Capital gains tax update 2008-09 income year

Case update

ConnectEast Management Ltd v Commissioner of Taxation [2009] FCAFC 22 - this case was an appeal against the decision of Heerey J in ConnectEast Management Ltd v FCT [2008] FCA 557 which confirmed the Commissioner's decision that the Subsidiary Trust did not acquire the status of a 'listed widely held trust' pursuant to section 272-127 in Schedule 2F to the ITAA 1936.

Facts: The taxpayer (appellant) is the trustee of the ConnectEast Investment Trust (No 2) (the Subsidiary Trust). Units in the Subsidiary Trust are held by two other trusts of which the appellant is also trustee: ConnectEast Holding Trust and ConnectEast Investment Trust. The three trusts, together with other trusts and companies, form the ConnectEast Group.

The dispute arose from the application of the rules relating to carry forward losses by trusts, in particular the application of section 272-127 in Schedule 2F to the ITAA 1936. The taxpayer (an unlisted widely held trust) sought to obtain the status of a listed widely held trust under section 272-127 to obtain the more favourable tax treatment applicable to widely held trusts in relation to carry forward of losses.

At first instance, Heerey J decided in favour of the Commissioner that section 272-127 did not operate as argued by the taxpayer.

Decision: The Full Federal Court upheld the decision of Heerey J and dismissed the taxpayer's appeal.

Date of decision: 5 March 2009

Undershaft No. 1 Ltd v FC of T; Undershaft No. 2 BV v FC of T [2009] FCA 941 – these cases involved appeals (heard together) against the Commissioner's objection decisions to include capital gains made in the 2001 income year as assessable income.

The issue before the Court was whether the business profits articles in Australia's DTAs with the UK (in relation to Undershaft No.1 Ltd) and the Netherlands (in relation to Undershaft No.2 BV) covered capital gains made by the two non-resident entities, therefore denying taxing rights to Australia.

Facts: Undershaft No. 1 (first applicant) was a resident of the United Kingdom and was not a resident of Australia for all relevant purposes. Undershaft No. 2 (second applicant) was a resident of the Netherlands and was not a resident of Australia for all relevant purposes.

The UK DTA was signed in 1967 (pre-CGT) but was replaced by a new DTA in 2003. [The new DTA is not relevant because the capital gain in question was made in the 2001 income year]. The Netherlands DTA was signed in 1976 (pre-CGT).

Decision: Lindgren J held that Article 5 (the 'business profits' article) of the UK DTA applied as the taxes covered by the DTA included the tax imposed under the CGT regime in former Part IIIA of the ITAA 1936. It formed part of 'the Commonwealth income tax' or alternatively it was 'substantially similar' to 'the Commonwealth income tax' or either of the UK taxes referred to in the UK DTA and was therefore covered by the UK DTA. Therefore, the capital gain is exempt from Australian tax pursuant to Article 5 of the UK DTA.

Lindgren J found that Article 7 of the Netherlands DTA denied Australia the right to tax the capital gain made by the second applicant because the Australian tax on capital gains is a tax covered by the Netherlands DTA. Lindgren J concluded that the Taxes Covered Article of the Netherlands DTA was similar to that of the UK DTA and that there was no substantial difference between the expressions 'the Commonwealth income tax' in the UK DTA and 'the Australian income tax' in the Netherlands DTA. In his reasoning, Lindgren J commented that if capital gains been taxed in Australia by means of an independent and self-contained tax rather than being encompassed within the tax base of the income tax, it would not have been an existing tax for the purposes of the Taxes Covered Article (Article 2(1)) of the DTA.

Consequently, the capital gain made by the second applicant is subject to the provisions of the Netherlands DTA pursuant to Article 2(1)(a), and is exempt from Australian tax pursuant to Article 7.

Lindgren J's decision in these cases is consistent with the decision of Edmonds J in Virgin Holdings SA v. Commissioner of Taxation ATC20-051; [2008] FCA 1503.

Date of decision: 3 February 2009

Couch and Commissioner of Taxation [2009] AATA 41 – this case was an application to the Administrative Appeals Tribunal (AAT) for review of the decision by the Commissioner to disallow the taxpayers' objection to the ruling which stated that the capital gain made from the disposal of the taxpayers' unit was subject to CGT and that the taxpayers were not entitled to the main residence exemption.

