White v Commissioner of Taxation

Federal Court of Australia|2012-02-20|Before: Mr P, Gordon J

INTRODUCTION 1 This matter concerns the application of one of the small business concessions in Div 152 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act) to a sale of shares in Sixteenth Autex Pty Ltd (the Company) by Mr Peter White and Mrs Lorraine White (the Applicants) in the 2007 income year. 2 The concession is often described as the "15 year retirement exemption". It is contained in subdiv 152-B of the 1997 Act. In general terms, it provides a total exemption for capital gains tax (CGT) on an asset which would otherwise be subject to CGT, if the taxpayer owned the asset for at least 15 years and the taxpayer is 55 years of age or over and retiring or is permanently incapacitated. 3 To be eligible for the concession, a taxpayer must satisfy several basic conditions in s 152-10 of the 1997 Act. One of the basic conditions is the $5 million maximum net asset value (MNAV) test in s 152-15 of the 1997 Act. 4 The Applicants are husband and wife. Together, they owned a total of 58.2% of the issued capital in the Company. Mr White owned 30% of the issued capital. Mrs White owned 28.2% of the issued capital. The Applicants were each other's small business CGT affiliate for the purposes of subdiv 152-B of the 1997 Act. 5 On 12 December 2006, the Applicants sold their shares in the Company. As a consequence of that sale, Mr White made a capital gain of $1,887,571 and Mrs White made a capital gain of $1,887,572. 6 The Applicants applied the 15 year retirement exemption contained in subdiv 152-B of the 1997 Act to each of their capital gains, reducing them to nil on the basis that s 152-10(1)(c) of the 1997 Act was satisfied. In determining whether the Applicants satisfied the MNAV test, the Applicants included the value of their shareholding in the Company and otherwise excluded the net value of the assets of the Company. The Respondent, the Commissioner, disallowed the 15 year retirement exemption on the basis that the Applicants failed the MNAV test. In arriving at that decision, the Commissioner included the net value of the assets of the Company. 7 The Applicants contended that only the value of the shares in the Company that were held by the Applicants were to be brought to account in the MNAV test. The Commissioner contended that the asset values to be included in the MNAV test included the net values of the Company's assets and not the value of the shares owned by the Applicants. It was common ground that if the Company's assets were not to be included in the MNAV test, then the Applicants passed the MNAV test and were entitled to have their capital gains reduced to nil. 8 The only issue for determination is whether the Applicants passed the MNAV test. That conclusion turns on whether ss 152-20(3) and (4) of the 1997 Act exclude the value of the Company's assets from the MNAV test calculation. The Applicants submitted that they do. The Commissioner submitted that they do not. 9 For the reasons that follow, each Applicant satisfied the MNAV test and the 15 year retirement exemption did apply to the capital gain made by the Applicants on the sale of the shares in the Company in the 2007 income year. Before turning to the facts and analysis of the relevant provisions, it is important to state that the position of each Applicant must be considered separately. That is not to ignore that the statutory provisions require consideration, at various steps, of the fact that each Applicant is married to the other and each Applicant held shares in the Company. As will be demonstrated, the relevant sections on their proper construction and application determine the tax position of the individual taxpayer and it would be wrong to consider the position of each taxpayer without giving proper recognition of their individual position. In particular, it would be wrong to elide the distinction that must be maintained between each taxpayer and the Company in which each was a (minority) shareholder.

