Tagget v Commissioner of Taxation

Tagget v Commissioner of Taxation - [2010] FCA 25 - FCA 2010 case summary — Zoe

[5]

Background 6 Mr Tagget has been involved in the business of earth moving the whole of his working life. He lives in Tanglewood, New South Wales and has been involved in the Tanglewood Estate since the late 1970s. Tanglewood Estate covers approximately 1,100 acres of land overlooking Casuarina Beach, which is about 5 kms south of Kingston in the Tweed Shire of New South Wales. 7 In the late 1970s Mr Tagget started working with Tanglewood Valleys Pty Ltd (Tanglewood Valleys). Mr Geoff Bell was a director of Tanglewood Valleys and Mr Tagget came to know him well. Mr Tagget, through his involvement with Tanglewood Valleys and Mr Bell, became aware that in 1982 development consent was given by Tweed Shire Council for the development of part of Tanglewood Estate. The development consent provided for the construction of 44 lots within what is known as the Stage 5 development of Tanglewood (the Stage 5 Development). 8 In 1983 Mr Tagget started a business named Peter Tagget Earthmoving. He commenced working with Tanglewood Valleys on earthworks and road building and became a civil works contractor and adviser to the company. Between 1983 and 1987 Mr Tagget performed a large amount of work including land clearing and levelling, rubbish removal and landfilling, preparing driveways, laying bitchumen, installing water and electricity supply and arranging surveys in relation to the Stage 5 Development. In 1989 Mr Tagget sold the business of Peter Tagget Earthmoving to his brother. 9 In or about 1998, Mr Tagget became aware that Tanglewood Valleys was running into financial trouble and that the developer was not going to proceed with the Stage 5 Development. Financiers for the development had entered into possession and put the Tanglewood Estate up for sale. In early 1998, Mr Tagget acquired shares in Hillpalm which made an offer to MLC Lifetime Company Limited (MLC) to acquire the Tanglewood Estate. 10 In March 1998, Hillpalm and MLC entered into a contract for the sale of Tanglewood Estate by MLC to Hillpalm for the sum of $2,200,500. MLC allowed Hillpalm to enter into early possession of the Tanglewood Estate enabling Hillpalm to progress the development. In the meantime, Mr Tagget commenced negotiations with various parties in an attempt to raise finance for Hillpalm to complete the purchase. Those negotiations were unsuccessful. In July 1998 MLC terminated its contract with Hillpalm and in August 1998 MLC commenced proceedings against Hillpalm and Mr Tagget for breach of contract. 11 Mr Tagget then entered into negotiations with Joanne Hambrook and Pat Wilson with a view to having them take over Hillpalm. On 2 November 1998 the Deed was executed by Mr Tagget, Hillpalm, Joanne Hambrook and David Williams. Following execution of the Deed all shares in Hillpalm were transferred to another company associated with Ms Hambrook and Mr Williams. Mr Tagget and the other directors of Hillpalm resigned and Ms Hambrook and Mr Williams were appointed in their place. Hillpalm paid $2,275,000 to MLC which transferred the Tanglewood Estate to Hillpalm by memorandum of transfer dated 20 November 1998.

[41]

