NQZG v FC of T

Members:
L Hespe SM

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2020] AATA 379

Decision date: 2 March 2020

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L Hespe (Senior Member)

1. The Applicant has sought review of the decisions of the Respondent, (" the Commissioner ") denying his objections against income tax assessments for the years of income ended 30 June 2014, 30 June 2015, and 30 June 2016.

2. The issue in dispute concerns the character of an amount received by the Applicant, described in a Share Purchase Agreement (" SPA ") as a "Founders Retention Amount" (" FRA "). The Applicant self-assessed on the basis that the FRA was included in his assessable income outside of Part 3-1 of the Income Tax Assessment Act 1997 ("the 1997 Act"). The Applicant objected and contends that the amount is not assessable as ordinary or statutory income outside of Part 3-1 of the 1997 Act, but is required to be included in calculating any capital gain he made on the disposal of his shares for the purposes of that Part.

3. At the hearing, it appeared to be agreed by the parties that if the FRA was not otherwise included in the Applicant's assessable income, the FRA was required to be taken into account in calculating the capital gain made by the Applicant, in respect of the disposal of his shares in UPL. The issue in dispute is whether the FRA received by the Applicant is required to be included in the Applicant's assessable income outside of Part 3-1. If the FRA is so assessable, any capital gain made by the Applicant on the disposal of his shares is reduced under s 118-20 of the 1997 Act. Furthermore, the Commissioner did not seek to rely upon s 15-2 of the 1997 Act, and the parties confined their submissions to s 6-5.

FACTS

4. The background facts were not the subject of any real dispute.

5. The Applicant was one of two founders and initial shareholders of UPL. The other founder and initial shareholder was JH.

6. UPL conducted a business of providing mobile financial services software. UPL also owned 49% of the shares in UA. The remaining

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ATC 8550

51% of the shares in UA were owned by ASI, a company unrelated to UPL.

7. Pursuant to a SPA dated 12 September 2013, ADL, a subsidiary in the A group, agreed to acquire all the shares in UPL. At that time, the shareholders of UPL were: the Applicant (as to 46.975%), JH (as to 46.975%) and three other shareholders (owning 6.05% between them). ADL was not related to UPL or any of UPL's shareholders.

Background to the share sale

8. In January 2013, a representative of the A group contacted the Applicant and expressed interest in exploring a strategic relationship with UPL.

9. In February 2013, the Applicant and JH made a presentation over the telephone to representatives of ADL about the history and business of UPL. About a week after that presentation, the Applicant and JH agreed to meet with A group representatives in Singapore for the purpose of ADL undertaking a preliminary due diligence, with a view to a subsidiary of the A group potentially acquiring UPL.

10. In March 2013, the Applicant and JH met with A group representatives in Singapore. Subsequently, a representative from the A group invited the Applicant and JH to further discussions at ADL's headquarters in Israel.

11. In April 2013, the Applicant and JH met with representatives of the A group in Israel. The A group's representatives indicated that the A group was willing to pay USD 21 million to acquire the shares in UPL. The Applicant and JH did not accept this proposal. JH left Israel and returned to Singapore on or around 18 April 2013. The Applicant stayed in Israel and continued to have discussions with representatives of the A group. The Applicant left Israel on 21 April 2013. No agreement with any member of the A group had been reached at that time.

12. A couple of weeks later, a representative from the A group invited the Applicant and JH to meet A group's representatives in Bangkok.

13. In May 2013, the Applicant and JH met with A group's representatives in Bangkok. The A group presented a revised proposal which included total consideration to be paid by the A group of between USD 30 million and USD 30.2 million (some of which would be paid on completion and some of which would be deferred. Part of the amount would also be subject to the performance of UPL's business).

14. At the end of the meeting, the Applicant and JH were provided with a letter of intent ("LOI"). The LOI was dated 26 May 2013 but was signed by the Applicant and JH on 28 May 2013. Relevantly, the LOI stated:

AML [a member of the A group] directly or one or more of its affiliates, (all being directly or indirectly fully owned subsidiaries of the A group) was "very pleased to submit this non-binding (other than as specifically stated in Section 10 hereof) expression of interest to acquire (i) all (100%) of the equity interest (on a fully diluted and as converted basis (including all vested and unvested options (if any), warrants and any other convertible securities of [UPL], and (ii) all (100%) of the equity interest (on a fully diluted and as converted basis (including all vested and unvested options (if any), warrants and any other convertible securities) of the [UA JV], including the 51% of the equity interest in the JV held by [ASI]" (the " Proposed Transaction ").

15. The terms of the "non-binding proposal" provided for in clause 1 of the LOI were:

• (a) AML or one or more of its affiliates was "prepared to pursue the Proposed Transaction for an aggregate total consideration in the range of USD 30 - 30.2 million in cash (" LOI Purchase Price ") subject to the assumptions and adjustments set forth below".
• (b) Clause 1.1 Upfront Amount: an amount of USD 19.6 million of the LOI Purchase Price (minus the amounts deposited in escrow) would be paid in cash at the closing of the Proposed Transaction.
• (c) Clause 1.2 Founders Retention: an amount of USD 2 million of the LOI Purchase Price was to be retained and held back by the purchaser for a period of 30 months after closing "to ensure continuous employment of the Founders" until the expiration of such 30 months from Closing.