The issue before the AAT was whether the taxpayers (husband and wife) could disregard, pursuant to section 118-110 of the ITAA 1997, the capital gain they made from the disposal of their unit because it was considered to be their main residence for the entire ownership period.

Facts: The taxpayers acquired a unit in South Australia in June 2000 with the intention of using it as their matrimonial home. They contended that, because of employment interstate, it only became practicable for them to reside in the unit when they returned to Adelaide in January 2006 but at that time, the unit was still tenanted. They subsequently decided that the unit would not be suitable as a family home and, in December 2006, they sold the unit which had been leased out for the entire period of their ownership.

Decision: The AAT held that section 118-110 did not apply in respect of the disposal of the unit because the conditions in that section were not satisfied, and affirmed the Commissioner's objection decision.

In the opinion of the AAT, something that is only an intention by a taxpayer to occupy a property as a main residence is insufficient to give rise to the main residence exemption in section 118-110. That section contemplates that a dwelling will be occupied as a main residence throughout the ownership period, subject to the extension provisions in section 118-135. The taxpayers did not reside in the unit at any stage during the ownership period and, although they contended that this was for reasons beyond their control, the AAT held that the circumstances that prevented them from moving into the unit were not sufficient to enable the application of section 118-135.

Date of decision: 22 January 2009

Estate of Mr Cawthen (Deceased) and Commissioner of Taxation [2008] AATA 1168 – this case involved an application for review of the Commissioner's decision that the capital gain derived by the trustees of the estate of Mr Cawthen (deceased) from the disposal of an interest in a dwelling could not be disregarded under the main residence exemption provisions.

The AAT had to decide whether the main residence exemption in subsection 118-195(1) of the ITAA 1997 required that the interest disposed of by the trustees be the same interest that the deceased had in the dwelling.

Facts: The deceased acquired an ownership interest in the dwelling when the family company which he owned in equal shares with his wife granted him a right to occupy the dwelling. The company had purchased the house in 1969 and adjacent block of land in 1971. The dwelling was the main residence of the deceased from 1969 until his death in 1987. His estate included his 50% shareholding in the company. This company was liquidated in 1992 and a 50% interest in the land was distributed to the trustees of his estate.

Decision: The AAT confirmed that subsection 118-195(1) is not satisfied if the interest disposed of by the trustees of a deceased estate is not the same interest that the deceased had in the dwelling. As there was no continuity of the interest in the dwelling in this case, subsection 118-195(1) did not apply to exclude any capital gain by the trustees on disposal of their interest in the dwelling and the objection decision under review was confirmed.

The AAT observed that, because the deceased never had legal title to the dwelling, the former subsection 160ZZQ(15) of the ITAA 1936 would not have been satisfied and the principal residence exemption would not have applied.

Date of decision: 24 December 2008

National Mutual Life Association of Australia Limited v Commissioner of Taxation 2008 [FCA] 1871 – this case involved the interpretation of the former subsection 160ZH(3) of the ITAA 1936 to determine the reduced cost base of shares disposed of by National Mutual Life Association of Australasia Limited (National Mutual) in its wholly owned UK subsidiary, NM UK Limited (NMUK).

Facts: On 5 December 1993, National Mutual (the taxpayer) made a loss from the sale of shares held in its wholly owned UK subsidiary NMUK. The amount of the capital loss the taxpayer could claim for CGT purposes depended on whether its capital contribution of [sterling]42.912 million, formed part of the reduced cost base of the shares under paragraph 160ZH(3)(c) of the ITAA 1936.

Under paragraph 160ZH(3)(c), the reduced cost base included 'the reduced amount of any expenditure of a capital nature incurred by the taxpayer to the extent to which it was incurred for the purpose of enhancing the value of the asset and is reflected in the state or nature of the asset at the time of disposal of the asset'.

The parties agreed that the capital expenditure added value to the NMUK shares. The issue for determination is whether the capital contribution, at the time of disposal, was 'reflected in the state or nature' of the shares the taxpayer held in NMUK for the purposes of paragraph 160ZH(3)(c).

Decision: The Federal Court held that a capital contribution made by National Mutual to the shareholders’ funds of NMSAL, a wholly owned subsidiary of NMUK was not 'reflected in the state or nature' of the shares the taxpayer (National Mutual) held in NMUK for the purposes of subsection 160ZH(3).

Middleton J observed that the payment of the capital contribution to NMSAL was made for the purpose of, and had the effect of, increasing the embedded value of NMSAL and the embedded value of NMUK, and thus the value of the shares in NMUK. However, Middleton J rejected the notion that value forms any part of the nature or state of a share.

Date of decision: 10 December 2008

Notes:

1. TD 2004/2 states the ATO view on the issue considered in this case.
2. This issue does not arise under the current law. Subsection 110-25(5) about fourth element cost base (and therefore reduced cost base under subsection 110-55(2)) was amended, with effect for CGT events happening on or after 1 July 2005, to remove the requirement for the expenditure to be reflected in the state or nature of the asset at the time of the CGT event.

Handbury Holdings Pty Ltd v FC of T [2008] FCA 1787 – this case is an appeal against the decision of the Commissioner of Taxation to disallow in full an objection by Handbury Holdings Pty Ltd (the taxpayer) to an assessment to income tax in respect of the year ended 30 June 2005.

The issue before the Federal Court was the interpretation of a provision in Division 711 of the ITAA 1997, which is about the tax cost setting amount for membership interests for subsidiaries leaving consolidated groups. The correct construction of the phrase 'at the leaving time' in subsection 711-45(1) affects the calculation of capital gains made by the taxpayer on the sale of issued shares in the subsidiary. CGT event L5 under section 104-520 happens if, in working out the group's allocable cost amount for a subsidiary member leaving a consolidated group, the amount remaining after applying step 4 of the table in section 711-20 is negative.

Decision: The Federal Court stated that what was intended by the word 'at' in subsection 711-45(1) depended on the context in which it was used, including the subject matter and the legislative objects and principles. Subsection 711-5(3) expressly states that the object in subsection 711-5(2) was to be achieved 'by recognising the head company's cost for those interests, just before the leaving time' as equalling 'the cost of the leaving entity’s assets at the leaving time' reduced by its liabilities. In this context, the phrases 'just before the leaving time' and 'at the leaving time' were intended to refer to essentially the same time.

The Federal Court held that 'a liability of the leaving entity at the leaving time' in subsection 711-45(1) included liabilities of the subsidiary just before the leaving time.

Date of decision: 28 November 2008

Virgin Holdings SA v FCT 2008] FCA 1503 – this case involved an amended assessment for the 2004 income year in which the Commissioner sought to include a net capital gain. The issue was whether Australia's double tax agreements (DTA), concluded prior to the time Australia taxed capital gains on a comprehensive basis, deny Australia the right to tax the capital gains of enterprises of the other State under Australia's capital gains regime in circumstances where Australia is denied the right to tax the business profits of enterprises of the other State.

The Commissioner argued, in accordance with TR 2001/12, that 'Australian income tax' to which the Australian-Switzerland DTA applied did not include capital gains taxes as the DTA pre-dated the introduction of the Australian CGT. Therefore, the Commissioner contended that the relevant articles in the DTA that denied Australian taxing rights were not applicable, and that Australian CGT provisions could apply to tax the capital gain.

Decision: Edmonds J, sitting as a single judge of the Federal Court held that the term 'Australian income tax' as defined in the article 2(1)(a) of the Australia/Switzerland DTA ('the Swiss agreement') 'accommodated and encompassed, at the time of the conclusion of the Swiss Agreement, the taxation of capital gains'. (The Swiss agreement was entered into in 1980, before the introduction of Part IIIA into the ITAA 1936 which included net capital gains in assessable income.) This meant that the relevant article in the Swiss agreement operated to distribute taxing rights over the capital gain with the result, in this case that Australia did not have the right to tax the capital gain made by a Swiss resident.