The effect of the deed 42 Clause 3.1 of the Deed records a conditional undertaking by Hillpalm to transfer proposed Lot 157 to Mr Tagget for nominal consideration at a future time. As is clear from the recitals, Hillpalm had not yet acquired the Land (as defined) from which proposed Lot 157 was to be created at the time Hillpalm entered into the Deed. Further, as is clear from cl 3.1, no approval had been obtained by that time for the sub-division of the Land or, more specifically, the creation of proposed Lot 157. By cl 3.2, the sub-division and transfer of proposed Lot 157 was subject to Hillpalm realising $3.2 million in gross sale proceeds from the sale of the Land. 43 It is hard to see how Mr Tagget could have acquired any equitable interest in the Land prior to it being acquired by Hillpalm. However, recent authority establishes that upon acquisition of the Land by Hillpalm, Mr Tagget acquired what is sometimes referred to as a "contingent equitable interest": Bahr v Nicolay (No 2) (1988) 164 CLR 604 at 612 per Mason CJ and Dawson J; Chan v Cresdon Pty Ltd (1989) 168 CLR 242 at 252-253 per Mason CJ, Brennan, Deane and McHugh JJ; Stern v McArthur (1988) 165 CLR 489 at 522-523 per Deane and Dawson JJ. 44 It is not necessary to explore more fully the nature of the interest acquired by Mr Tagget in the Land or that part of it which was to make up proposed Lot 157 either at the time Hillpalm entered into the Deed or at the time it acquired the Land. It may be accepted that by the time Hillpalm acquired the Land Mr Tagget's interest was a contingent equitable interest. 45 Clause 6.1 of the Deed deals with the timing of the transfer of proposed Lot 157 to Mr Tagget pursuant to cl 3.1. It provides that the transfer shall occur upon the earlier of "the date determined in accordance with Clause 3.2 …" or "24 months after the Linen Plan in respect of the Stage 5 development approval is sealed by the Tweed Shire Council and released to Hillpalm". As I have mentioned, cl 3.2 provides, relevantly, that the subdivision is subject to Hillpalm realising gross sale proceeds from the sale of the Land in the sum of $3.2 million. 46 There is no evidence that Hillpalm ever achieved gross sales of $3.2 million, nor is there any evidence that the plan of subdivision in respect of the Stage 5 Development was approved by Council. So far as the evidence reveals, neither of the conditions precedent to the transfer of proposed Lot 157 was ever satisfied. 47 This brings me to cl 3.3. It is concerned with a situation in which, for reasons beyond the control of Hillpalm, the approval necessary to enable Hillpalm to transfer proposed Lot 157 to Mr Tagget cannot be obtained. In that situation Hillpalm is required to pay to Mr Tagget a sum of money equal to the unimproved value of proposed Lot 157 as agreed or as determined by a registered valuer appointed by the President of the Institute of Valuers. Clause 3.3 then provides that "Tagget will accept the compensation in full and final satisfaction of all claims." 48 The evidence does not really address the question whether the failure to obtain the relevant approval was beyond the control of Hillpalm. Assuming such a failure was beyond its control, it is clear that Mr Tagget was entitled to be paid compensation in an amount determined in accordance with cl 3.3 of the Deed. Even if such a failure was not beyond Hillpalm's control, it is difficult to see how Mr Tagget could be entitled to any lesser sum by way of damages for breach of contract if the failure was the result of a breach of Hillpalm's obligation under cl 6.1 to do everything that was reasonably required to achieve that outcome. But in that case Mr Tagget's entitlement to damages would not be restricted by the concluding words of cl 3.3.

[42]