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  ATC 8551

  The said amount would be released to the Founders in tranches as follows:
  • (i) 50% after the expiry of 18 months following closing, "subject to continuous employment of the Founders until such date";
  • (ii) 25% after the expiry of 24 months following closing, "subject to continuous employment of the Founders until such date";
  • (iii) remaining 25% after the expiry of 30 months following closing, "subject to continuous employment of the Founders until such date"

    and divided equally between the Founders (defined to mean the Applicant and JH).

• (d) In the event that the Founder's employment was terminated, not for "cause" or "good reason" (as to be mutually defined in the Definitive Agreement and/or relevant employment agreements), then such Founder would be entitled to receive his portion of the retention amount mentioned above in full. "Parties acknowledge that [JH] is the sole shareholder of [MPL] and any reference to the [LOI] Purchase Price or the retention amount to be allocated to JH shall be construed to be such portion of the [LOI] Purchase Price or the retention amount to be allocated to [MPL]. For the avoidance of doubt, JH will sign the employment contract with UPL in his personal capacity".
• (e) Clause 1.3 Employees' Retention: an amount of USD 0.5-0.7 million of the LOI Purchase Price was to be held back by the purchaser for a period of 24 months after the Closing "to ensure continuous employment of other key employees mutually identified by [the purchaser], [UPL] and the Founders during the due diligence process. The said amount will be paid to such Key Employees in accordance with their respective employment contracts with the Companies."
• (f) Clause 1.4 Performance based: an Earnout of up to USD 7.9 million of the LOI Purchase Price was to be payable to the shareholders of UPL based on the revenues from the sale of UPL products (as to be mutually defined in the Definitive Agreement) for the two annual periods of July 2013 to end of June 2014, and July 2014 to end of June 2015, "payment will be subject to achieving the applicable Revenues target" set out in the letter.
• (g) Clause 1.5: An amount of USD 3.92 million (20% of the total upfront payment) shall be set aside and deposited at Closing for (i) 1/3 of such amount to be held for a period of 18 months in escrow following the Closing and (ii) 2/3 of such amount to be held for a period of 24 months in escrow following the Closing "which will serve as security for indemnification undertakings of the Companies shareholders". The purchaser agreed to consider lowering the amount to be kept in escrow to 15% of the total upfront payment after the completion of its due diligence.
• (h) Clause 1.10 Retention of the Founders and Key Employees (collectively with the Founders, the " Key Personnel "): was "an essential element of a successful transaction…. The entry into retention/employment agreements with such Key Personnel on terms acceptable to [the purchaser], the Companies and the respective Key Personnel, for a period of at least 24 months (and at least 30 months with respect to the Founders) following Closing will be one of the conditions precedents to the Closing of the Proposed Transaction. As will be more fully defined in the Definitive Agreement, it is our intention that such retention/employment agreements shall offer a total compensation package in aggregate not less favourable than the total compensation package each respective Key Personnel currently enjoys.
• We do not view this to be a contentious issue, rather one that is equally important to the Companies and to [the Purchaser]. Thus, it is our practice to structure the retention mechanisms, together with the Companies management after we have more insight into the existing provisions of each of the Company's benefit plans and your thoughts and input on this subject."
• (i) Clause 2 Structure: the structure of the Proposed Transaction shall be an

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  ATC 8552

  acquisition, directly or indirectly, of all the outstanding share capital of the Companies.
• (j) Clause 10 Non-Binding Effect: except for certain specified provisions (relating to non-solicitation, confidentiality, exclusivity and expenses), "this letter is not intended to, and shall not, constitute a binding agreement among the parties hereto, shall not impose any legal obligations on the parties to proceed with or consummate the Proposed Transaction or enter into a definitive agreement …"

The Share Purchase Agreement

16. Following due diligence, a SPA was negotiated between the parties. The agreement was dated 12 September 2013 but the Applicant's testimony was that it was executed on 24 September 2013. The parties to the agreement were UPL (defined to be "Company"), ADL or any of its Affiliates (defined to be the "Purchaser"), each of the persons identified in Exhibit A (each a "Seller") and the Applicant, solely in his capacity as the representative of the Sellers.

17. The terms of the agreement are critical.

18. The recitals to the agreement relevantly stated:

"WHEREAS, Company engages in the business of developing, distributing, implementing, supporting and maintaining software systems, mobile finance services and airtime top up solutions; and

WHEREAS, Sellers own of record and beneficially all (100%) of the issued and outstanding share capital of Company ….;

WHEREAS, the Company owns of record and beneficially forty-nine percent (49%) of the issued and outstanding share capital of [UA] … and the remaining shares capital of fifty one percent (51%), on a Fully Diluted Basis, of [UA] is owned of record and beneficially by ASI; and

WHEREAS, the Purchaser desires to acquire from the Sellers, and the Sellers desire to sell to the Purchaser, all of the Purchased Shares (as defined below), on the terms and conditions set forth herein; and

WHEREAS, on the date hereof, and as an inducement for the Purchaser to enter into this Agreement, the Founders (as defined below) are entering into new employment agreements with the Company or Purchaser or Affiliate of the Purchaser (the "Founders Employment Agreements"), all of which are conditional on the Closing; and

WHEREAS, on and subject to the Closing, and as an inducement for the Purchaser to enter into this Agreement, the Key Employees (as defined below) shall enter prior to the Closing into new employment agreements with Company or the relevant Subsidiary….