Further, although it was not necessary to decide the point on appeal, Edmonds J considered that if the tax on capital gains was not encompassed within 'the Australian income tax', it was a 'substantially similar tax' to 'the Australian income tax' in terms of Article 2(2) of the Swiss treaty.

In allowing the taxpayer's appeal, the Federal Court has ruled on a significant CGT issue that has awaited judicial clarification for many years.

Date of decision: 10 October 2008

Metlife Insurance Ltd v Commissioner of Taxation [2008] FCAFC 167 – this case was an appeal against the decision in Metlife Insurance Ltd v FCT [2008] FCA 568 regarding the Commissioner's power to amend an assessment at 'any time' under section 170(10AA) of the ITAA 1936.

Facts: The taxpayer was an insurance company that sold its business under a contract entered into on 19 July 2000 and which was settled on 21 January 2001. The taxpayer returned a capital gain of over $28m for the income year in which the contract was made. Under the self-assessment regime, the assessment was deemed to have been made when the company lodged its tax return on 16 July 2001. However, more than 4 years later, the Commissioner exercised his power under section 170(10AA) of the ITAA 1936 to issue an amended assessment to also include an additional $12m capital gain attributable to the sale of policy rights occurring under the sale.

The taxpayer argued that the Commissioner's power to amend an assessment under section 170(10AA) at any time 'to give effect' to the relevant taxing provision listed in the section (including CGT event A1) could only apply if the subsequent event that gave rise to the need for the amendment occurs after the original assessment is made. In this case, the taxpayer argued that there was no such event as the relevant 'matrix of facts' which gave rise to the additional capital gain occurred before the assessment was made. In particular, the taxpayer contended that in the case of CGT event A1, the power to amend under section 170(10AA) was intended to be exercised only when settlement of the contract occurs more than four years after entering it.

Decision: The Full Federal Court unanimously allowed the taxpayer's appeal and essentially agreed with the taxpayer that the Commissioner's unlimited power to amend under s 170(10AA) for the purpose of 'giving effect' to the taxing provisions listed in that section was limited to the situation where the event that gave rise to the need for the amendment occurred after the original assessment was made. In arriving at its conclusion, the Full Court noted the following matters.

For the purpose of giving effect to

First, the issue in this case turned on the meaning of the phrase 'for the purpose of giving effect to' the taxing provisions listed in s 170(10AA). In this regard, the timing provisions in CGT event A1 had already operated to include the capital gain in the income year in which the contract was made. As a result, to seek an amendment of the assessment under s 170(10AA) to include the capital gain from the insurance policies would be doing more than giving effect to CGT event A1, the Court said.

No new facts after the assessment

Secondly, the purpose of s 170(10AA) was to allow the Commissioner to amend an original assessment when a new fact occurs after that assessment and where certain provisions of the tax law would be frustrated if the Commissioner were not able to take these new facts into account by so amending the original assessment. However, this was not the case here, as the new facts did not arise after the assessment. Moreover, they were matters that could have been dealt with in the original assessment. As a result, the Court said the Commissioner could not use the powers in s 170(10AA) to correct his oversight in the treatment of the insurance policy proceeds.

No mischief arises

Thirdly, in situations where the settlement occurs before the making of the assessment, s 170(10AA) will generally have no work to do because the timing provisions in CGT event A1 will have already operated to assess the gain in the original assessment. In other words, in the Court's view, where an assessment is made at a time when all relevant events have occurred, no mischief arises and no amendment under s 170(10AA) is needed to 'give effect to' the retrospective consequences of the subsequent facts.

The Full Court held that the Commissioner could not rely on section 170(10AA) to amend the original assessment for the purpose of giving effect to CGT event A1 as no new facts had arisen after the making of the original assessment that needed to be accounted for.

Date of decision: 3 October 2008

AAT Case [2008] AATA 890, Re Bottazzi and FCT – this case was an application for review of the Commissioner's decision to disallow the taxpayer's objection to an amended assessment for the year ended 30 June 1998, which included a capital gain of $178,867 plus a penalty of 75% of the tax shortfall.

Facts: The capital gain arose from the sale of a residential property in March 1998. The property was transferred from a long time friend, Mr Scharkosi, into the taxpayer's name during renegotiation of a bank loan to pay for it.