Was the land ordinary income of Mr Tagget in the tax year ended 30 June 2006? 49 Counsel for Mr Tagget submitted that the land received by Mr Tagget never formed part of Mr Tagget's ordinary income. His argument involved three essential steps. First, cl 3.3 vested in Mr Tagget contractual rights to either acquire proposed Lot 157 for nominal consideration or to receive compensation in the event that proposed Lot 157 never came into existence. Secondly, these contractual rights were choses in action that could have been turned to pecuniary account by Mr Tagget and were, therefore, ordinary income derived by him upon entry into the Deed. Thirdly, the receipt of the land by Mr Tagget in September 2005 was the result of the exercise by him of the contractual rights acquired by him upon entry into the Deed and, as such, did not form part of Mr Tagget's ordinary income. 50 Counsel for Mr Tagget relied upon the decision of the House of Lords in Abbott v Philbin [1961] AC 352, arguing that the facts of this case were within the principles laid down by the majority in that case. He sought to characterise cl 3.1 not as an option, but as something stronger. I agree that cl 3.1 does not confer upon Mr Tagget an option to purchase land. In substance, Hillpalm agreed to sell and Mr Tagget agreed to buy proposed Lot 157 for nominal consideration subject to the conditions set out in the Deed. There was nothing in the nature of an option about it. But for reasons that I will explain I do not think it is either meaningful or correct to say that the rights acquired by Mr Tagget were stronger than the option under consideration in Abbott v Philbin. What is important is that Mr Tagget's entitlement to proposed Lot 157 or the sum of money payable under cl. 3.1 was in each case of a contingent nature. This is a feature which distinguishes the rights granted to Mr Tagget under the Deed from the option rights granted to the taxpayer in Abbott v Philbin. 51 In Abbott v Philbin the taxpayer was granted an option to purchase 2,000 ordinary shares in a company of which he was secretary at the price of 68s. 6d. per share. The option was granted in October 1954. The price of the option was £20 and it was expressed to be non-transferable and to expire after 10 years or on the earlier death or retirement of the taxpayer. In March 1956 when the market price of the shares was 82s. per share, the taxpayer exercised the option in respect of 250 shares. The taxpayer was assessed to income tax under Schedule E of the Income Tax Act 1952 (U.K.) in the year 1955-56 on £166 which constituted the difference between the option price and the market price of the shares (with a deduction of a proportionate part of the cost of the option) as being a perquisite received by him by virtue of his employment. The taxpayer appealed the assessment and, by majority, the House of Lords upheld his appeal. 52 The Income Tax Act 1952 (U.K.) provided that "Tax under Schedule E shall be annually charged on every person having or exercising an office or employment of profit … in respect of all salaries, fees, wages, perquisites or profits whatsoever therefrom for the year of assessment …". Viscount Simonds appears to have decided the case on the basis that the option was something of value which could be turned to pecuniary account. His Lordship said at 365: My Lords, I cannot entertain any doubt that, when the company granted the option to the appellant, he acquired something of potential value. I do not think that it matters whether it falls into the category of proprietary or contractual right, or into some dim twilight that divides those juristic conceptions. We are concerned with a taxing statute whose language is to be reconciled with the law of England and Scotland alike, and the chosen words "perquisite or profit whatsoever" are as wide and general as they well could be. I can concede no relevant limitation of their meaning except in the oft cited words of Lord Watson in Tennant v. Smith that they denote "something acquired which the "acquirer becomes possessed of and can dispose of to his advantage-in other words, money-or that which can be turned to "pecuniary account." 53 Similarly, Lord Radcliffe said at 378-9: I think that the Revenue are right in saying that a line has to be drawn somewhere between convertible and non-convertible benefits, and that somehow we have to put a general meaning on the not very precise language used in Tennant v. Smith. What I do not think, however, is that a non-assignable option to take up freely assignable shares lies on that side of the line which contains the untaxable benefits in kind. The option, when paid for, was thereafter a contractual right enforceable against the company at any time during the next 10 years so long as the holder paid the stipulated price and remained in its service. That right is, in my opinion, analogous for this purpose to any other benefit in the form of land, objects of value or legal rights. It was not incapable of being turned into money or of being turned to pecuniary account within the meaning of these phrases in Tennant v. Smith merely because the option itself was not assignable. What the option did was to enable the holder at any time, at his choice, to obtain shares from the company which would themselves be pieces of property or property rights of value, freely convertible into money. Being in that position he could also at any time, at his choice, sell or raise money on his right to call for the shares, even though he could not put anyone he dealt with actually into his own position as option holder against the company. I think that the conferring of a right of this kind as an incident of service is a profit or perquisite which is taxable as such in the year of receipt, so long as the right itself can fairly be given a monetary value, and it is no more relevant for this purpose whether the option is exercised or not in that year, than it would be if the advantage received were in the form of some tangible form of commercial property.

