandum and Articles of Association of the Company.  Subject to those terms, the Option can be exercised only by the Option Holder completing and signing a form of application for shares on exercise of the Option and delivering it to the Option Register at any time prior to the expiry of the Option Period accompanied by this Option Certificate and payment of $1.50 in respect of each share”.

7.      The terms and conditions of the options provided that the final day of the option period was 29 July 2000 or an earlier date if the option holder resigned, was dismissed or retired.  Clauses 2 to 5 of the terms and conditions stated:-

“2.  Subject to paragraphs 1 and 12, the Options may be exercised wholly or in part by giving notice in writing (‘Notice of Exercise’) to the Board at any time during the Option Period.

3.  In respect of the Options, the exercise price for each (which is payable immediately upon exercise) is $1.50 (‘Exercise Price’).

4.  On receipt by the Company of the Notice of Exercise and payment of the relevant Exercise Price, the Company must, within 14 days, allot to the Option Holder the number of Shares in respect of which the Option is exercised and despatch the relevant share certificate or other appropriate acknowledgment as soon as reasonably practicable thereafter.

5.  Shares allotted on the exercise of any Options will rank equally in all respects with the then existing issued ordinary fully paid shares in the company and will be subject to the provisions of the Memorandum and Articles of Association of the Company”.

Clause 6 to 10 related to adjustments to the number of shares over which options exist or the exercise price in the event of changes to the capital structure of the company.

Clauses 11 to 13 provided:-

“11.  At all times while the Options are capable of exercise the Company will keep available sufficient authorised capital to satisfy the exercise of the full extent of all Options which have neither lapsed nor been fully exercised, take account of other obligations of the Company to issue Shares.

12.  All unexercised Options will lapse in the event of the liquidation of the Company.

13.  The options may not be transferred by the Option Holder”.

8.      The option certificate included a notice of exercises of options in the following terms-

“I hereby give notice of exercise of the Option evidenced by this Option Certificate for ……………… ordinary shares of 10 cents each in the capital of the Company and enclose payment of the Exercise Price (being $1.50) in respect of each of those shares.  I confirm that the number of Options exercised accords with paragraphs 1 and 3 inclusive of the Terms and Conditions of Options and is for a multiple of 100 shares.

I request that you allot me that number of shares and I agree to accept the number of shares on the terms referred to on the Option Certificate and the Memorandum and Articles of Association of the Company.  I authorise you to place my name on the register of members in respect of the shares allotted to me.

If the Option has been exercised in respect of part only of the shares covered by the Option Certificate, I authorise you to cancel the Option Certificate and issue a new option certificate in respect of shares over which the Option has not been exercised.

Please forward share certificates and any new option certificate to me by post at the address set out below.”

9.      In Laybutt v Amoco Australia Pty Ltd (1974) 132 CLR 57, Gibb J commented on the true nature of an option to purchase and said (at p.71-72):-

“However, there is what Dixon C.J. in Braham v. Walker (1961 104 CLR 366 at p.367) called a “standing controversy” as to the true nature of an option to purchase.  One view is that an option to purchase is “a contract for valuable consideration, viz., to sell the property (or whatever the subject matter may be) upon condition that the other party shall within the stipulated time bind himself to perform the terms of the offer embodied in the contract”: per Griffith C.J. in Goldsbrough, Mort & Co. Ltd. v. Quinn (1910) 10 CLR 674 at p.678.  The other view is that “an option given for value is an offer, together with a contract that the offer will not be revoked during the time, if any, specified in the option”: per Latham C.J. in Commissioner of Taxes (Q.) v. Camphin (1937) 57 CLR 127 at p. 132”.

10.     That case involved an option to purchase land which was sought to be exercised by the grantee after the death of the grantor.  Although holding that there was not a valid exercise of the option, His Honour found (at p. 76):-

“For these reasons I consider that an option to purchase (at least one in a form similar to that in the present case) is a contract to sell the land upon condition that the grantee gives the notice and does the other things stipulated in the option.  An option to purchase, regarded in that way, is not an agreement which gives one of the parties the right to perform it or not as he chooses; it gives the grantee the right, if he performs the stipulated conditions, to become the purchaser”. 