The taxpayer's primary contention was that the property was at all times held in trust for Mr Scharkosi who was the beneficial owner. The taxpayer also submitted three alternative contentions as follows:

• the cost base of the property should include $50,000 of improvements
• the acquisition of the property was not at arm's length and therefore the cost base of the property should be the market value of $260,000 assessed at the time of securing the bank loan, or
• the amended assessment was invalid because it was issued more than 4 years after the original assessment was due and payable.

Decision: The Tribunal found that there was no documentary evidence of any express or implied trust supporting the taxpayer's primary contention. It noted that the taxpayer had included rental income from the property and had claimed deductions relating to the property for the 1996 and 1997 income years.

The Tribunal also found that there was no evidence of either the cost of any improvements or the date on which they were made. It further found that there was no evidence that the transfer of the property was made on a non-arm's length basis. While the Tribunal acknowledged that the amended assessment was issued more than four years after the original assessment, it noted that the Commissioner may amend an assessment at any time if there had been an avoidance of tax due to fraud or evasion. The Tribunal, on balance, was satisfied that there was an avoidance of tax due to evasion and therefore the amended assessment was valid.

In conclusion, the Tribunal affirmed the Commissioner's decision on the inclusion of a $178,867 capital gain from the sale of the property as assessable income of the taxpayer. However, it reduced the additional tax penalty from 75% to 25% of the tax shortfall because the taxpayer was not legally represented at the hearing.

Date of decision: 6 October 2008

Kafataris v DCT [2008] FCA 1454 – in this case, the Federal Court was required to determine whether the exception to CGT event E1 in section 104-55 of the ITAA 1997 for a sole beneficiary of a trust who is absolutely entitled to as against the trustee applied.

Facts: A husband and wife had jointly purchased a commercial property in 1987 for $612,000. In 2002, they each executed identical trust deeds over their respective interests in the property for the purpose of establishing superannuation funds for themselves.

The taxpayers argued that no CGT event happened when the trust over the asset was created because the sole beneficiary exception applied.

Decision: The Federal Court confirmed that CGT event E1 applied to the creation of the trusts. The Court found that under the terms of each trust deed, neither taxpayer was the sole beneficiary of the trust nor absolutely entitled to the trust asset (that is, the interest in the property) as against the trustee. Accordingly, the exception to CGT event E1 did not apply to the creation of the trusts.

To establish 'absolute entitlement', the Court held that a beneficiary must have had a vested, indefeasible and absolute entitlement in trust property and be entitled to require the trustee to deal with the trust property as they direct. The Court found that neither taxpayer could establish 'absolute entitlement' because the deeds gave the trustees a power of sale over the trust property, which meant that the interest of each taxpayer in the trust asset was defeasible. The Court noted that the only entitlement which either taxpayer had was to require the trustee to pay a benefit once the conditions of entitlement were satisfied.

Date of decision: 19 September 2008

Davies v Commissioner of Taxation [2009] AATA 297 - the husband and wife taxpayers (applicants) in this case sought a review of objection decisions relating to assessments that denied them the small business retirement exemption in Subdivision 152-D of the ITAA 1997.

Facts: The taxpayers were both beneficiaries of family trusts that owned adjoining farming properties. The taxpayers were also the directors of the nominee company that is the trustee of the trusts. Both taxpayers worked on the farms owned by the trusts until the sale of the properties. There was no written contract of employment, the taxpayers did not receive a regular wage and the trustee did not take out any worker’s compensation insurance or make any PAYG income tax or superannuation payments on the taxpayers’ behalf.

The trustee of the trusts sold the farming properties in March 2004 and both trusts made capital gains which were distributed to the taxpayers as beneficiaries. In April 2005, the taxpayers personally signed elections to apply the small business retirement exemption provisions in Subdivision 152-D to the capital gains from the sale of the land, contending that an implied contract of employment existed between the trustee of the trusts and themselves.

The issue before the AAT was whether the conditions in Subdivision 152-D were satisfied, in particular, whether the requirements for the trusts to have chosen to disregard the capital gain and to have made eligible termination payments to the taxpayers had been satisfied.

