ZBFF and Commissioner of Taxation (Taxation)
[2021] AATA 275
•2 February 2021
ZBFF and Commissioner of Taxation (Taxation) [2021] AATA 275 (2 February 2021)
Division:Taxation and Commercial Division
File Number(s): 2020/1688
Re: ZBFF
APPLICANT
Re:PVVZ
OTHER PARTY
AndCommissioner of Taxation
RESPONDENT
DECISION
Tribunal:Deputy President Bernard J McCabe
Date:2 February 2021
Place:Sydney
The objection decision under review is affirmed.
.................................SGD.....................................
Deputy President Bernard J McCabe
CATCHWORDS
TAXATION – capital gains tax – transfer of property – contract of sale – terms of agreement – formally document an oral agreement – trust property – decision affirmed.
LEGISLATION
Conveyancing Act 1919 (NSW)
Freedom of Information Act 1982 (Cth)
Income Tax Assessment Act 1997 (Cth)
Cases
Belfora Pty Ltd v Vinflora Pty Ltd [2020] NSWSC 1229
Bruce Mining Pty Limited v Wright Prospecting Pty Limited [2015] HCA 37
Commissioner of Taxation v AXA Asia Pacific Holdings Ltd (2010) 189 FCR 204
County Securities Pty Ltd v Challenger Group Holdings Pty Ltd [2008] NSWCA 193
Dingwall v Federal Commissioner of Taxation (1995) 57 FCR 274
Trustee for the Estate of the late AW Furse No 5 Will Trust v Federal Commissioner of Taxation (1990) 21 ATR 1123Secondary Materials
REASONS FOR DECISION
Deputy President Bernard J McCabe
It may have been Oscar Wilde who observed “No good deed goes unpunished”.[1] This case considers whether a good deed will go untaxed. The good deed in question arose out of an agreement between the taxpayer and an old friend, whom I shall call Mr Green. The taxpayer was (and is) a prosperous businessman who had the means to help Mr Green when Mr Green was going through a divorce in 2006. Rather than see Mr Green lose his family home in the divorce settlement, the taxpayer agreed to purchase the property for an agreed sum on terms favourable to Mr Green. The property was acquired by the taxpayer’s family trust in 2006. The property was sold to a third party in 2016. The net proceeds of the sale in 2016 (an amount of $611,144 - that is, the sale price less the family trust’s cost of acquisition and its holding costs) were remitted to Mr Green.
[1] Nobody knows for sure whether Oscar Wilde was the first to say this, and there is some doubt whether he said it at all. But it certainly sounds like something Oscar Wilde would say.
The precise terms of the arrangement between the taxpayer and Mr Green are the subject of controversy in these proceedings. The Commissioner of Taxation says the terms of the arrangement are contained in a letter from the taxpayer’s solicitor dated 22 June 2006 (which also refers to the contract of sale). The terms of that letter contemplated Mr Green selling the property to the taxpayer and thereafter retaining a right to reside in the property. The letter also said Mr Green had an option to repurchase the property within 18 months. There is no reference in the letter to Mr Green having other rights, including a right to remain in the property indefinitely or a right to direct a sale and recoup the profits after the 18-month period mentioned in the letter had expired. The taxpayer and Mr Green insist those additional rights were always part of the arrangement between them, even if they were not mentioned in the letter of 22 June 2006. They say their subsequent behaviour (which included Mr Green continuing to live in the property before he directed a sale some years later) was in accordance with the underlying agreement which came into existence when the property was first sold to the taxpayer. The Commissioner suspects the subsequent behaviour of the parties reflected the persistence of their long-term friendship rather than the terms of an agreement negotiated in 2006. The Commissioner argues any capital gain derived from the sale of the property in 2016 was taxable in the taxpayer’s hands notwithstanding the fact he did not retain those monies. The taxpayer says he is not liable to pay tax; Mr Green agrees. At the hearing, Mr Green’s lawyers led the charge.
The answer to the question I posed in the first paragraph turns on:
(a)My findings of fact about the extent of the agreement made between the parties in 2006 when the property was acquired by the taxpayer’s family trust. The taxpayer and Mr Green say that if I accept the agreement was as they describe it, the taxpayer is not liable to pay capital gains tax on any part of the sale proceeds. They insist the letter of 22 June 2006 captures only part of what was agreed between them; and
(b)The operation of the capital gains tax provisions – specifically, whether the amount paid by the family trust to Mr Green:
(i)increased the family trust’s cost base in the property;
(ii)reduced the trust’s capital proceeds from the sale; or
(iii)caused the trust to make an off-setting capital loss.
WHAT TRANSPIRED BETWEEN THE TAXPAYER AND MR GREEN?
The taxpayer is a wealthy businessman with significant assets. Some of the assets are owned through his family trust. The taxpayer is a director of the trustee company as well as a beneficiary. The taxpayer and Mr Green became acquainted through business dealings during the 1990s. They developed a friendship which appears to have endured to this day.