FACTS 10 The facts were agreed. 11 The Applicants are husband and wife. Before 12 December 2006, they together owned a total of 58.2% of the issued capital in the Company. In the 2007 income year, the Company had 1,000 ordinary issued shares. The shares carried the same voting, dividend and capital rights. Before 12 December 2006, Mr White owned 300 ordinary issued shares (or a 30% interest) in the Company and Mrs White owned 282 ordinary issued shares (or a 28.2% interest) in the Company. The remaining 41.8% interest in the Company was held by three entities, Rolloyd Enterprises Pty Ltd, June Curnow and Maxwell Curnow, none of whom were related to or connected with Mr White or Mrs White for the purposes of subdiv 152-B of the 1997 Act. 12 Mr and Mrs White each had one small business CGT affiliate for the purposes of subdiv 152-B of the 1997 Act - their respective spouse: see [20] below. The Company was an entity connected with each Applicant for the purposes of subdiv 152-B of the 1997 Act: see s 152-30 of the 1997 Act: see [21]-[22] below. 13 Pursuant to a contract of sale dated 12 December 2006, Mr and Mrs White both sold their shares in the Company. As a consequence of that sale, Mr White made a capital gain of $1,887,571 and Mrs White made a capital gain of $1,887,572. 14 The Applicants applied the 15 year retirement exemption in subdiv 152-B of the 1997 Act to each of their capital gains, reducing them to nil on the basis that s 152-10(1)(c) of the 1997 Act was satisfied (that is, that the MNAV test under s 152-15 of the 1997 Act was satisfied). In determining whether the Applicants satisfied the MNAV test, the Applicants included the value of their shareholding in the Company and otherwise excluded the net value of the assets of the Company. The Commissioner disallowed the 15 year retirement exemption on the basis that the Applicants failed the MNAV test. In reaching that decision, the Commissioner included the net value of the assets of the Company. 15 The net value of the Company's assets was such that if the value of those assets was included in calculating each Applicant's MNAV pursuant to s 152-15 of the 1997 Act, each Applicant's maximum net asset value would exceed $5 million. If the net value of the Company's assets was excluded from the MNAV test in s 152-15 of the 1997 Act, each Applicant would satisfy the $5 million MNAV test and be entitled to the 15 year retirement exemption contained in subdiv 152-B of the 1997 Act. 16 On 18 August 2010, the Commissioner issued amended notices of assessment for the 2007 income year. In making the amended assessments, the Commissioner applied the 50% discount under Div 115 of the 1997 Act. The net capital gain made by Mr White for the 2007 income year was assessed at $943,785, and his taxable income was assessed at $1,665,656. The net capital gain made by Mrs White for the 2007 income year was assessed at $943,786, and her taxable income was assessed at $1,656,027.

LEGISLATIVE FRAMEWORK 17 Section 152-10 of the 1997 Act provided that: (1) A *capital gain … you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain: … (c) you satisfy the maximum net asset value test (see section 152-15); … 18 For the purpose of determining whether the MNAV test was satisfied in the 2007 income year, the relevant operative statutory provisions were ss 152-15 and 152-20 of the 1997 Act, and the people or entities referred to were identified in ss 152-25 and 152-30 of the 1997 Act. 19 Section 152-15 of the 1997 Act provided that: You satisfy the maximum net asset value test if, just before the *CGT event, the sum of the following amounts does not exceed $5,000,000: (a) the *net value of the CGT assets of yours; (b) the net value of the CGT assets of any entities *connected with you; (c) the net value of the CGT assets of any *small business CGT affiliates of yours or entities connected with your small business CGT affiliates (not counting any assets already counted under paragraph (b)). (Emphasis added.) 20 A "small business CGT affiliate" was identified by s 152-25 of the 1997 Act. A taxpayer's spouse, child under 18 or a person who acts or could reasonably be expected to act in accordance with a taxpayer's directions or wishes or in concert with the taxpayer was a taxpayer's small business CGT affiliate. As noted at [12] above, each Applicant had one small business CGT affiliate - the other Applicant. 21 An "entit[y] connected with you" was identified by s 152-30 of the 1997 Act. Section 152-30(1) of the 1997 Act relevantly provided that an entity is connected with another entity if either entity controls the other entity in the way described in s 152-30(2). Section 152-30(2) of the 1997 Act relevantly provided that an entity (the first entity or person) controls another entity if its small business CGT affiliates or the first entity together with its small business CGT affiliates: … (b) if the other entity is a company - beneficially own, or have the right to acquire beneficial ownership of, shares in the company that carry between them the right to exercise, or control the exercise of, at least 40% (the control percentage) of the voting power in the company… … 22 The Applicants each had one relevant connected entity, the Company. The Company was "connected" to each of the Applicants because, between them, they owned enough shares to control it. In other words, each Applicant, together with his or her small business CGT affiliate (being the other Applicant), beneficially owned shares in the Company that carried between them the right to exercise, or control the exercise of, at least the control percentage of the voting power in the Company: see s 152-30(2)(b) of the 1997 Act. Each of the Applicants individually owned insufficient shares to control the Company in the required sense and the Company only became a "connected" entity of each of them because of the other. 23 Subsections (3) and (4) of s 152-20 of the 1997 Act applied in working out the net value of assets of an entity that was "connected" with each Applicant's spouse; that is, the Company. For the 2007 income year, ss 152-20(3) and (4) of the 1997 Act read as follows: Net value of the CGT assets of others (3) In working out the net value of the CGT assets of: (a) your *small business CGT affiliate; or (b) an entity that is *connected with your small business CGT affiliate; include only those assets that are used, or held ready for use, in the carrying on of a *business by you or another entity *connected with you (whether the business is carried on alone or jointly with others). (4) However, disregard assets under subsection (3) that are used, or held ready for use, in the carrying on of a *business by an entity that is *connected with you only because of your *small business CGT affiliate. Example: You and your husband sell a florist's business that you jointly carry on. Your husband also wholly owns a company that carries on a newsagency business. You yourself have no other involvement with the newsagency business. Under subsection (4), you disregard the newsagency company's assets in working out whether you satisfy the maximum net asset value test because, although the company is "connected" with you, it is so connected only because of your small business CGT affiliate (your husband). (Emphasis added.)

Section 152-15 24 At the relevant time, the MNAV test in s 152-15 of the 1997 Act (see [19] above) treated the small business, and all of its related entities, as a single economic unit. The market value of that unit was not to exceed the $5 million net asset threshold just before the CGT event: s 152-15. The section provided for the "sum" of certain items to be included in calculating the market value of that economic unit. If the sum of the net assets of the economic unit exceeded $5 million, the unit was not considered a small business and was ineligible for the small business concessions in Div 152 of the 1997 Act. 25 What then was included in that economic unit? Under s 152-15 of the 1997 Act, it could consist of the net value of the CGT assets of: 1. the taxpayer: s 152-15(a) of the 1997 Act; 2. one or more connected entities of the taxpayer (see [21] above): s 152-15(b) of the 1997 Act; 3. one or more small business CGT affiliates of the taxpayer (see [20] above): s 152-15(c) of the 1997 Act; and 4. one or more connected entities of the small business CGT affiliate or affiliates: s 152-15(c) of the 1997 Act. It is unnecessary to consider the issues raised in the context of a partnership. 26 In the present case, it was common ground that, for each Applicant, the MNAV test calculation would include the net value of the Applicant's own CGT assets under subs (a) of s 152-15 of the 1997 Act. 27 However, just before the CGT event (the sale of the shares in the Company), the Company was a connected entity of each Applicant: see [22] above. On a literal interpretation of s 152-15(b) of the 1997 Act, the net value of the assets of the Company would be included under s 152-15(b) of the 1997 Act. However, it was common ground that whether the net value of the assets of the Company (as a connected entity of each Applicant) was included under subs (b) was subject to the operation of s 152-15(c) and ss 152-20(3) and (4) of the 1997 Act. The Applicants contended that the net value of the assets of the Company was, by the operation of s 152-15(c) and ss 152-20(3) and (4) of the 1997 Act, excluded from both ss 152-15(b) and (c) of the 1997 Act. The Commissioner disagreed and included them in the calculation of the MNAV test. 28 To work out "the net value of the CGT assets of any *small business CGT affiliates of [the taxpayer] or entities connected with [the taxpayer's] small business CGT affiliates" under s 152-15(c) of the 1997 Act, it was necessary to have regard to ss 152-20(3) and (4) which excluded certain assets from the MNAV test.

Section 152-20(3) of the 1997 Act 29 Section 152-20(3)(a) of the 1997 Act relevantly provided that in working out the net value of the CGT assets of a small business CGT affiliate, only those assets that are used, or held ready for use, in the carrying on of a business by the taxpayer or "another entity" connected with the taxpayer were to be included. In the present case, the "small business CGT affiliate" was the spouse. Two questions arose - did the taxpayer carry on a business or did "another entity" connected with the taxpayer carry on a business. No relevant business was carried on by the Applicants. What about the other aspect - that in working out the net value of the CGT assets of the small business CGT affiliate (the spouse), the taxpayer only includes those assets that are used, or held ready for use, in the carrying on of a business by "another entity" connected with the taxpayer. 30 The phrase "another entity" also appeared in subpara (b) of s 152-20(3) of the Act. It provided that in working out the net value of the CGT assets of an entity that is connected with the taxpayer's small business CGT affiliate (in this case, the Company) include only those assets that are used, or held ready for use, in the carrying on of a business by the taxpayer or "another entity" connected with the taxpayer. Again, the carrying on of a business by the taxpayer can be put to one side. But what does the phrase "another entity" in s 152-30(3) refer to? 31 The Applicants submitted that the phase "another entity" in s 152-20(3) of the 1997 Act must refer to an entity other than an entity that is connected with the taxpayer's small business CGT affiliate. That is, an entity other than the entity referred to in s 152-20(3)(b). In other words, according to the Applicants, "an entity" under subpara (b) and "another entity" cannot be one and the same entity. 32 The Commissioner submitted to the contrary. He submitted that ss 152-20(3) and (4) of the 1997 Act should be read together as a composite provision and that those provisions had an underlying purpose to exclude from the MNAV test non-business assets and those business assets that are used in a business carried on by a taxpayer's small business CGT affiliate (for example, their spouse) independently of the taxpayer. Therefore, the Commissioner submitted, if the assets are used in a business jointly run by the taxpayer and the taxpayer's small business CGT affiliate, then those assets are to be included for the purposes of determining whether the taxpayer passes the MNAV test. 33 In support of the argument, the Commissioner referred to the legislative history of ss 152-20(3) and (4) of the 1997 Act. Section 152-20(3) of the 1997 Act originally read: In working out the net value of the CGT assets of an entity that is your *small business CGT affiliate, disregard assets of that entity that are not used, or held ready for use, in carrying on a *business that you, or an entity *connected with you, carry on (whether alone or jointly with others). (Emphasis added.) 34 In 2000, that provision was split into two - ss 152-20(3) and (4) - which read: (3) Subsection (4) applies in working out the net value of the CGT assets of an entity that is: (a) your *small business CGT affiliate; or (b) *connected with your small business CGT affiliate. (4) Disregard assets of that entity that are not used, or held ready for use, in the carrying on of a *business (whether alone or jointly with others) by: (a) you; or (b) an entity *connected with you (unless the connection with you is only because of your *small business CGT affiliate). (Emphasis added.) 35 In 2007, the provisions were amended to read as they do in [23] above by the Tax Laws Amendment (2006 Measures No 7) Act 2007 (Cth) (the Tax Laws Amendment Act). The Tax Laws Amendment Act commenced on 12 April 2007 and applied to CGT events happening in the 2006-2007 income years (and later income years): s 68 of the Tax Laws Amendment Act. That amendment was explained by the Explanatory Memorandum that accompanied the Tax Laws Amendment (2006 Measures No 7) Bill 2006 (Cth) (Explanatory Memorandum) at [1.32] as follows: When working out whether or not a taxpayer exceeds the $5 million net asset value test, the taxpayer takes into account assets of an entity connected with them that are used in the entity's business. However, the taxpayer does not take into account such assets if the entity is connected with the taxpayer just because another entity is the taxpayer's small business CGT affiliate. This amendment does not change the law; it rewrites the provisions to make them clearer. (Emphasis added.) 36 Paragraph 1.32 of the Explanatory Memorandum continued: This amendment addresses Recommendation 6.10 of the Board of Taxation report. Recommendation 6.10 of the Board of Taxation report, entitled A Post-implementation Review of the Quality and Effectiveness of the Small Business Capital Gains Tax Concessions in Division 152 of the Income Tax Assessment Act 1997: A Report to the Treasurer (The Board of Taxation, Canberra, October 2005) (the Report), provided that: Certain non-business assets held by a small business CGT affiliate or entity connected with the small business CGT affiliate are excluded from the maximum net asset value test of a taxpayer by operation of subsection 152-20(4). Subsection 152-20(4) is difficult to read and understand and should be amended to improve its readability. (Emphasis added.) It is apparent that the Explanatory Memorandum relates to the amendment to subs 152-20(4) of the 1997 Act, not subs 152-20(3). 37 The Commissioner submitted that s 152-20(3) of the 1997 Act did not operate to exclude the Company's assets in determining whether the Applicants each passed the MNAV test for the following reasons: 1. the expression "another entity" must be construed in a manner that promotes the underlying legislative purpose. Properly construed, "another entity" was a reference to an entity, other than the taxpayer, that was carrying on the relevant business in which the assets of the entity that is connected with the taxpayer's small business CGT affiliate are being used, or being held ready for use. This means that where the assets in question are those of an entity that is connected with both the taxpayer and the taxpayer's small business CGT affiliate, those assets that are being used, or being held ready for use, in the carrying on of that entity's business will be counted. 2. Section 152-20(3) of the 1997 Act in its original form referred to a business carried on by the taxpayer or "an entity" connected with the taxpayer. Section 152-20(4) of the 1997 Act, before the 2007 amendment, also referred to "an entity" connected with the taxpayer. As the Explanatory Memorandum makes plain, the 2007 amendment to ss 152-20(3) and (4) did not effect any change in the law. It merely rewrote the provisions to make them clearer: see [35] above. In light of this, "another entity" in s 152-20(3) of the 1997 Act should be construed to mean "an entity other than the taxpayer", and not "an entity other than the entity referred to in s 152-20(3)(b)". (This argument must be rejected at the outset as the Explanatory Memorandum does not assist in the interpretation of s 152-20(3) of the 1997 Act: see [36] above). 3. The Applicants' construction overlooks the situation where the assets in question are those of the taxpayer's small business CGT affiliate, not those of an entity connected with the small business CGT affiliate. In that situation, there will be no other subpara (b) entity. The phrase "another entity" must be given a construction that is operable irrespective of whether one is working out the net value of assets of the taxpayer's small business CGT affiliate or an entity that is connected with the taxpayer's small business CGT affiliate, which the Commissioner's construction does. 4. The example given beneath s 152-20 of the 1997 Act contemplates that "another entity" and a subpara (b) entity are one and the same entity, the company that carries on the newsagency business. 38 As in any statutory interpretation case, one begins with the plain language before moving to considerations of context, purpose and legislative history: Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355. 39 Under s 152-20(3) of the 1997 Act (as in force at the relevant time), the net value of the CGT assets of the Company (being an entity connected with each Applicant's small business CGT affiliate - see [20]-[22] above) was limited to the net value of those of the Company's assets that were used, or held ready for use, in the carrying on of a business by: 1. the Applicant's spouse (first limb); or 2. an entity connected with the Applicant's spouse (second limb). 40 In the present case, the Company's assets were not used or held ready for use by either Applicant in carrying on a business by the Applicant, and accordingly the first limb of the MNAV test is not engaged. 41 In relation to the second limb of the MNAV test, it is necessary to work out the net value of the CGT assets of the Company (being an entity connected with each Applicant's spouse). However, the second limb was subject to the qualification at the end of the paragraph. That qualification provided that only those assets used (or held ready for use) in the carrying on a business by the taxpayer or another entity connected with the taxpayer were to be included. In the present case, the Applicants submitted that there was not another entity, only the Company, and therefore the net value of the CGT assets of the Company were not to be included. I reject that contention. The section must be read as a whole and in context. The phrase "another entity" appeared in the qualification that the net value of the CGT assets of the Company were only to be included if those assets are used, or held ready for use, in the carrying on of a business by the taxpayer (not the present case) or "another entity connected with [the taxpayer] (whether the business is carried on alone or jointly with others)". The intention of the legislature was to expand the economic unit to include those assets of the small business CGT affiliate or an entity associated with the small business CGT affiliate (here, the Company) only where the assets are used (or held ready for use) in the carrying on of a business by the taxpayer or entity connected with the taxpayer. In the present case, the assets of the Company were used in the carrying on of a business by an entity connected with each Applicant - the Company. That result is not surprising. Indeed, it would, on any view, be an absurd result if the economic unit excluded the net value of the assets of the Company. Such a result would be contrary to the legislative purpose of the subdivision.

