Tax Facts

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In brief:    This important question was addressed in a decision handed down this week. The taxpayer was one of 3 equal shareholders in a private company that was sold for a total price of $17.7M. His1/3rd share of the sale price was consequently $5.9M which, together with the net values of other assets, exceeded the $6M threshold for the maximum net asset value test. The taxpayer nevertheless argued that the market value of his shares in the company was less than the actual sale price of $5.9M. And that, consequently (given that all other conditions were satisfied), he was entitled to the small business CGT concessions on the sale of his shares.

Deputy President Frost in the AAT agreed with the taxpayer. His short point of principle was that the market value of the taxpayer's shares for the purposes of the maximum net asset value test must be determined by reference to the well established formulation in Spencer v The Commonwealth [1907] HCA 82. And in applying that principle, the Deputy President accepted that a discount should apply to the sale price in order to recognise the taxpayer's lack of control as a minority shareholder. The taxpayer's objections were allowed in full.

More:    There are numerous occasions in tax practice where the correct determination of the market value of an asset is of critical importance. But the concept is not well understood and market value issues are often the subject of controversy. This case is a very important one because it directs us to the precise question that must be addressed – what is the market value of the relevant asset(s) on the basis of the Spencer formulation, without ‘factors that are extraneous to the purpose for which such a value is to be ascertained’? In this case, the contemporaneous sales of the shares owned by the other 2 shareholders, giving the buyer 100% control of the company, were factors extraneous to the valuation of the taxpayer's shares alone.

These principles have widespread implications! (Miley and Commissioner of Taxation [2016] AATA 73)

In brief:    A Bill to enact the proposed new Small Business Restructure Rollover with effect from 1 July 2016 was introduced yesterday. It contains significant changes from the exposure draft legislation released last November. In particular, rollover assets (other than depreciating assets) will need to be active assets, small business entities will not now also need to satisfy the $6M net asset value test in order to qualify, consideration for asset transfers may be provided and a rollover transaction must be part of a ‘genuine restructure of an ongoing business’ (with an optional safe harbour rule for a genuine restructure, comprising a period of 3 years after the transaction with no relevant changes relating to rollover assets). Further, the Bill has a provision that will neutralise any other direct tax consequences where the rollover applies.

The broad thrust of the rollover is nevertheless unchanged from the exposure draft. The proposed rollover will be optional and is to extend to trading stock, depreciating assets and revenue assets, as well as other CGT assets generally. And there must be no material change in the proportionate interests of individuals who have the ‘ultimate economic ownership’ (a term not defined) of the assets. However, there will be no change in the ultimate economic ownership interests if a discretionary trust that has made a family trust election is a party and all individuals having ultimate economic ownership before and after the transfer are members of the family group relating to the trust.

More:    If the Bill is enacted, the rollover will provide a welcome concession to small business entities (including their affiliates and connected entities). It is an exciting development – providing a mechanism by which previous structuring errors can be fixed and facilitating some very beneficial planning strategies. The new rollover also opens up additional options for passing a business to the next generation, although it will often be preferable to capture the small business CGT concessions rather than opt for the rollover in those cases.

In brief:    A recent case in the Queensland Supreme Court illustrates the potential dangers involved where one spouse is intended to control a family trust after divorce. In this case, the parties had agreed that the husband take future control of the trust after their divorce, but the power given to them both under the trust deed to appoint and remove trustees was not dealt with in the Family Court consent order dealing with the property of the marriage. After the husband's subsequent death, the wife and de facto spouse of the deceased husband purported to appoint the wife as trustee of the trust in place of the corporate trustee, then controlled by the husband's daughter from an earlier marriage.

The Court refused to grant the wife's application for a declaration that she had been validly appointed. Although the wife was still named in the trust deed as a person having the joint power, it could only be exercised with the surviving spouse of the deceased husband. And, as a matter of construction of the trust deed, the husband's de facto spouse did not come within that definition. In any case, it was held that the Family Court was the appropriate forum in which any dispute about the trust should be resolved.

More:    The applicant wife was unsuccessful in this case, although not before the drama and costs of a Supreme Court action. And a lay observer might think that the wrong outcome was reached, given that it seems that the unsuccessful wife intended to administer the trust to benefit the children of her and the deceased, as well as the deceased's de facto spouse at the time of his death. So, on the face of things, there was limited estate planning for the deceased. That is one lesson from the case.