Mr Green experienced some business setbacks in the early 2000s. Worse was to come. His marriage fell apart. He faced the prospect of losing his family home in the divorce settlement which was under negotiation in 2006. In his statement (exhibit 2), the taxpayer recalled a discussion with Mr Green in or around early June 2006 in which they discussed the possibility of the taxpayer acquiring the family home from Mr Green and then holding it until Mr Green was in a position to buy it back: at [3]. The taxpayer said he was agreeable to an arrangement along those lines. On that basis, they say Mr Green consented to Family Court orders dated 6 June 2006 that provided he would sell the property to the taxpayer for $1.4 million.
After the orders were made, the taxpayer and Mr Green had at least one further discussion about the terms of the arrangement between them. The taxpayer said the terms of the agreement included the following matters set out in his statement (exhibit 2) at [6]:
6a: [The taxpayer] would acquire the Property in accordance with the Family Law Order, in my family trust – [The trust] ; and
6b: Mr Green would retain certain rights with respect to, the Property, including the right to occupy it until such a time as he instructed [the taxpayer] (as director of [The trust]):
(i)that he would acquire the Property from [The trust] for an agreed purchase price of $1.4 million plus any other costs incurred by [The trust] in acquiring and holding the Property, in which case [The trust] would transfer the legal title back to [Mr Green]; or
(ii)to sell the Property, in which case [The trust] would transfer [to Mr Green] any proceeds of sale which exceeded the $1.4 million [The trust] paid to acquire the Property and any other costs incurred by [The trust] in acquiring and holding the Property, to [Mr Green].
The taxpayer conceded during his oral evidence that he did not recall precisely when those negotiations occurred, or whether the agreement was reached during one conversation or over several conversations. He did not recall how it came to pass that his family trust was identified as the purchaser notwithstanding the taxpayer being named as the purchaser in the Family Court orders. (The taxpayer said it was always understood and intended that his family trust would make the purchase because he routinely used the trust to hold personal investments.) He also did not recall the details of the instructions he subsequently gave to his lawyers to formalise the arrangement.
The taxpayer’s lawyer subsequently wrote to Mr Green on 22 June 2006 (i.e. after the date of the Family Court orders). That letter was formally tendered as exhibit 5. The letter was countersigned by Mr Green to indicate his agreement with the contents. The letter referred to the contract of sale in respect of the property and confirmed:
·the taxpayer’s family trust had agreed Mr Green would be permitted to occupy the property for 18 months on terms and conditions set out in the contract. That period was described as “the Occupation Period”. (I note the contract of sale was not produced during these proceedings. It may have been lost. While it would have been interesting to read the terms and conditions, I am not sure how much assistance that material would have provided.)
·in consideration of Mr Green paying a token amount, the trust had granted Mr Green the option to (re)purchase the property for $1.4 million (plus costs incurred by the trust) “within the Occupation Period” – that is, within the 18-month period following the acquisition during which Mr Green was permitted to occupy the property pursuant to the terms of the contract. The letter added that Mr Green could exercise the right to purchase the property “no earlier than 43 days from the date of this letter and no later than 18 months from the date of this letter”.
The letter expressly acknowledges the terms of the contract of sale which provided for Mr Green to continue occupying the premises for 18 months after the sale. To that extent, the letter does not purport to be an exhaustive statement of the terms of the entire agreement at the time. It does not expressly exclude other documents or oral terms, and it does not state the written document contains the entirety of the agreement between the parties. That being said, the document does record an agreement that appears to be complete on its face (with the exception that it refers to the contract of sale).
The Commissioner says the letter is a complete and accurate record of what the parties agreed at the time. He argues there is no reason to suppose the parties agreed to anything other than a right to occupy and an option to purchase that were both time-limited – an agreement that would lapse once the 18-month time limit expired if the option were not exercised.
The taxpayer was unable to clearly explain in his oral evidence why the written document referred to an 18-month period. He said he is now unsure whether he read the document at the time and he did not recollect reading the contract of sale. That is not surprising in and of itself: the taxpayer is an important businessman and I did not form the impression he would have immersed himself in the details of this transaction. He said he recalled he was relaxed about the arrangement since the trust owned the property. There was no risk involved, he said, and no hurry to do anything with the property. He said the parties had assumed Mr Green’s financial position would improve within 18 months, although the taxpayer conceded he was not across the detail of his friend’s financial affairs and relied on Mr Green’s assessment of when he would be in a position to complete the deal. Notwithstanding that, the taxpayer insisted the arrangement he had negotiated with Mr Green was not limited in time, and it included the option to direct a sale and reclaim the profits in due course.
I accept the taxpayer did his best to assist me when he gave evidence. He did not purport to remember the precise details of everything he said to Mr Green in 2006. I accept he was motivated by a desire to do his friend a favour when the arrangement was negotiated, and he has continued to stand by his friend in the years since. I do not criticise him for the quality of his recollection: the acquisition occurred long ago, and the deal was not especially large or memorable from his point of view. The taxpayer candidly said Mr Green was likely to have a superior recall of the details.
