CGT Discount Denied for Employee Share Scheme interest holder

The Administrative Appeals Tribunal (AAT) has denied a taxpayer a capital gains tax (CGT) discount on a gain on the disposal of shares she acquired as part of an employee share scheme (ESS).

The matter, Mangat v Federal Commissioner of Taxation [2018] AATA 2012 was decided on 27 August 2018 and related to a taxpayer, Dr Mangat, who had acquired 150,000 shares in Virtus Health Pty Ltd (Virtus). The shares were later cancelled when the company became listed on the Australian Stock Exchange.

The issue the AAT was required to determine was when exactly Dr Mangat had acquired the ESS interest. This was relevant to determine whether Dr Mangat was entitled to a 50% reduction in the associated CGT on the disposal of the shares having held them for 12 months, pursuant to section 115-25 of the Income Tax Assessment Act 1997 (Cth).  Dr Mangat argued that she had held the shares since late 2011. By contrast the Federal Commissioner of Taxation (Commissioner) had determined that the shares were acquired in late 2012, being less than 12 months prior to the disposal and therefore found that the gain was ineligible for the CGT discount.

Dr Mangat had entered into a contract of employment on 30 December 2011 for a position of contract doctor with IVF Australia Pty Ltd (IVFA) and Virtus. Dr Mangat stated that she had first been offered the shares as part of a discussion in November 2011, however the AAT noted that the relevant information documents Dr Mangat referred to in this statement were dated 16 December 2011 and therefore found that the statement by Dr Mangat was unlikely to be accurate.

Dr Mangat further stated that she had acquired the shares as part of signing her employment contract. However the AAT, on reviewing the contract noted that it was silent as to any offer of shares. Versions of the contract provided to the Commissioner varied, with one copy attaching a schedule including the share offer and another version missing such an attachment. The AAT determined that the schedule was not executed on the same day as it was not identified in the employment contract.

The AAT, noting emails and evidence provided by Dr Mangat’s coworkers and the Commissioner, found that the evidence indicated that the share offer was made and accepted in or about August or September 2012, being less than 12 months before the disposal. The AAT therefore upheld the Commissioner’s determination denying the taxpayer’s CGT reduction.

The AAT also considered whether the administrative penalty of 50% of the shortfall imposed by the Commissioner was appropriate. The AAT denied Dr Mangat’s request for a full remission and instead reduced the penalty to 40% of the tax shortfall, noting that Dr Mangat had failed to provide the Commissioner with relevant information as part of the Commissioner’s audit of the CGT claim and had a history of non-compliance. Whilst appreciating Dr Mangat’s efforts to bring her compliance up to date in recent times, Ms Lazanas, Senior Member of the AAT, noted at paragraph 100 of the decision:

Dr Mangat impressed me as a highly intelligent and resourceful professional who should have known about her annual taxation compliance obligations and sought advice well before the due dates.

This case highlights the need for employees to carefully consider ESS being proposed, to understand the tax consequences of later disposals and to keep appropriate documentation. It further demonstrates the importance of being open and transparent in dealing with tax audits by the Commissioner. For businesses this case demonstrates that where a public offering of the business is intended in the near future, ESS may not be the best equity arrangement for incentivizing staff.

If you would like advice on managing a tax audit, understanding an ESS you are considering participating in, or if you are a company looking to offer staff equity and would like advice on an appropriate plan to meet your objectives, please contact:

Laura Spencer
Sladen Legal
T +61 3 9611 0110
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia

Daniel Smedley
Principal | Accredited Specialist in Tax Law
Sladen Legal
M +61 411 319 327 |  T +61 3 9611 0105
Level 5, 707 Collins Street, Melbourne, 3008, Victoria, Australia