Section 152-20(4) of the 1997 Act 42 It is then necessary to consider s 152-20(4) of the 1997 Act. 43 Section 152-20(4) of the 1997 Act required that assets which would otherwise be included in the calculation of net value of CGT assets under subs (3) be disregarded if those assets were "used, or held ready for use, in the carrying on of a *business by an entity that is *connected with you only because of your *small business CGT affiliate" (emphasis added). 44 The Commissioner submitted that each Applicant controlled, and was "connected" with, the Company by reason of their beneficial ownership of the shares in the Company. That is, absent one Applicant's shareholding, there would have been no control of, and therefore no connection with, the Company. Therefore, the Commissioner submitted, the Company was not connected with one Applicant "only because of", or solely by reason of, the other Applicant's ownership of shares in the Company. 45 The Applicants submitted to the contrary. They submitted that the phrase "only because" imported a "but for" test: but for the Applicant's small business CGT affiliate owning a 28.2% or 30% (as the case may be) interest in the Company, the Company would not have been connected with the Applicant. 46 The section focuses on the fact or facts which gave rise to the "connection". Here, the connection (between the Company and the Applicant under consideration) arose only because of the relationship between that Applicant and that Applicant's spouse. Or to put the same point another way, the Applicant under consideration was connected with the Company only because his or her spouse had a shareholding which together with the Applicant's shareholding exceeded the 40% threshold prescribed by s 152-30. But for that circumstance, that taxpayer was not connected with the Company: see [21]-[22] above. 47 Accordingly, the net value of the assets of the Company are to be disregarded under s 152-20(4) and each Applicant was correct to not include the Company's net assets in their MNAV test calculation.

ORDERS 48 For those reasons, I consider that each Applicant satisfied the MNAV test and that the 15 year retirement exemption applied to the capital gain each Applicant made on the sale of the shares in the Company in the 2007 income year. 49 The parties will be directed to bring in orders to give effect to these reasons for judgment by 4:00pm on 27 February 2012. I certify that the preceding forty-nine (49) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gordon.

Measures No 7) Act 2007(Cth)

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