That brings me to the evidence of Mr Green. Mr Green’s recollection of the discussion in advance of the Family Court property orders in 2006 was more detailed. In his statement (exhibit 3), he said the conversation took place in May 2006. He said he and the taxpayer exchanged words to the following effect (at [20]):
[Taxpayer]: I will buy your house so you can pay out your wife. It is a good asset. You can keep living in it as the owner and buy it back later for what I paid for it when you have the money, or sell it when you want. If you decide to sell you can pay me back what I paid to you and keep all of the profits. As long as you pay all of the costs associated with the ownership of the house and I am not out of pocket that will be fine.
[Mr Green]: That’s great, that will really help me out thanks.
In his statement, Mr Green added (at [21]):
That was the agreement we reached in May of 2006. The agreement has been afoot, and its terms honoured ever since that time.
Mr Green was cross-examined about his recollection of the terms of the agreement he reached in 2006. He agreed he could not recollect the precise words that passed between he and the taxpayer during the negotiations but insisted the essence of the agreement was captured in the passage set out above. He said he definitely recalled using the word ‘owner’: he said it was understood between the two of them that he would essentially be the owner of the property and would have all of the rights of an owner, including the right to direct a sale and retain the profits in due course. It was ultimately unclear from his evidence whether the parties explicitly agreed in the course of the discussion that he would have a right to direct a sale, or whether he assumed that was implicit from their shared understanding he would be the owner and would therefore have the right to sell.
When asked why the letter he countersigned dated 22 June 2006 only referred to a right to occupy and an option running for 18 months, Mr Green ventured that was because in his experience (albeit in a different context) options routinely had a finite term. He agreed the parties expected at the time that the repurchase would occur and the arrangement would conclude within 18 months, just as the letter indicated. He was unable to explain why the written document was so confined and why it did not refer to the larger agreement that he said existed between him and the taxpayer. Mr Green conceded the lawyer (who was known to him) was a precise individual who was not given to misunderstanding instructions.
Mr Green’s financial position did not improve after the transaction was completed in 2006. He lost money in the global financial crisis that occurred in 2007-2008 and experienced other business setbacks. He was unable to exercise the option to purchase within the 18-month period indicated in the contract. He continued to reside in the property and carry on as before. In his statement (exhibit 3 at [29]), he explained he paid for the costs associated with the maintenance and upkeep of the house. In his oral evidence, he suggested he behaved as if he were the owner. He said his behaviour was consistent with what the parties had agreed in 2006. I note he did not pay council rates or land tax at the time, although the trust kept a record of those amounts and other holding costs.
In his statement, Mr Green recalled he and the taxpayer thought it would be a good idea to more formally document the oral agreement they say they reached in 2006. He said they decided to make a written record of that pre-existing oral agreement sometime in late 2014 or early 2015. He said the taxpayer’s lawyer had some input into the formulation of the document, but Mr Green was not specific about the extent of the lawyer’s contribution and the lawyer was not called to give evidence about what transpired. The document was signed by Mr Green and the taxpayer. It is undated, although Mr Green said it was signed by mid-2015 at the latest. Mr Green said the document faithfully recorded the essence of the oral agreement that was struck in 2006 which was (he said) only partially recorded in the letter of 22 June 2006.
After acknowledging the family trust had purchased the property for $1.4 million, the undated document went on to provide:
[Mr Green] retains the equitable right to live in the house at [address] until such time as he buys it back or on-sells it.
The price at which [Mr Green] can buy back the house is the original cost price paid by [the trust] plus any costs incurred by [the trust] during his period of ownership.
If [Mr Green] chooses to on-sell the property rather than buy it back the parties confirm that any profit from the on-sale of [the property] will be to the account of [Mr Green].
I have no reason to doubt the document accurately described how the parties perceived the arrangement between them by 2014 or 2015 – if only because the parties acted consistently with this understanding in late 2015 when Mr Green instructed the taxpayer’s family trust to sell the property. Mr Green pointed out in his statement (at [33]) he arranged for the property to be renovated in preparation for a sale. He also arranged for the appointment of the marketing agent and managed the sale process, albeit the taxpayer on behalf of the trust was required to formally authorise the agent to proceed. The property was sold at auction in April 2016 for $2.45 million.
A CLOSER LOOK AT THE TERMS OF THE AGREEMENT STRUCK IN 2006
I must decide whether I am satisfied the parties actively turned their minds in 2006 to the question of whether Mr Green would have the right to direct a sale and retain the net proceeds at some point beyond the 18 month period nominated in the letter dated 22 June 2006. That more extensive right is not mentioned in the letter. The Commissioner argues the letter makes clear the parties expected the arrangement would run its course in 18 months and the right to repurchase would lapse if it had not been exercised within that period. Once it became clear Mr Green would not be unable to exercise the option referred to in the document, the Commissioner surmises the parties revisited the agreement and produced the undated document they signed in 2015. The Commissioner does not argue the taxpayer and Mr Green are being untruthful in their evidence now; he says their recollection of what transpired in 2006 is coloured by the course of their friendship. They both remember what they would have agreed if they had turned their minds to the possibility Mr Green would be unable to exercise the option within 18 months as contemplated in the written agreement. The Commissioner suggests the agreement Mr Green and the taxpayer would have struck has taken the place of the actual agreement in their minds. To put it differently, the Commissioner argues the taxpayer and Mr Green are now conflating the spirit of the agreement between them – an agreement born out of the taxpayer’s desire to help his friend – with the terms that were actually negotiated at the time and reduced, in their entirety, to written form in the letter of 22 June 2006.