11. In Sydney Futures Exchange Ltd v Australian Stock Exchange Ltd and another (1995) 128 ALR 417, Gummow J referred to the question of the nature of an option and said (at p. 451):-

“We were referred to authorities (particularly Laybutt v Amoco Australia Pty Ltd (1974) 132 CLR 57 at 71-2; 4 ALR 482 per Gibbs J) dealing with the question whether an option is in truth a conditional contract to sell or a contract to keep an offer open.  The House of Lords has since given support to the latter characterisation, in United Scientific Holdings Ltd v Burnley Borough Council [1978] AC 904.  However, in Spiro v Glencrown Properties Ltd [1991] Ch 537, Hoffmann J exposed a further dimension of the dispute.  (The references to the considerable academic discussion the case has provoked are collected in the Note, All ER Rev 1991 at 200).  After discussing various authorities, his Lordship stressed the importance of the context, particularly the statutory context, in which the question of characterisation arises.  He said (at 544):

The purchaser’s argument requires me to say that “irrevocable offer” and “conditional contract” are mutually inconsistent concepts and that I must range myself under one or other banner and declare the other to be heretical.  I hope that I have demonstrated this to be a misconception about the nature of legal reasoning.  An option is not strictly speaking either an offer or a conditional contract.  It does not have all the incidents of the standard form of either of these concepts.  To that extent it is a relationship sui generis.  But there are ways in which it resembles each of them.  Each analogy is in the proper context a valid way of characterising the situation created by an option.  The question in this case is not whether one analogy is true and the other false, but which is appropriate to be used in the construction of s 2 of the Law of Property (Miscellaneous Provisions) Act 1989”.

12.     In Elmslie and others v Federal Commission of Taxation 93 ATC 4964, the Federal Court was required to consider the question of whether shares were acquired before or after 19 September 1985. The parties had signed a Heads of Agreement on 28 June 1985 with the transaction requiring Foreign Investment Review Board approval. On 7 November 1985, after receiving approval, the parties exchanged formal agreement documents and shares were allotted. S.160U of the Income Tax Assessment Act 1936 (“the 1936 Act) provided for the ascertainment of the time of acquisition of an asset and sub-section (3) provided that, where the asset was acquired under a contract, the time of acquisition shall be taken to have been the time of the making of the contract. In finding that it was the 7 November 1985 contract under which the shares were acquired, Wilcox J., said (at p. 4975):-

“The submission does not resolve the critical question in the case: whether the statutory formula “under a contract” encompasses a contract that envisaged, or provided for, the acquisition of the asset - or even required a party or parties to undertake the transaction that constituted the acquisition of the asset  -  but was not the means by which the asset was actually acquired.  I have reached the conclusion that this question must be answered in the negative, with the result that the acquisition of the subject shares cannot be said to have taken place before 7 November 1985.

……..

In other words, the company agreed to accept offers to take shares when they were made.  Even if it be added that, by their adherence to the Heads of Agreement, each of the applicants agreed to apply for shares equal to one eighth of the company’s issued share capital, this was no more than an agreement to enter into an allotment contract at a future date.  It did not constitute an agreement that actually allotted shares.  It was not intended to do so and could not do so.

……..

I say that the document could not constitute an allotment of shares because the directors had not yet decided how many shares would be issued.

………

The later contracts of allotment were an essential part of the plan agreed in June.  They cannot be treated as unnecessary formalities and a conclusion reached that the source of the shares was the Heads of Agreement document”.

His Honour concluded (at p.4976):-

“Section 160U(3) substitutes a different rule where the asset “was acquired … under a contract”.  In that case the date of “the making of the contract” applies.  It will be noted that the word “contract” is in the singular.  The assumption is that a contractually acquired asset will be acquired under only one contract, the date of which will precisely fix the date of acquisition of the asset.  This assumption is irreconcilable with the notion that it is enough that there be a contract that envisages or requires the acquisition of the asset.  In a particular case there may be several contracts that contemplate or require a party to acquire an asset.  Those contracts may bear different dates.  If subs (3) extended to all those contracts, and not just to the contract that directly got in the asset, it would provide a multiplicity of dates in respect of one asset.  Unless all the dates happened to fall within the same quarter, the legislation would become unworkable in relation to that asset.  It seems to me that, for the legislation to work satisfactorily, it is necessary for the courts to confine the words “under a contract”, in s.160U(3), to the contract that directly effected the acquisition.  It is necessary to disregard any earlier contract obliging one or both parties to the acquisition to enter into the immediately operative contract.

This approach is consistent with the interpretation given in decided cases to analogous phrases, such as “under an enactment” and “under this lease”.  I have already referred to some of these cases.  They demonstrate that the word “under” usually imports a direct connection between the relevant act and the instrument.  Chan is particularly telling. In that case, it was not enough that there was a contract (the lease) that envisaged that the lessee would go into possession and, indeed, required it to do so. It was not enough that, absent the lease, the lessee would not have gone into possession and the liability for rent not arisen. For the guarantors’ liability to arise, the rental liability had to be incurred under the lease; that is, through its operation as an instrument that created a legal interest. In the same way, the contract under which an asset is acquired, within the meaning of s.160U(3), is the contract through whose operation the asset changes ownership”.

