The Federal Court has held, in a decision that the Court itself described as an “unpalatable result”, that the capital gains tax (CGT) discount did not apply to the sale of shares held by a trust. The Court’s determination was based on the fact that the shares had been acquired through an unbroken series of roll-overs (but included one roll-over of the wrong ‘type’) in the 12 months preceding their disposal and therefore the deemed time of acquisition rules did not apply.
All legislative references are to the Income Tax Assessment Act 1997 (Cth).
The Taxpayers are Mrs Anna Paule, Mrs Cornelia Paule, Mr Terry Paule and Mr Spiro Paule (together, the Paules) and Mr Philip Hart. The Paule’s were beneficiaries of S&TP Trust, Terry a beneficiary of STP Trust, and Spiro a beneficiary of SP Trust. Mr Hart was a beneficiary of the Grosvenor Trust.
Through a series of roll-overs, one undertaken pursuant to subdivision 124-N and two in accordance with subdivision 124-M, that occurred 14 January 2008 and 15 January 2018 respectively, the Paule’s trusts exchanged units they held in various trusts for shares in a company called Findex.
Mr Hart also undertook roll-overs on the same days with his interest, one pursuant to subdivision 122-A and two in accordance with subdivision 124-M until business assets held directly by the Grosvenor Trust became shares in Findex.
Three days after the roll-overs, on 18 January 2008, all parties sold their shares in Findex.
Were the applicants entitled to a discount capital gain under subdivision 115-A on the disposal of their shares in Findex?
This issue before the Court fell on the key requirement of the CGT discount, being that the assets, that is, the shares in Findex, had been held for at least 12 months prior to their disposal. Section 115-25 states:
(1) To be a *discount capital gain, the *capital gain must result from a *CGT event happening to a *CGT asset that was *acquired by the entity making the capital gain at least 12 months before the CGT event.
Note 1: Even if the capital gain results from a CGT event happening at least a year after the CGT asset was acquired, the gain may not be a discount capital gain, depending on the cause of the CGT event (see section 115‑40) and the nature of the asset (see sections 115‑45 and 115‑50).
Note 2: Section 115‑30 or 115‑34 may affect the time when the entity is treated as having acquired the CGT asset.
Note 2 states that section 115-30 and 115-34 may affect when an entity is deemed to have acquired a CGT asset. The applicants contended that the effect of sections 115-30 and 115-34 was that the Findex shares were deemed to have been acquired when the original units had been acquired and therefore the discount capital gain applied. The Commissioner, and the Court, found differently.
Contained with section 115-30(1) is a table. Item 1 refers to CGT assets acquired via same asset roll-overs. Item 2 refers to CGT assets acquired via replacement asset roll-overs, such as subdivisions 122-A and 124-M roll-overs. Roll-overs under subdivision 124-N are both same asset and replacement asset rollovers.
The Findex shares disposed of were CGT assets acquired via the subdivision 124-M roll-over and therefore consideration fell to Item 2. Item 2 of section 115-30 states:
A * CGT asset that the acquirer * acquired as a replacement asset for a * replacement-asset roll-over (other than a roll-over covered by paragraph 115-34(1)(c))
(a) when the acquirer acquired the original asset involved in the roll-over; or
(b) if the acquirer acquired the replacement asset for a roll-over that was the last in an unbroken series of replacement-asset roll-overs (other than roll-overs covered by paragraph 115-34(1)(c))-when the acquirer acquired the original asset involved in the first roll-over in the series
Ordinarily, section 115-34(1)(c) works to deem a share to have been acquired at least 12 months before the CGT event where the share had been acquired pursuant to a subdivision 122-A, 122-B, or 124-N roll-over.
However, the shares in Findex were acquired via a subdivision 124-M replacement-asset roll-over not mentioned in 115-34(1)(c). Consideration then fell to section 115-30 and whether the deeming rules in that provision applied.
As the Taxpayers’ acquired the Findex shares via a subdivision 124-M replacement-asset roll-over, Item 2 in section 115-30 (above) applied with the time of acquisition depending on paragraphs (a) and (b) of Item 2.
Under paragraph (a), the “original asset” was the share acquired under the first 124-M roll-over, which was three days before, on 15 January 2008.
In relation to (b), the Court found that an unbroken series of replacement-asset roll-overs had occurred. However, Item 2 did not apply to deem an earlier acquisition date as the series included the subdivision 124-N roll-over covered by section 115-34(1)(c). Therefore again, the date of acquisition was 15 January 2008.
That is, under both (a) and (b) of Item 2 of section 115-30, section 115-25 was not satisfied as the Taxpayers did not acquire the Findex shares at least 12 months earlier than the date of disposal.
The same outcome also applies where the first rollover was under subdivision 122-A, as used by Mr Hart, as 122-A is also listed in section 115-34(1)(c) .
Section 115-30 was retrospectively amended in 2010, after these transactions occurred in 2008. As part of the 2010 amendments sections 115-32 and 115-34 were included. Therefore, whilst at the time of the transactions this law did not exist, it was applied retrospectively to capture these transactions.
Alternate Submissions – Construction and Interpretation
The taxpayer submitted that the provisions could be interpreted in more than one way and therefore the construction should be determined with reference to the legislative history and intended effect of the 2010 amendments to section 115-30.
Indeed, when considering the context of the 2010 amendments and the Explanatory Memorandum to those amendments, there seemed a clear inconsistency. The Court however stated that it was not for the Court to assume the legislation was incorrect and give it meaning, such as to apply to a roll-over, where the provisions plainly state it should not apply.
Further, the Applicant’s alternative case was that the Court should “read into” the section the words that would mean the exemption applies. This submission, consistent with the principle in Cooper Brookes, was also denied by the court.
An unpalatable decision?
This decision is clearly, as the Court put it, an “unpalatable result”. Through a series of roll-overs, supported by the broad policy of the legislation, amended retrospectively after the roll-overs but with the policy intent staying, the taxpayers held, in economic substance, the same asset. However, the legal form was different.
Had the shares been held by a company and three roll-overs under subdivision 124-M undertaken, then the result would have been a discount capital gain. There are no clear policy reasons for excluding a scenario where there is a roll-over pursuant to subdivision 124-N (or 122-A), followed by two roll-overs undertaken in accordance with subdivision 124-M.
The Court acknowledged this but stated that it is not for the Court “to second guess the legislature or the Commissioner’s administration of the tax laws.”
We expect that the Taxpayers will appeal. Irrespective of the outcome of any appeal, whether the provisions will be taken back to the legislatures for a redraft is currently unknown. However, the case acts as a cautionary tale of the devil being in the detail when undertaking restructures, particularly where a series of roll-overs are being undertaken.
If you are considering a restructure and would like to understand the tax implications, or have undertaken a restructure and are concerned about tax consequences that may have been triggered, contact our tax specialists: