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Tax Telegraph, April 2013

CasesDisposal for the purposes of CGT event A1 occurred upon execution of Heads of Agreement

Confidential and Commissioner of Taxation [2013] AATA 76

The Administrative Appeals Tribunal (AAT) has held that the disposal of the taxpayer’s interest in a business for the purposes of CGT event A1 occurred when the Heads of Agreement was executed, not when the contract of sale of business was executed. The taxpayer sold his interest in a business and claimed the small business active asset exemption and the small business retirement exemption to reduce a net capital gain of $704,129 to $0 in the 2009 income year. The Commissioner issued the taxpayer a notice of assessment which included a capital gain of $704,129 in his taxable income for the 2009 income year, as well as a notice of assessment for shortfall penalty, and disallowed the taxpayer’s objection to the assessment.

The parties agreed that CGT event A1 occurred when the taxpayer disposed of his interest in the business, but disagreed on when the disposal contract was entered into, as the Heads of Agreement was executed on 7 August 2008 followed by the execution of the contract for the sale of business on 17 December 2008. The date on which the disposal of the asset occurred was critical because to be eligible for the small business relief under Division 152-A of the Income Tax Assessment Act 1997 (ITAA 1997), the applicant must satisfy the maximum net asset value test just before the CGT event. The taxpayer contended that the disposal took place sometime after the parties had agreed to the terms and conditions under a formal contract of sale, while the Commissioner contended that the disposal occurred at the time the parties entered into a Heads of Agreement on 7 August 2008.

The AAT was of the view that the Heads of Agreement document was legally binding on the parties upon its execution, as it contained a clause expressly stating that the parties agreed to the sale and purchase of the business and agreed to be bound by its terms. The fact that there was a special condition which provided that the agreement was “subject to and conditional upon”, the parties executing a formal contract of sale as soon as practicable did not negate the existence of a binding legal agreement. Therefore, the AAT found that the disposal of the taxpayer’s CGT asset comprising his interest in the business occurred on 7 August 2008.

Share trading activities found to be Australian sourced

Picton Finance Limited and Commissioner of Taxation [2013] AATA 116

A Vanuatu incorporated company has had a partial win before the AAT which held that the proceeds from share trading by the taxpayer were Australian sourced, but the taxpayer had demonstrated that an assessment in relation to the 2007 tax year was excessive.

The taxpayer was incorporated in Vanuatu in December 2003 with its sole activity being investing in a company called EnviroGold Limited (EnviroGold). Between September 2004 and October 2007, the taxpayer bought and sold EnviroGold shares in ‘off market’ transactions, and in ‘on market’ transactions between August 2007 and April 2008. The Commissioner issued default assessments in respect of the 2007 and 2008 tax years on the basis that the share transfers were undertaken in the course of a share trading business, or otherwise undertaken for the purpose of profit making, and that the taxpayer’s net share sale proceeds were Australian sourced income, and imposed related penalties.

The taxpayer’s objection to the assessments was primarily on the following grounds:

  • The 2007 and 2008 assessments overstated the ‘off market’ EnviroGold share sale proceeds
  • The 2007 and 2008 assessments understated the relevant cost or value of the EnviroGold shares
  • The share sales did not give rise to Australian sourced income.

In respect of the above grounds, the AAT found as follows:

  • The taxpayer had established that the Commissioner’s assessments overstated the taxpayer’s sale proceeds for the ‘off market’ transfers in the 2007 and 2008 tax years
  • While the taxpayer had discharged its onus in relation to establishing the cost of shares in 2004, it had failed to do so in respect of the 2005 share acquisition
  • As the 2008 assessment was based on the overstated cost of a 2007 share acquisition, the taxpayer’s assessable income was understated
  • The taxpayer’s income from share trading was Australian sourced on the basis that broadly, the sequence of events resulting in the sale of the shares indicated that the final conclusion of the sale contracts occurred in Australia.

The taxpayer further contended that it should be treated as having made elections under sections 70-30(1) and 70-45 of the ITAA 1997 for the 2007 and 2008 income years to take the market value of its shares as their relevant cost in calculating the net proceeds of the various sale transactions. The AAT held that the taxpayer was entitled to have its 30 June 2007 closing stock valued as a letter tendered by the taxpayer dated 3 August 2012 was sufficient to show that an effective election had been made. However, in respect of the 2008 income year the AAT held that the taxpayer had not established that its shareholding retained the character of trading stock as at 30 June 2008.

Accordingly, the Commissioner’s decision in respect of the 2007 tax year was set aside and remitted to the Commissioner for redetermination and his decision in respect of the 2008 tax year was affirmed.

Taxpayers assessable on funds deposited into bank accounts by private company

Confidential and Commissioner of Taxation [2013] AATA 112

The AAT has affirmed the Commissioner’s decision that the taxpayers were assessable on approximately $20 million deposited into their bank accounts from a private company (of which the taxpayers were directors) during the 2005 to 2008 income years, as either dividends or ordinary income.

The taxpayers were the directors and shareholders in a private company that carried on a services business and in December 2008 the Commissioner commenced an audit of the company’s tax affairs followed by an audit of the taxpayers in February 2009. As a result of the audits, the Commissioner issued amended assessments to the taxpayers for the four income years on the basis that the deposits made by the company to the taxpayers’ personal bank and credit card accounts were assessable as either dividends, ordinary income, or deemed dividends. The Commissioner disallowed the taxpayers’ objections against the amended assessments.

It was contended by the taxpayers before the AAT (among other things) that the payments received by them from the company were for the following purposes:

  • Used to make payments to subcontractors
  • Loans paid to them by the company
  • Fringe benefits provided to them by the company
  • The purchase of property to protect the company’s assets.

In summary, the AAT rejected the taxpayers’ contentions and decided the deposits were assessable to the taxpayers as unfranked dividends under section 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or ordinary income under section 6-5 of the ITAA 1997, for the following reasons:

  • The evidence provided by the taxpayers of reconstructed documents after a considerable time from which the transactions were claimed to have occurred, could not be accepted without copies of original invoices or contemporaneous documentation
  • In relation to dividends received from the company, there was insufficient evidence to support an allocation of franking credits to the alleged distributions to the taxpayers
  • The evidence available did not establish that the company had made a loan to the taxpayers, or that the payments were fringe benefits, or that the funds were used to preserve the assets of the company.

Although not necessary, the AAT went on to consider whether the deposits would be assessable as deemed dividends under Division 7A of the ITAA 1936 and found that the necessary elements had been satisfied and the taxpayers had failed to prove that the Commissioner’s value attributed to the distributable surplus of the company was excessive.

Finally, the AAT rejected numerous contentions on procedural grounds made by the taxpayers against the Commissioner’s objection decision, and upheld the 75% penalty for shortfall resulting from intentional disregard of tax law.

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