Decision: The AAT affirmed the Commissioner's decision under review and dismissed the taxpayers' appeal. Because the capital gain was made by the trustee of the trust, it was the trustee that was required to make the election. There was no evidence to show that the trustee of the trust chose to disregard the capital gain. The taxpayers personally signed the election to apply the exemption. There was no evidence that the trustee of the trusts paid eligible termination payments to the taxpayers pursuant to subsection 153-305(2) of the ITAA 1997, that the taxpayers were ever employees of the trustee or that an implied employment contract existed. The taxpayers failed to discharge their onus to show that they were entitled to the exemption and the conditions for the exemption were not satisfied.

Date of decision: 20 March 2009

AAT Case [2008] AATA 519 Lean v FCT – this case involved an application for review by the Administrative Appeals Tribunal (AAT) of the Commissioner's decision to disallow the taxpayer's objection against the Commissioner's previous decision disallowing the taxpayer's claim for deductions against their US share sale profits for the trading loss of $1.36m and a loss of $3.28m for misappropriations by the investment fund manager in their Hong Kong operations.

Facts: In July and August 2001, the taxpayer had his US stockbrokers transfer two sums totalling about $4.63m to a Hong Kong bank nominated by Mr Heffernan who the taxpayer believed was a reputable securities trader and investment manager. In early 2002, the taxpayer was repaid $150,000. By June 2002 the only documentary evidence the taxpayer had of any trading or investment relating to his funds was a 'margin deposit statement' which recorded trading losses of AUD$1,367,566 on the Hong Kong Futures Exchange in September 2001. The taxpayer concluded the balance of his funds had been used by Heffernan to operate a ponzi scheme and was irrecoverable. He has not since recovered any more of his original $4.63m.

The taxpayer in his 2002 return claimed deductions including the trading loss of $1,367,566 and the misappropriation by Heffernan of $3,287,749. The Commissioner disallowed the claimed deductions in the 12 May 2006 Notice of Assessment. The taxpayer objected. On 28 August 2006, the Commissioner confirmed the basis of the disallowance as follows:

• the misappropriation loss was not deductible under section 8-1 of the ITAA 1997
• alternatively, even if the misappropriation loss was otherwise deductible under section 8-1, it and the trading losses (the disallowance of trading losses had not been challenged in the Objection) were only deductible to the extent of any foreign assessable income because of section 79D of the ITAA 1936.

Before the AAT, the taxpayer relied on four contentions to support his deduction for the Hong Kong losses:

• the alleged $1.367m trading loss and the misappropriation loss were each deductible under the general deduction provisions in section 8-1 of the ITAA 1997 and gave rise to a total deduction of $4.63m
• alternatively, the $4.63m loss (again including its two separate components) was a loss that arose from carrying on a profit-making undertaking and was deductible under section 25-40 of the ITAA 1997
• alternatively, the misappropriation loss was 'caused by theft or misappropriation' by an agent and was deductible under section 25-45 of the ITAA 1997, to the extent of $2.8m - the latter being the amount of the assessable income to which it related
• the US share sale profits were foreign income and any loss was a foreign loss, consequently section 79D of the ITAA 1936 did not preclude deduction of the $2.8m loss under section 25-45 of the ITAA 1997, and the balance of the loss was a general deduction that could be carried forward to subsequent income years.

Decision: The AAT concluded that the taxpayer was entitled to a deduction for only part of $4.63m (e.g. over $2.3m) under section 25-45 of the ITAA 1997 for the misappropriation by his agent of the profit from the sale of his US shares (see paragraph 80, page 35 of the reasons for decision). The proceeds from the sale had been transferred to the taxpayer's agent in Hong Kong for re-investment and had not been recovered. In arriving at its decision, the AAT first found that the party was in fact an agent of the taxpayer, that the funds had been misappropriated and that the profits were of a capital nature that had been previously returned as a capital gain. Accordingly, it concluded that the taxpayer was entitled to a deduction under section 25-45 for 'a loss in respect of money' caused by 'misappropriation' by an agent. It also found that the limitations on deductions for foreign losses under section 79D of the ITAA 1936 did not apply to limit a deduction that is allowed under section 25-45.