Contracts, 101
An enforceable contract involves the meeting of minds. The existence of a contract is, in that sense, a fact. The existence of the contract and the terms which have been agreed are not determined by examining the subjective intentions of the parties. One must look to the objective manifestation of what they have agreed with each other.
The contractual agreement may be articulated orally or in writing, or it may be partly oral and partly in writing. Where the parties have reduced the agreement to writing and the written document appears to record the complete contract, the best guide to the agreement will usually be the terms of the document itself. Evidence of what the parties individually intended to achieve in the document will not ordinarily be admissible.[2]
[2] For a more detailed discussion, see Mount Bruce Mining Pty Limited v Wright Prospecting Pty Limited (S99/2015; S102/2015)[2015] HCA 37; (2015) 256 CLR 104 at [48]-[50] per French CJ and Nettle and Gordon JJ.
Parties to a contract sometimes expressly acknowledge in a document that the document contains a complete and accurate record of the terms of the contract. There was no clause to that effect in the letter of 22 June 2006. I am left to ask: does the document suggest the parties intended it to be a complete record of their agreement? Do the circumstances suggest the document only tells part of the story of what was actually agreed?
The letter of 22 June 2006 does not purport to be a complete record of the agreement because it expressly refers to another document, being the contract of sale. It does not refer expressly or by implication to any other document or interaction. The document otherwise has the appearance of describing a complete agreement. But there is other evidence – most obviously the accounts of the two parties involved – that suggests there was more to the agreement. If I accept that evidence, it is clear the agreement was partly written and partly oral.
Where the evidence suggests the agreement was partly written and partly oral, the next challenge is work out how the different components fit together to make up the whole bargain. The analysis of each component proceeds in different ways. Whereas the court has rules for interpreting the words of a written agreement, there might not be a definitive form of words used in an oral agreement. In that event, one must divine what the parties intended by having regard to all the surrounding circumstances: see County Securities Pty Ltd v Challenger Group Holdings Pty Ltd [2008] NSWCA 193 per Spigelman CJ at [7].[3]
[3] Spigelman CJ was in the minority in County Securities however his reasoning was subsequently approved by the Court of Appeal in Lawrence v Ciantar [2020] NSWCA 89 per Bathurst CJ at [114]; see also Belfora Pty Ltd v Vinflora Pty Ltd [2020] NSWSC 1229 at [42].
The challenge of dealing with witnesses recalling oral contracts negotiated some time before was discussed in Watson v Foxman(1995) 49 NSWLR 315. In that case, McClelland J cautioned (at p 319):
…human memory of what was said in a conversation is fallible for a variety of reasons, and ordinarily the degree of fallibility increases with the passage of time, particularly where disputes or litigation intervene, and the processes of memory are overlaid, often subconsciously, by perceptions or self-interest as well as conscious consideration of what should have been said or could have been said. All too often what is actually remembered is little more than an impression from which plausible details are then, again often subconsciously, constructed. All this is a matter of ordinary human experience.
SO…WHAT WERE THE TERMS OF THE AGREEMENT?
I accept the taxpayer bears the onus of establishing the assessment was incorrect, and that he must establish what the correct assessment should be. I also accept it is appropriate to look carefully at self-serving evidence provided by a taxpayer given he or she has an interest in the outcome. I also acknowledge the witnesses are offering their recollections of what occurred a long time ago, and that with the best will in the world their memories may be affected by the passage of time and (in a case like this) the circumstances of their friendship. Having said that, it is clear the Tribunal may rely on oral evidence from the taxpayer that is not otherwise corroborated by objective evidence. Where there is objective evidence that is inconsistent with the oral account, it will be necessary to assess the weight and make findings that explain what happened.
As a practical matter, the taxpayer must affirmatively establish he and Mr Green entered into the contract they have both described in 2006.
There are some issues with the taxpayer’s case. First, there is the fact the contract of sale was formally a contract between the trustee of the taxpayer’s family trust and Mr Green. That agreement was struck in circumstances where the Family Court orders contemplated a sale to the taxpayer. I note the taxpayer was a beneficiary under the relevant trust. He said it was common for him to arrange for personal investments to be made through the trust. I do not think anything turns on this detail for present purposes. The taxpayer clearly understood the reasons why he might use a different vehicle in the course of arranging what he plainly regarded as his personal affairs.