[44]

55 Abbott v Philbin was followed by Bowen CJ in Eq. in Donaldson v Federal Commissioner of Taxation (1974) 3 ALR 516. His Honour held that convertible notes which carried the right to purchase shares in Hooker Corporation Limited were benefits of an income nature in the hands of a taxpayer who was an employee of that company. The options were the subject of various conditions including one which excluded any right to exercise them until after the employee had remained in the company's employment for a specified period. 56 His Honour held that the options to purchase shares granted to the taxpayer were benefits within what was formerly s 26(e) of the 1936 Act. For the taxpayer it was argued that the options were not a benefit that could be enjoyed by him in the income year in question. His Honour said at 532-3: …I find myself in general agreement with the argument advanced by counsel for Mr Donaldson that the Income Tax Assessment Act is dealing with what "comes in" to the taxpayer, and, generally, with what is enjoyed or capable of being enjoyed by the taxpayer in the income year in question. But these are generalizations which do not greatly assist in the resolution of the present case. I am unable to accept a proposition that the option rights conferred on Mr Donaldson did not "come in" to him or were not enjoyed by him in the year of income. Items rendered assessable income by s 26(e) have to be regarded according to their nature, whether they are meals, use of quarters, or option rights. To say the option rights could not be exercised in the year of income is no answer to the application of s 26(e). Indeed, it is to confuse the enjoyment of the fruit of the rights with the enjoyment of the rights, a mistake made in argument on behalf of the Crown in Abbott v Philbin, supra. Again, to say rights are non-transferable is no answer to the application of s 26(e). Meals which are consumed may be non-transferable and yet they are within s 26(e). What is made assessable income by s 26(e) is the value to the taxpayer of the benefit allowed, given or granted to him, that is to say, the rights conferred on him which others lack. Whether they have any value to him, and what that value is, are matters to be determined according to the facts of each particular case, preferably with the assistance of expert evidence. But that does not affect the principle that where such rights are given they are present rights, though exercisable in the future, and confer an immediate benefit upon the taxpayer which he enjoys as the owner of them.

[45]

57 Federal Commissioner of Taxation v McArdle (1988) 19 ATR 1901 was also concerned with the application of what was then s 26(e) of the 1936 Act. Mr McArdle, the taxpayer, had been granted options to acquire his employer's stock between 1975 and 1980. In 1979 Mr McArdle entered into what was referred to as a "limited stock appreciation rights agreement". The effect of the agreement was to allow Mr McArdle to receive a cash payment in certain circumstances in lieu of the stock to which he would be entitled if he exercised his options. The cash payment would equal the difference between the value of the stock and the exercise price of the options. In the year ended 30 June 1982 Mr McArdle received a payment under the agreement. 58 The Full Court agreed with the trial judge who held that the payment should not have been included in the taxpayer's assessable income. Davies, Gummow and Lee JJ said at 1909: His Honour held that the agreement by Delhi International to pay $1,100,000 was made by Delhi International, not in consequence of Mr McArdle's employment with the Delhi group, but in consequence of and as consideration for the surrender by Mr McArdle of his stock options and his limited stock appreciation rights. … We respectfully agree with his Honour that what occurred in the year ended 30 June 1982 was not the grant to Mr McArdle of a valuable benefit assessable under the provisions of s 26(e) of the Act but rather the exploitation by him of rights received in previous years, the value whereof would have been assessable under s 26(e) in those years but for the period of s 26AAC(10). Had we been of the view that, in the year ended 30 June 1982, Delhi International granted to Mr McArdle a benefit of value, we would have thought that the value was assessable to tax under s 26(e). However, an analysis of what occurred in the year ended 30 June 1982 shows that what was done was not the grant by Delhi International to Mr McArdle of a valuable benefit in respect of, for or in relation, directly or indirectly, to the services he had rendered for the Delhi group. Rather, Mr McArdle negotiated with Delhi International a means of exploiting the rights which had been granted to him by Delhi International in prior years. Before the trial judge and again on appeal, reliance was placed on s 25(1) of the Act. We need say no more about this matter than did the trial judge, namely, that it was a capital receipt, being received as consideration for the surrender of valuable rights. The sum was not received by way of a reward for service and was negotiated as the consideration for the surrender of valuable rights.