The AAT also concluded that the taxpayer did not incur any trading losses as stated in the 'margin deposit statement'; instead the taxpayer's money was simply misappropriated.

Date of decision: 20 June 2008

Commissioner of Taxation v Lean [2009] FCA 490 - This was an appeal from a decision in AAT Case [2008] AATA 519 Lean v FCT as discussed above. From that AAT decision, the Commissioner appealed to the Federal Court, raising the following three questions of law:

• whether the proceeds of sale of a capital item can be included in a taxpayer's assessable income for the purposes of section 25-45 on the basis that a taxpayer's assessable income includes the taxpayer's net capital gain, and the net capital gain is worked out by reference to the proceeds of sale of the capital item;
• whether it was sufficient for a taxpayer to establish that a loss caused by misappropriation by the taxpayer's agent could be traced to money that had been included in the taxpayer's assessable income; and
• whether the taxpayer must establish that, at the time of the relevant misappropriation, the money had retained its character as assessable income.

Decision: The Federal Court allowed the appeal. The Court held that:

• If certain money was properly included in the taxpayer's assessable income, whether it was derived as "income" per se or as a "capital gain" was not relevant. Section 25-45 did not require that the money be acquired as income, only that it be included in assessable income.
• The subsequent point of transition from characterisation as "money included in assessable income" to characterisation as capital funds may be difficult to determine. However, once money received as income was deployed by the taxpayer for expenditure or investment, the characterisation as income was no longer appropriate and the loss could not be said to have been incurred in respect of the money included in assessable income.
• It was necessary but not sufficient for a taxpayer to establish that a loss caused by misappropriation by the taxpayer's agent could be traced to money that had been included in the taxpayer's assessable income. The characterisation must remain the same. In this case, once the stockbroker, acting on the taxpayer's instructions, transferred the share sale proceeds to Heffernan for the purpose of investment, the characterisation of the money as income was inappropriate and the loss could not be described as in respect of money that was included in his assessable income. The AAT erred in failing to recognise this requirement of section 25-45.

Date of decision: 14 May 2009

Commissioner of Taxation v Futuris Corporation Limited [2008] HCA 32 – this case involved the Commissioner's appeal to the High Court of the Full Federal Court decision in Futuris Corporation Ltd v Commissioner of Taxation [2007] FCAFC 93 The Commissioner is successful on the appeal.

The High Court has unanimously upheld the Commissioner's appeal from the decision of the Full Federal Court. In that case, the Full Federal Court exercised its powers under subsection 39B(1) of the Judiciary Act 1903 to declare that a Part IVA amendment assessment issued to the taxpayer was invalid because the Commissioner had deliberately included a capital gain of $20m that had already been included in the taxpayer's assessable income under the value shifting provisions.

In short, the Full Court ruled that the assessment did not involve a bona-fide exercise of the Commissioner's power to assess, despite the Commissioner's stated intention to exercise his powers under subsection 177F(3) of the ITAA 1936 to amend the assessment to exclude one of the amounts once the value shifting issue had been decided on appeal. In this regard, the Full Court decided that subsection 177F(3) could not be used in this manner to eliminate the double counting.

However, the High Court ruled that the Full Court had erred in exercising its powers under section 39B to declare the assessment invalid. This was because the manner in which the assessment was issued did not amount to a deliberate failure to comply with the provisions of the tax law in terms of section 175 of the ITAA 1936. Furthermore, the High Court held that if the Commissioner had erred in exercising his powers, it was not the kind of error that warranted invalidating the assessment on the grounds of 'bad faith' i.e. it was not an error of conscious maladministration or corruption on the part of the Commissioner.

The High Court also held that the more appropriate manner for determining the double counting issue, and the question of the Commissioner exercising his powers under subsection 177(3), was the appeals and review process under Part IVC of the Taxation Administration Act 1953 (which remains pending). The High Court also indicated that the Commissioner's intention to use subsection 177F(3) to eliminate the double counting pointed against any lack of 'bona-fides' on his behalf.

Date of decision: 31 July 2008