Second, I note the taxpayer did not call the lawyer who prepared the letter of 22 June 2006 to give evidence about the instructions he received. The lawyer might have confirmed the parties were talking about a wider arrangement. That evidence, if it were available, would have assisted the taxpayer. There was no suggestion the lawyer was unavailable. In those circumstances, I am entitled to assume any evidence provided by the lawyer would not have assisted the taxpayer. Having said that, I hesitate to draw an adverse inference from the decision to proceed with the evidence from the lawyer. As I understand the taxpayer’s argument, the lawyer might have been able to give evidence about the instructions he was given but there was no evidence the lawyer was a witness to the negotiations or was inevitably aware of what the two friends had discussed. In the circumstances, the taxpayer was entitled to rely on the evidence of his own recollection and that of Mr Green, since they were the ones who knew what happened when the deal was struck. Evidence from the lawyer about what the taxpayer said they had discussed may well have carried little weight if it was hearsay. I also gained the clear impression from the taxpayer’s evidence that he was an experienced businessman who used lawyers to achieve a purpose – in this case, to ensure the transaction was appropriately documented for the purpose of the trust’s records so the trust would not be exposed if something went wrong. That is not the same thing as involving the lawyer in the negotiation of the entire arrangement or taking the lawyer into one’s confidence. I will have more to say about this below.
I have already acknowledged the taxpayer has an interest in the outcome of the case, although the amount of money involved was not large from his point of view. Mr Green also has an interest. At a minimum, he is anxious to avoid his friend being required to pay tax on monies that were remitted to Mr Green. I have also made clear I am satisfied both individuals did their best to assist the Tribunal. The taxpayer candidly admitted when he could not recall all the details in circumstances where a less honest witness might have offered a more aggressive account. Mr Green, for his part, presented his evidence in a straight-forward way. He made concessions as appropriate (e.g., he acknowledged the lawyer who prepared the letter of 22 June was likely to be acting on instructions, and he ultimately conceded he may not have read the original contract of sale) but his story was substantially unchanged. The minor discrepancies between the witnesses’ accounts are explicable by the passage of time and do not change the central thrust of their evidence: while the parties expected the arrangement would be concluded within 18 months when they negotiated it in 2006, the arrangement between them was not exhaustively recorded in the terms of the letter of 22 June 2006. That document was drafted on instructions that did not reflect the true extent of the bargain between the parties.
I note the letter of 22 June 2006 appears on its face to be the product of careful lawyering. It makes detailed provision for the calculation of the purchase price under the option and the term of the agreement. It even includes a statement required under s 66ZH of the Conveyancing Act 1919 (NSW) where there is an option to purchase a residential property. The Commissioner argues the level of detail evident in the document tends to suggest it was the product of clear and comprehensive instructions.
There is something to be said for that view, but I am satisfied the letter should be approached with an eye to the reality of the situation. Just as the taxpayer inserted the family trust into the arrangement in the documents to suit the exigencies of the taxpayer’s situation, I am satisfied from his evidence that he was given to issuing instructions strategically. He was obviously confident in the arrangement he had struck with his friend. He was an experienced businessman used to negotiating deals, and this deal was not especially significant from his point of view. There is no reason to suppose he was careful to instruct his lawyers about all aspects of the deal. It is likely the instructions given to the lawyer were intended to facilitate the most likely outcome under the arrangement, which was a sale within 18 months. In other words, the instructions were intended to facilitate a transaction, not accurately and exhaustively record the terms of the agreement. I accept that larger agreement always contemplated Mr Green having the rights of an owner which would include (a) being able to remain living in the property until he either acquired the property or it was sold and (b) being entitled to the net proceeds of the sale to a third party if that occurred. That is the clear recollection of Mr Green. His recollection is consistent with the evidence of the taxpayer, and it is consistent with the history of their behaviour between 2006 and 2016. I would add it is consistent with common sense when one understands the relationship between the two men: given the nature of the friendship, it is unthinkable that the taxpayer conceived of the arrangement as being limited so that Mr Green’s rights would disappear if the option contemplated in the letter of 22 June 2006 was not exercised in accordance with the terms recorded therein. In the circumstances, I am satisfied I should accept Mr Green’s account. It follows I accept the production of the otherwise undated document in 2014 or 2015 represents nothing more than a belated attempt to create a contemporary record of an existing agreement that was not adequately described by the letter of 22 June 2006.
THE TAXPAYER IS RIGHT ABOUT THE AGREEMENT. BUT DOES THAT MEAN HE SUCCEEDS?
The arguments about the application of the capital gains tax provisions turned on the determination of the various elements of the cost base. Before considering those arguments individually, I should put them in their legislative context.
I start from the proposition that a net capital gain is included in a taxpayer’s assessable income. Section 102.5 sets out the general rules for determining the amount of the net capital gain in each year of income. Section 102.20 says the taxpayer can only make a net capital gain or loss in connection with a CGT event – which would include the sale of the property by the trust to the third party in 2016. In such a case, the amount of the net capital gain that must be reported is equal to the capital proceeds less the asset’s cost base. In this case, the capital proceeds are comprised of “the money you have received, or are entitled to receive, in respect of the event happening”: see s 116.20(1)(a) Income Tax Assessment Act 1997 (Cth) (ITAA97). As I will explain, the taxpayer has an argument on this issue which he makes in light of the factual findings he urged upon me. Both sides then proceed to argue about the cost base. The general rules governing the cost base are set out in s 110.25. Section 110.25(1) says the cost base has five elements:
(i)the first element (referred to in s 110.25(2)) is comprised of the money one paid (or was required to pay) in respect of acquiring the asset and the market value of any property one gave (or was required to give) in the same connection. Note that the market value of the asset at the time of its acquisition might be substituted for amounts actually given or paid in some cases – including where “you did not deal at arm's length with the other entity in connection with the acquisition”: see s 112.20(1)(c);
(ii)the second element (referred to in s 110.25(3)) includes the incidental costs related to the acquisition or the CGT event as defined in s 110.35. There is no dispute about the incidental costs in this case;
(iii)the third component (referred to in s 110.25(4)) includes the costs of owning a CGT asset acquired after 20 August 1991 such as interest on borrowings, the cost of repairs and maintenance, and land tax. There is no dispute about the costs of owning the CGT asset in this case;
(iv)the fourth component (referred to in s 110.25(5)) includes any capital expenditure the taxpayer incurred:
(a)the purpose or the expected effect of which is to increase or preserve the asset's value; or
(b)that relates to installing or moving the asset.
As we shall see, the taxpayer argues the monies remitted to Mr Green following the sale should be treated as a capital expenditure made to preserve the value of the property;
(v)the fifth component (referred to in s 110.25(6)) includes “capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset.” As we shall see, the taxpayer says the payment to Mr Green may answer this description because the taxpayer believed Mr Green had rights with respect to (or an interest in) the property arising out of the agreement.
THE ARGUMENTS ABOUT COST BASE AND OTHER MATTERS ARISING OUT OF THE CAPITAL GAINS TAX PROVISIONS
Having persuaded me there was an agreement in 2006 to permit Mr Green to remain in the property over a longer period and thereafter purchase it at the agreed price or direct a sale and retain the proceeds, the taxpayer says that is the end of the matter in a practical sense.
At the risk of oversimplification, it appeared Mr Green’s first argument on the law comes down to this. The taxpayer’s agreement with Mr Green means the taxpayer is only entitled to receive $1.4 million plus the holding costs incurred since 2006, with the balance of the proceeds of sale being remitted to Mr Green. On that approach, the amount of $1.4 million plus holding costs must be regarded as the capital proceeds of the CGT event within the meaning of s 116.20(1)(a). The actual sale price achieved by the trust does not factor into the calculation of the capital proceeds. Given this smaller amount is the same as the amounts forming part of the first and third elements of the cost base (i.e., the $1.4 million expended to acquire the asset from Mr Green and the costs of owning the asset), it follows there is no capital gain. I note the taxpayer gave evidence that the trust always treated the property as being worth $1.4 million plus expenses incurred from time to time; it never treated the asset as being worth more, even as it presumably increased in value, because the trustee regarded itself as committed to receiving an amount upon sale calculated in accordance with the agreement with Mr Green.
It is a neat argument, but it raises questions. Most obviously: while the taxpayer had agreed the trust would remit the profits on the sale to Mr Green under the terms of the oral bargain they had struck, the amount the trust was entitled to receive through the trust (and the amount the trust actually did receive) under the contract of sale which lay at the heart of the CGT event was $2.45 million. It is not clear why the capital proceeds of the CGT event are limited to $1.4 million plus holding costs.
The taxpayer and Mr Green have other arguments. Mr Richardson, counsel for Mr Green, argued the taxpayer’s payment of $611,144 to Mr Green was properly regarded as a “capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset” within the meaning of s 110-25(6). On this argument, the taxpayer’s payment of the net proceeds of the sale served to extinguish or at least pre-empt a possible claim Mr Green might bring in which he alleged a legal or equitable interest in the property. (That claim would presumably arise out of the terms of the contract, but even if I had made different findings about the extent of the contract there might still be arguments over the existence of a legal or equitable interest.) Even in the absence of litigation or threats of litigation, the decision to make the payment had the effect of ‘buying out’ Mr Green to forestall any difficulty. That meant the payment would form part of the fifth element of the cost base of the property. Mr Richardson added it was not necessary under the relevant test for me to identify evidence that the taxpayer acted with the intention of forestalling a claim – which is just as well, as neither the taxpayer or Mr Green referred to the possibility of legal action if the taxpayer did not act at Mr Green’s direction in 2016. (Mr Richardson did point out in submissions that Mr Green spoke in terms of giving ‘a direction’ to sell the property which the trustee appeared to accept, but there is no contemporaneous evidence of the trustee articulating a belief that it was obliged to conform to that direction.) I was told it is enough for the taxpayer to have acted to that effect.[4] In the alternative, the remittal of the net proceeds of the sale amounted to a “capital expenditure… incurred… the purpose or the expected effect of which is to increase or preserve the asset's value”: s 110.25(5). On that argument, the payment likely formed part of the fourth element of the cost base. In either event, the amount would be added to the first and third elements of the cost base which I have already identified. It follows there would be no net capital gain even if I preferred a less generous view of the concept of capital proceeds because the total amount the trust was entitled to receive was offset by the various elements of the cost base.
[4] Mr Richardson supported his argument on this point by referring me to a draft or preliminary opinion provided from within the ATO’s Tax Counsel Network that was obtained under a request made pursuant to the Freedom of Information Act 1982 (Cth). I do not think citing the opinion adds anything to the weight of the submissions offered by the taxpayer.
