The AAT has confirmed that ETPs paid to husband and wife taxpayers who owned a private healthcare company were not to be taken into account as liabilities for the purposes of the maximum net asset value test in determining whether they each qualified for the CGT small business concessions. Instead, the AAT found that the ETP liability was not an enforceable liability that had arisen "just before" the relevant CGT event as required. In any event, the AAT also found that the liability did not "relate" to any CGT assets of the business for the purposes of the test.

Background

The husband and wife taxpayers were the sole shareholders and directors of a private healthcare company which they sold, via their shareholding, for some $14 million in the 2007 income year. The taxpayers claimed they were entitled to the CGT small business concessions in Div 152 of the ITAA 1997 in respect of the capital gain made on the sale of their shares. In particular, they claimed that they satisfied the $6 million maximum net asset value (MNAV) test "just before" the relevant CGT (namely, CGT event A1) as required by s 152-15, on the basis that the liability of the company to pay them ETPs totalling some $2.75 million were liabilities to be taken into account for the purpose of the MNAV test, as the liabilities arose just before the CGT event and that they were "related" to the assets of the company.

In the alternative, the taxpayers argued that their contractual right to the payment of the ETPs out of the company funds were assets "used solely for the personal use and enjoyment" of the taxpayers and therefore were CGT assets that were specifically excluded from the MNAV test by s 152-20(2)(b). In addition, the Commissioner also argued that any company obligation to pay the ETPs to the taxpayers formed part of the capital proceeds from the sale of the assets and therefore helped generate the capital gain, rather than being a liability in respect of the sale. Finally, the taxpayers contested the imposition of 25% shortfall penalties for failing to take reasonable care.

Decision

The AAT first examined the key issue of when the contract for the sale of the shares was actually made (noting that in terms of CGT event A1, the "time of the event" is when the contract is made, and not settled). After extensively examining established case law on the matter and applying it to the facts in question, the AAT concluded that the contract was made on 24 November 2006. In arriving at this conclusion, the AAT emphasised that the issue depends on the intention of the parties as objectively ascertained from the terms of the relevant documents and that the existence of a "condition precedent" (such as a "due diligence" enquiry, in this case) will usually only be a condition precedent to the "performance" of the contract and not its "making". Accordingly, the AAT concluded that, on the facts, any requirement to pay ETPs to the shareholders occurred after the contract of sale was made and that therefore the ETPs, even if relevant liabilities, could not be taken into the MNAV test because they had not arisen "just before" the relevant CGT event.

Furthermore, the AAT found that the requirement to pay the ETPs were not "enforceable" liabilities, even though the company had made resolutions (via the husband and wife directors) to pay them. In this regard, the AAT stated that "the passing of a resolution by the Board of Directors of a company cannot, by itself, create a legal or equitable liability that is enforceable against the company by persons who stand to benefit should the company act in accordance with the resolution. The resolution simply authorises the company to take particular action. Therefore, a company may be authorised by resolution to enter into a contract with a particular person or persons for a particular purpose. However, unless there is an enforceable agreement between the company and, for example, its employees regarding certain payments, no liability can arise.

In any event, the AAT also found there was no documentary evidence between the company and the taxpayers creating a legal obligation to make the payment – and, instead, the evidence pointed to the payments having the hallmarks of a gratuitous payment in the circumstances. As a result, the AAT found that the requirement to pay the ETPs was not enforceable liabilities that could be taken into account for the purposes of the MNAV test.

The AAT then found that if such an enforceable liability did in fact exist at the appropriate time, then it could not be said to be "related" to the CGT assets of the company in terms of the requirement in s 152-20(1) for the purposes of ascertaining the net value of the CGT assets of a taxpayer and related entities (in this case, the respective husband and wife taxpayers plus their spouse as a "small business CGT affiliate" as then defined and the company itself). In particular, the AAT said that liabilities related to such assets refers to expenditure incurred by the entity in obtaining those assets and that in this case while borrowings and interests on loans were incurred to acquire the assets of the business were such liabilities, the obligation to pay ETPs to the taxpayers were clearly not such liabilities (especially as the payments were not taken into account in working out the net value of the company for sales purposes and as they were made in recognition of past work of the taxpayers).

The AAT also readily dismissed the taxpayers' argument that their right to the payment of the ETPs were assets "used solely for the personal use and enjoyment" of the taxpayers and therefore were specifically excluded from the MNAV test by s 152-20(2)(b). In this regard, the AAT first noted that as it had previously found that there was no enforceable contractual liability for the payment of the ETPs. It then found that, even if it was wrong on this matter, a "right" to a payment could not be equated with it "being used" as required by the exclusion and that therefore the exclusion had no application.

The AAT also agreed with the Commissioner's contention that, on the assumption that the requirement to pay the ETPs to the taxpayers was a contractual right that formed part of the sale agreement, then the ETPs to the taxpayers formed part of the capital proceeds for the CGT event and therefore helped generate the capital gain, rather than being a liability in respect of it. In this regard the AAT noted, among other things, that the purchase price for the shares included adjustments for various debts of the business, but not for the payments of the ETPs to the taxpayers. Finally, the AAT affirmed 25% shortfall penalties for failing to take "reasonable care" primarily on the grounds that the position they adopted was not reasonably arguable and that there were no grounds for remission.

Appeals update

The taxpayers have lodged a notice of appeal to the Federal Court against the decision.
Re Scanlon and FCT [2014] AATA 725, http://www.austlii.edu.au/au/cases/cth/AATA/2014/725.html.