[46]

59 In the present case the Deed created various contractual rights including a right in favour of Mr Tagget to have Hillpalm transfer proposed Lot 157 to him for nominal consideration subject to the fulfilment of conditions which would make that possible. This was coupled with a right in favour of Mr Tagget to be paid compensation if, for reasons beyond Hillpalm's control, the conditions which would make the transfer of proposed Lot 157 possible could not be fulfilled. These rights were legal choses in action which I am prepared to assume (though there is no evidence to this effect) that Mr Tagget could have turned to pecuniary account in the same way the options under consideration in Abbott v Philbin were held to be capable of being turned to pecuniary account. But I do not think it follows that the choses in action were ordinary income of Mr Tagget. 60 A distinction needs to be drawn between an agreement which confers a right upon a person to obtain property or money and an agreement in which property or money is actually vested in him or her. Each of the cases I have referred to was concerned with a situation in which the taxpayer was granted share options by his employer. Moreover, the grant of the options was not conditional or contingent in any respect. Of course, the options may not have been exercisable unless certain conditions were fulfilled; Mr Donaldson, for example, could not exercise his options until he had completed specified periods of further service. But that is quite different to saying that the grant of the options was conditional upon Mr Donaldson completing the specified periods of further service. If Mr Donaldson's employer had promised to grant him options on condition that he completed a period of further service then I do not consider that promise would have been a benefit to which s 26(e) would have applied - at least not until Mr Donaldson had completed his period of further service. 61 As the late Professor R W Parsons explains in Income Taxation in Australia (1985) at para [2.15]: …Generally where there is a right to some benefit or to property other than money there cannot be a derivation, whether the taxpayer is on accruals or cash, until the benefit or property has come to be vested in the taxpayer. Property for this purpose may, it seems, include a chose in action. Thus the taxpayer in Abbott v. Philbin [1961] A.C. 352 and the taxpayer in Donaldson (1974) 74 A.T.C. 4192 who came to have rights to options over shares were regarded as having derived those options at the time when a distinct set of legal relations constituting the options came into existence. There is, it seems, a difference for tax purposes between a contractual right to an issue of options which will not involve a derivation and the actual issue of options which will involve a derivation…

[50]