The taxpayer and Mr Green also argued they were dealing at arms’ length so there was no scope for the operation of the ‘market value substitution’ rule in s 112.20(1)(c) of ITAA97. Mr Richardson pointed out in written submissions that if that rule were to apply, there was valuation evidence which confirmed the trust paid market value for the property when it was acquired. That would be relevant to the first element of the cost base set out in s 110.25. I was told it would lead, in practice, to the same outcome for which the taxpayer contends.
I should mention two alternative arguments made by the taxpayer and Mr Green. The first was that the trust made a capital loss when it disposed of the property in 2016. Mr Richardson argued the transfer extinguished the trust’s rights under the agreement at that point, which would qualify as CGT event C2. His argument was based on s 104.25, which deals with the cancellation, surrender or ending of intangible assets. As I understand the argument, the trust incurred a cost – the payment to Mr Green – to effect the transfer of the property. The capital loss in that amount was equal to or exceeded any gain the trust made, which led to the same practical outcome for which the taxpayer contends.
The second argument turns on the application of s 40-880 of the ITAA97. The section deals with the deductibility of certain business capital expenditures. As I understand the argument, the trust was in the business of investing in property, and it disposed of several properties during the relevant year of income. (I was referred to the profit and loss statement of the trust and the evidence of the various sales in order to make good the proposition that the trust was conducting a business.) The expenditure incurred when it remitted the monies to Mr Green. That amount needed to be taken into account as a business capital expenditure for the purposes of s 40-880 because it was related to the business of holding property and other assets. In particular, Mr Richardson argued the expenditure was paid in relation to the business because it cleared the way for the property to be sold and returned funds that had been invested which were then available for other business purposes.
The Commissioner’s written submissions were mostly framed on the assumption the agreement between the taxpayer and Mr Green was limited to the terms set out in the letter of 22 June 2006. Yet in oral submissions counsel for the Commissioner insisted the taxpayer is liable to tax even if I found the agreement the taxpayer struck with Mr Green included terms which permitted Mr Green to (a) remain in the property beyond the 18 month period referred to in the letter of 22 June 2006 and (b) either repurchase the property for $1.4 million plus holding costs or direct a sale of the property and be paid the net proceeds.
I will consider the Commissioner’s arguments in the order they were addressed in the written and oral submissions. Those arguments addressed the various elements of the cost base and the other matters raised by the taxpayer and Mr Green.
Mr Lewis, counsel for the Commissioner, began by arguing in written submissions that there was no basis for including the payment of any profit on the sale in 2016 in the first element of the cost base. Mr Lewis pointed out that on the most favourable view of the agreement, the obligation to pay Mr Green the profits was contingent upon him electing to direct a sale, and upon that sale occurring at a high enough price. Mr Green might have elected to buy the property himself – that was originally the plan, of course – in which case there would be no obligation on the taxpayer (or the trust, to the extent there was a meaningful distinction between the two) to pay anything to Mr Green. That sort of contingent liability was not an amount the trust or the taxpayer was required to pay withing the meaning of s 110.25(2)(a), which means the profit could not form part of the first element of the cost base: see Dingwall v Federal Commissioner of Taxation (1995) 57 FCR 274 at 282 per O’Loughlin J. Mr Lewis conceded it was potentially appropriate to include the market value of Mr Green’s option under the contract in the first element of the cost base, but Mr Lewis pointed out there was no valuation evidence before me that quantified the value of that right when it was negotiated. Mr Lewis went further and argued the amount which should be included in the first element of the cost base was $1.4 million because that was the market value of the property that was acquired. Mr Lewis said it was appropriate to have regard to the market value rather than any amount actually paid because the parties were not dealing at arms’ length: s 112-20(1)(c).
The debate about whether the parties negotiated at arms’ length is an interesting one. The arrangement between Mr Green and the taxpayer (or the trust) is unusual. There is no doubt the taxpayer was doing his friend a favour. Mr Lewis also pointed out in submissions the Family Court orders which directed the sale were the result of an agreement which involved Mr Green’s former spouse, which complicated the picture somewhat. But that does not necessarily mean the parties to the bargain failed to act at arms’ length. One must focus on whether the parties’ bargain, taken as a whole, suggested they dealt “with each other as arm’s length parties would normally do, so that the outcome of their dealing is a matter of real bargaining”: see, for example, Trustee for the Estate of the late AW Furse No 5 Will Trust v Federal Commissioner of Taxation (1990) 21 ATR 1123 at p 1132 per Hill J; see also Commissioner of Taxation v AXA Asia Pacific Holdings Ltd (2010) 189 FCR 204; [2010] FCAFC 134 at [119] per Edmonds and Gordon JJ. I do not think the friendship between the parties, or the favourable terms suggest they were not acting at arms’ length. I note the Commissioner accepts the market value of the house when it was acquired was $1.4 million, so there is no difference to that extent. Yet my finding about whether the transaction was negotiated at arms’ length does not detract from the Commissioner’s other point, which is that the taxpayer and the trust were not required to pay the profits under the sale unless and until the property was sold at a high enough price at Mr Green’s direction. The Commissioner’s analysis is correct, and I agree in those circumstances it would be inappropriate to include the profit in the first element of the cost base.