The other lesson is that it is important to have a clean, effective break if one spouse is to assume complete control of a family trust after divorce. This is the reason why Tax Strategies’ trusts now contain automatic mechanisms to remove one spouse as a beneficiary and from any other role under the trust, such as the power to appoint and remove trustees. That is achieved by only one spouse being nominated as the main beneficiary to start with (called the ‘Family Beneficiary’) – the one who will logically take control of the trust if there is a relationship breakdown. The other will still have their normal rights in relation to the trust property as a matter of family law, but it will be plain that that other is completely excluded. And that exclusion will occur right from the moment of separation, even if the parties are still legally married. (Kneipp v Annunaka Pty Ltd [2015] QSC 359)

In brief:    Dismissing the Commissioner's appeal, the Full Federal Court has confirmed that the small business participation percentages in a company were not affected by a ‘dividend access share’ in the company. Consequently, the small business CGT concessions could be applied to the capital gain of nearly $4.4M derived by the company from its sale of shares in another company.

More:    At issue was the effect of the words ‘the percentage of any dividend that the company may pay’ in item 1 of the table in s 152-70(1) of the Income Tax Assessment Act 1997. It is often the case that, if the whole of a dividend may be declared for the benefit of holders of dividend access shares, ordinary shareholders cannot be said to hold any percentage at all of any dividend that the company may pay. And the benefit of the small business CGT concessions may then be lost if it is necessary to have a significant individual or CGT concession stakeholders in the company.

The outcome in this case turned on matters of company law – the correct interpretation of members’ entitlements, against the background of the company's Constitution and company law generally. In the particular circumstances of this case, the directors were not free to pay a dividend on the issued dividend access share immediately before the relevant CGT event – there was an intervening pre-condition that had to be satisfied before that next step to declare a dividend on the dividend access share could be taken. And that meant that the dividend access share could effectively be disregarded in determining whether there was a significant individual or CGT concession stakeholder in the company. (FC of T v Devuba Pty Ltd [2015] FCAFC 168)

In brief:    The Commissioner in a recent Federal Court decision was successful in denying application of the small business CGT concessions. At issue was whether a ‘loan’ from a family trust to the individual who controls the trust, and was the sole trustee of the trust, had to be counted for the $6M net asset value test. The taxpayer argued that the loan was statute barred and consequently that no value should be attributed to it.

The Court held that action to recover the loan would be one under the relevant South Australian Limitation of Actions Act 1936 ‘to recover trust property’ and that no limitation period was prescribed in that case. In any case, the Court said that a statute barred debt continues in existence. A limitation statute creates a defence that can be pleaded by the debtor, but generally does not extinguish the cause of action. Also, Courts were generally empowered to extend certain limitation periods. And the debtor in this case was the sole trustee of the trust to which the ‘loan’ was owing, so a breach of trust would likely be involved if the trustee pleaded expiry of any limitation period for his own benefit.

More:    The outcome in this case could be different in other circumstances. Although a limitation statute might not extinguish the cause of action for a debt, expiry of a limitation period would undoubtedly affect the value of the debt. And it is the market value of the debt, not its face value, that is relevant for the $6M net asset value test. However, the case appears to have been run on the basis only that the whole value of the debt should be excluded, not that its value was less than face value. And the reason for that was presumably that the total net values of other assets were agreed by the taxpayer and Commissioner to amount to $5,930,913. (Breakwell v FC of T [2015] FCA 1471)

In brief:    The Administrative Appeals Tribunal has held that a commercial pilot who worked overseas for a foreign airline was nevertheless an Australian tax resident and liable to tax on his earnings accordingly. The taxpayer was found to be a resident according to ordinary concepts. In any case, the Tribunal said that he would also be a resident because of his Australian domicile during the relevant years of income, without a permanent place of abode outside Australia. The Tribunal said that the taxpayer was a ‘fly-in fly-out’ worker, working overseas in order to access better career opportunities.

More:    There was evidence of shared accommodation available to the taxpayer overseas during some periods. And also family tensions because his wife had to manage the family home in Australia and their children, mostly on her own. Nevertheless, the taxpayer spent nearly one half of each of the 3 years of income under consideration physically in Australia during his days off work as part of his monthly rotation. And that time was mostly spent with his wife and children in the family home. (Hughes v C of T [2015] AATA 1007)