64 In Barratt v Commissioner of Taxation (1992) 36 FCR 222 the question that arose was whether the income of taxpayers, who were medical practitioners registered under the Medical Practitioners Act 1938 (NSW), should be computed on a cash or an accruals basis. In finding that an accruals basis was appropriate, Gummow J (with whom Northrop and Drummond JJ agreed) said at 231: No doubt a debt that is presently recoverable by action generally will be an amount "derived" in the relevant sense by the creditor. The creditor will have a present right to receive the amount in question, something both earned and quantified, without the presence of any element of contingency or defeasibility. At the other end of the scale, where the right of the taxpayer is contingent, there will be no derivation before the contingency is satisfied: see R W Parsons, Income Taxation in Australia (1985), s 11.49. Nor will there be derivation if the debt is yet to be quantified: see Farnsworth v Commissioner of Taxation (Cth) (1949) 78 CLR 504 at 513, per Latham CJ. The present case is at neither extreme end of the spectrum. But it is well to bear in mind that what is being sought is a method of giving, for each year of income, a substantially correct reflex of the true income of the taxpayers, having regard to what Fullagar J called the truth and reality of the situation: see Ballarat Brewing Co Ltd v Commissioner of Taxation (Cth) (1951) 82 CLR 364 at 369. 65 In Gasparin v Commissioner of Taxation (1994) 50 FCR 73 the Full Court was concerned with the tax treatment of allotments of land that were the subject of contracts of sale which were expressed to be conditional upon registration of a plan of subdivision. The plan of subdivision was duly registered. It was nevertheless held that the allotments of land continued to form part of the vendor's trading stock up to the time of settlement of the contracts of sale. It was also held that the vendor did not derive income from the sale of allotments until a debt accrued due from the purchaser, something which, it was found, did not occur until settlement. Only then could it be said that "the vendor finally loses all dispositive power, and the contingency that the sale will not proceed to completion disappears" per von Doussa J at 83 (with whom Jenkinson and Spender JJ agreed). After referring to Gummow J's judgment in Barratt's case, his Honour observed at 81 that "[t]he element of contingency is an important one". And after referring to the judgments of the High Court in Farnsworth v Commissioner of Taxation (Cth) (1949) 78 CLR 504 his Honour explained at 83: The reason for the proposition stated in the judgments of the High Court that income is derived when a debt has accrued due, is to eliminate the element of contingency and uncertainty in the exercise of determining when income is derived for the purpose of levying taxation. See also the decision of the Full Court in BHP Billington Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation (2002) 126 FCR 119. 66 It was anticipated at the time of entry into the Deed that it might take some years before proposed Lot 157 could be transferred to Mr Tagget: see cl 6.1(b). If for reasons beyond Hillpalm's control, such a transfer was not possible then cl 3.2 would apply and Mr Tagget would be entitled to compensation equal to the unimproved value of proposed Lot 157. I think the compensation would have to be based upon a valuation as at the date cl 3.3 was engaged as opposed to a valuation as at the date of the Deed. The significance of this is that at the date of the Deed the value of Mr Tagget's entitlement to either land or compensation was quite uncertain. The value of Mr Tagget's entitlements would in all probability vary over time in accordance with fluctuations in the property market and could never be fixed with any degree of certainty until either land or compensation was received by him. 67 In my opinion Mr Tagget did not derive income merely by entering into the Deed. Moreover, nothing in the nature of income could come in to Mr Tagget under cl 3.1 or cl 3.3 of the Deed until proposed Lot 157 was transferred to him under cl 3.1 or a sum of money became due to him as a result of an agreement reached or a valuation struck under cl 3.3. Even then, if Mr Tagget's income was computed on a cash basis (as would seem to be appropriate in his circumstances) such sum would not be derived by him for tax purposes until it was received. 68 If proposed Lot 157 had been transferred to Mr Tagget pursuant to cl 3.1, or if he had instead been paid a sum of money pursuant to cl 3.3, then the value of the land, or the sum of money in question, would have been ordinary income derived by Mr Tagget when the transfer or payment occurred. That being so, both parties accepted that the land received by Mr Tagget under the Deed of Release would also form part of his ordinary income. This view is supported by the relevant authorities: see, for example, Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540 at 568 and Tinkler v Commissioner of Taxation (Cth) (1979) 29 ALR 663 at 666. 69 It was faintly argued by Counsel for Mr Tagget that the land received by him in September 2005 might not be income according to ordinary concepts. A related question touched upon in argument was whether Mr Tagget was carrying on business at relevant times. If he was not then s 21A of the 1936 Act would not apply to him: see the definition of "income derived by a taxpayer" in s 21A(5). But even if Mr Tagget was not carrying on business, his entitlements under the Deed were given in return for him agreeing to make his services available to Hillpalm: see, in particular, cl 7. I would therefore have no hesitation in finding that the receipt of the land was income according to ordinary concepts. Assuming s 21A of the 1936 Act did not apply to Mr Tagget, s 21 of the 1936 Act would deem the money value of the land to have been paid or given to him. In any event, although an application for leave to raise an additional ground of objection was foreshadowed, it was not pursued by Mr Tagget and I accept the submission made by Counsel for the Commissioner that it is not open to Mr Tagget to rely on any such argument in this appeal since it raises a ground of objection that was not included in the Notice of Objection. 70 The appeal should be dismissed with costs. I certify that the preceding seventy (70) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Nicholas .

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