I turn next to the Commissioner’s argument with respect to the fifth element of the cost base and the taxpayer’s contention the payment of the profits to Mr Green amounted to a capital expenditure to establish, preserve or defend the taxpayer’s title or a right over the asset.
The written submissions asserted the payment to Mr Green was not a capital expenditure as such. The point was not developed in oral submissions. But Mr Lewis did develop an argument that the payment in question had nothing to do with the trust’s title to the property. The trust’s title was never in question and the payment was not intended to establish, preserve or defend the trust’s title which it was able to convey to the third-party purchaser without encumbrance. The Commissioner is right. While it is possible for the taxpayer to argue the payment to Mr Green might head off action against the trustee arising out of the agreement, there was no reason why that challenge would threaten the trustee’s title to the property – especially in circumstances where the sale was occurring at the request (indeed, the direction) of Mr Green. To put it another way, the trustee paid Mr Green the money because that is what the taxpayer agreed the trust would do. The payment was made in fulfilment of the bargain the taxpayer and Mr Green had struck. It was not about perfecting or defending the trust’s title in the property. It follows the payment of profits should not be counted as part of the fifth element of the cost base.
The Commissioner also argued the payment of profits to Mr Green should not be counted as part of the fourth element of the cost base which deals with “capital expenditures you incurred…the purpose or the expected effect of which is to increase or preserve the asset’s value…”. Mr Lewis pointed out in oral submissions that the argument on this point mirrored the argument in relation to the fifth element of the cost base: first, that there was no capital expenditure as such; and second, that the expenditure, such as it was, was made because that is what the taxpayer had always agreed would occur upon the sale of the property at the request of Mr Green. On that analysis, the payment had nothing to do with increasing or preserving the value of the property. It was entirely explicable by the terms of the agreement. The factual findings I have made about the content of the agreement make clear the Commissioner is right in this respect. In those circumstances, the payment of profits to Mr Green cannot form part of the fourth element of the cost base.
I note the Commissioner also addressed an argument that had been raised about the consequence of treating the transaction as if it involved a merger of the trust’s rights in the property with the rights of Mr Green. The written outline of submissions delivered by Mr Green (which the taxpayer also relied on) did not address that argument, and there was no reference to it in the oral submissions. I assume it is not pressed. That leaves the taxpayer’s alternative arguments.
The first of those is the capital loss argument. I have already explained the argument contemplates the taxpayer acquiring rights from Mr Green in 2016 in return for a payment equal to the profit on the sale of the property – the occasion of the sale being CGT event C2. I was told the amount of the expenditure cancelled out any gain that occurred.
The argument must fail because there is no factual basis for the claim that Mr Green was paid anything to acquire a right. As I have already explained, the payment was made because that is what the agreement with the taxpayer provided. The taxpayer was not acquiring any rights when it made the payment; it was merely fulfilling an agreement. In those circumstances, there was no acquisition of rights, no capital expenditure or loss, and no CGT event C2.
The last argument of the taxpayer was made after the taxpayer sought leave to amend the grounds of objection. The Commissioner did not object to leave being given. As I have already mentioned, the argument suggests the payment to Mr Green of the profits from the sale was a business capital expenditure made in relation to the trust’s business of holding property and other assets. Those expenditures might be deductible, I was told, pursuant to s 40-880. Mr Richardson argued I could assume the trust was conducting a business given it had undertaken property transactions that were referred to in the profit and loss statement. Mr Lewis had a short answer to that contention. He said it was unsafe to assume on the evidence before the Tribunal that the trust was conducting a business within the meaning of that section. Mr Lewis is right.
It is incumbent on the taxpayer to establish the trust was entitled to take advantage of s 40-880. That includes an obligation to establish (a) the trust was conducting a business, and (b) there was a nexus between the particular expenditure and the business. The first requirement would be satisfied by referring to evidence which confirmed the entity exhibited a range of features one ordinarily associated with a business. I was not provided with sufficient evidence to that end. The fact the entity has made several investments and has bought property in a particular period is not enough. The second requirement is unlikely to be fulfilled given my earlier finding the payment was made to Mr Green pursuant to an obligation in the contract. It was not a capital expenditure in any relevant sense related to the business.
CONCLUSION
While I was persuaded by the taxpayer’s case in relation to the substance of the agreement, the operation of the capital gains tax provisions means the payment that was remitted to Mr Green forms part of the taxpayer’s net capital gain on the sale of the property. It must therefore count as part of his assessable income. It follows the objection decision under review must be affirmed.
I certify that the preceding 56 (fifty -six) paragraphs are a true copy of the reasons for the decision herein of
..............................SGD.......................................
Associate
Dated: 2 February 2021
Date(s) of hearing: 1 October 2020 - 2 October 2020 Solicitors for the Applicant: Ms Adria Askin Counsel for the Respondent: Mr David Lewis Solicitors for the Respondent: Self - Represented Counsel for the Joined Party: Mr Scott Richardson Solicitors for the Joined Party: Mr Kevin Munro
0
7
0