13.     In my view the option agreement in this case is an offer together with a contract that the offer will not be revoked during the time specified in the option.  It was suggested by Mr Sest that the decision in Laybutt (supra) could be distinguishable from this case because in Laybutt the option related to existing identifiable land whereas here the option relates to shares which have not been allotted and do not exist as shares at the time of the grant of the option.  I do not see the non present existence of the shares at the time of the option as a fundamental reason for not recognising the option agreement as “the contract”.  There are many instances which can be brought to mind where a contract of purchase can be validly entered into in relation to an asset then not in existence.  A contract to construct a building or to provide a new motor vehicle are but two such contracts.  However, here the option agreement is one where the grantor agrees to allot a then unknown number of shares at some unknown future date if the grantee so requests that they be allotted and pays the required amount per share.  Here there was an entitlement to the applicant under the option contract to apply for up to 500,000 shares.  Ultimately he applied for 226,666 shares in three applications.  Under the terms and conditions of the options the number and subscription price could change between the date of the grant of the options and an exercise date if the capital structure of the company changed.  In my view the date of the contract for acquisition of the relevant share, was in the words of Wilcox J in Elmslie (supra) the date of the contract that directly effected the acquisition of the shares and that was the date on which the applicant applied for and was allotted the shares.  Prior to that date the applicant had not contracted to acquire the shares.  He was simply in possession of an irrevocable offer to allot up to 500,000 shares to him at a pre-determined price if he chose to request such allotment within the period of the offer.  In my view it cannot be said that a contract for the acquisition of the relevant shares was entered into by the applicant prior to the date on which he applied for and was allotted such shares.  It is clear that a share when allotted is a completely different chose in action and asset to the chose in action asset of an option.  The provisions of the legislation are directed at the date of acquisition of the asset which was disposed of and, in my view,   s.109-10 refers to the contract under which the shares were acquired not a contract which entitled the applicant to so enter into the contract for such acquisition. 

14.     Mr Murphy referred the Tribunal to the decision of the Full Federal Court in Brooks and another v Federal Commission of Taxation 2000 ATC 4362. This case was concerned with a forfeited deposit where purchasers failed to complete a contract for the sale of land. In arguing that the decision in that case supported the argument that there was but one contract for the acquisition of shares pursuant to an option, the Courts comments at paragraph 26 and 27 were relied on:-

“We have already noted the effect of the provisions of s.160ZZC dealing with options, which was introduced into the Income Tax Assessment Amendment (Capital Gains) Act 1986. Absent that section it was arguable that the grant of an option would fall to be considered under s.160M(6) or s.160M(7) and constitute a disposition by the grantor of an asset deemed to have been owned by the grantor and the acquisition by the grantee of an asset, that being the right under the option. The exercise of the option could then constitute a disposition by the grantee of that asset by the performance of the option contract: 160M(3); and the ultimate sale of property the subject of the contract would likewise be a disposition capable of giving rise to a capital gain. In this argument the possibility of there being further dispositions by virtue of the formation of the contract upon exercise of the option has been disregarded.

27.  Clearly Parliament intended that where there was an option, followed by exercise and ultimate disposition, the transaction should be looked at as involving but one disposition capable of giving rise to a capital gain.  On the other hand, where the option was not exercised and the grantor of the option received an option fee, the option fee would be taken into account in the computation of a capital gain to the grantor.  This would be the case where the option was granted to purchase investment land, as well as where the option was granted to purchase a residential dwelling, notwith-standing that a disposition of that dwelling could fall within the provisions of s.160ZZQ(12).”

15.     However it should be noted that the Court was primarily directing its attention to whether there was a disposition by the grantor of an option rather than a contract of acquisition by the grantee and section 160ZZC(1) provides that the section does not apply in relation to an option to which Division II applies.  Division II applies to options issued to shareholders to acquire unissued shares in the company.  Section 160ZYV(i) provides:-

“160ZYV(1)  When the option is exercised, whether by the shareholder or by a person who acquired the option directly or indirectly as a result of the disposal of the option by the shareholder, the person who exercised the option shall be deemed, for the purposes of this Part, to have acquired the new shares at the time when the option was exercised”.

As a result, I am unable to see that the decision provides any assistance in resolving the question before the Tribunal in this case.

16.     It follows that I am of the view the shares in question were acquired on the dates when the applicant gave notice of the exercise of the option to request allotment of the shares.  As a result, the shares sold were not acquired more than 12 months prior to the date of their sale and the applicant is not entitled to the discount of 50% provided for under Division 115 of the 1997 Act.  The decision under review should be affirmed.

I certify that the 16 preceding paragraphs are a true copy of the reasons for the decision herein of Mr B. Pascoe, Senior Member.

Signed:         ......C. Irons .......................................................
  Secretary

Date/s of Hearing  23 October 2002
Date of Decision  16 December 2002
Counsel for the Applicant         KPMG
Solicitor for the Applicant           
Counsel for the Respondent     departmental representative
Solicitor for the Respondent