….

WHEREAS, the Parties agreed that one of the conditions precedent to the obligations of the Purchaser to consummate the Transactions shall be the concurrent consummation, at the Closing, of the purchase and receipt by Company of all the assets of [UA], whether by acquisition of entire share capital of [UA] or by the acquisition of [UA] Assets and the transfer by the Company of 49% of the share capital of [UA] held thereby to [ASI], all in accordance with and pursuant to the terms of the [UA] Agreements (as defined below) to be entered into prior to Closing;

NOW, THEREFORE, in consideration of the mutual representations, warranties, promises, covenants and agreements contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto , intending to be legally bound, hereby agree as follows:"

19. "Purchased Shares" was defined to mean "all the shares of Company owned by the Sellers, being 403,044 ordinary shares, representing 100% of the issued and paid up share capital of the Company …"

20. Article II of the Agreement was entitled "Purchase of Shares". It was divided into sections. Section 2.01 provided:

• (a) Subject to the terms and conditions set forth in this Agreement, and in reliance on the representations, warranties and covenants of Company and the Sellers, at the Closing the Sellers shall sell, as legal

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  ATC 8553

  and beneficial owner, to the Purchaser all of the Purchased Shares and the Purchaser shall purchase, acquire and accept from the Sellers all of the Purchased Shares, in each case, free and clear of any and all Liens; and
• (b) The Purchaser may but shall not be obligated to proceed to Closing if the [UA] Agreements are not consummated simultaneously with this Agreement; and
• (c) As a result of the foregoing, immediately and after Closing, the Purchaser shall be the sole owner, free and clear of any and all Liens, of 100% of the Shares of Company on a Fully Diluted Basis, and (unless the condition under Section 8.02(j) has been waived by the Purchaser) Company shall be the sole owner, free and clear of any and all Liens, of the [UA] Assets.

21. Section 2.02 was entitled "Consideration". Relevantly, it provided:

• (a) General
  • (1) In consideration of the sale, assignment, transfer and delivery of the Purchased Shares to the Purchaser at the Closing under the terms and conditions of this Agreement each Seller shall be eligible to receive, subject to the terms of this Agreement and the procedure set forth in this Section 2.02, such Seller's respective Pro Rata Portion (if any) of each payment of the Purchase Price (other than the Founders Retention Amount) as set forth on Exhibit K hereto.
  • (2) Allocation of Payment. The Purchaser shall disburse each payment of the Purchase Price (other than the Founders Retention Amount) to the Sellers in accordance with the allocation and the wire instructions or delivery instructions, as applicable, set forth in Exhibit K but subject to compliance with Section 2.03. The allocation of the Pro Rata Portions among the Sellers (including the allocation of the Closing Amount, the Escrow Amount and the Earn Out Amount among the Sellers), as set forth in Exhibit K is solely the responsibility of the Sellers… Any payment by the Purchaser of any portion of the Purchase Price shall be made in US Dollars by wire transfer of immediately available funds subject to withholding and set-off under this Agreement and any Applicable Law …
  • (3) Payment Terms and Schedule. The Purchase Price shall be paid to the Sellers in accordance with and subject to the following terms and conditions:
    • (i) Closing Amount. With respect to each Seller, such Seller's Pro-Rata Portion of the Closing Amount will be paid at the Closing.
    • (ii) Earn Out Amount. The Earn Out Amount shall be payable to the Sellers based on the Earn Out Revenues (as defined below) during the two annual periods of the 2014 Year and the 2015 Year and subject to achieving the applicable amount of Earn Out Revenues targets …
    • ….
    • (n) Any payments made pursuant to this Section 2.02 shall be treated as an adjustment to the Purchase Price by the parties for Tax purposes, unless otherwise required by Law.
    • (iii) Escrow Amount. The Purchaser shall deliver the Escrow Amount to the Escrow Agent at the Closing.
    • (iv) The Founders Retention Amount. The Founders Retention Amount shall be payable in accordance with Section 2.02(d) below.
• (b) Purchase Price Adjustment. [This clause provided for adjustments to be made to the Purchase Price depending on differences between the level of working capital and net debt as estimated prior to Closing, and the final levels of working capital and net debt as determined after Closing. Where an adjustment resulted in an Excess Amount in the Purchaser's favour "at the Purchaser's discretion, the Excess Amount may be reimbursed immediately to the Purchaser by the Escrow Agent, from the Escrow Amount and/or deducted from any succeeding payment/s. The reimbursement of the Excess Amount, from the Escrow Amount and/or as a reduction from any succeeding payment, as aforesaid, shall be allocated

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  ATC 8554

  between the Sellers based on the Pro Rata Portion thereof."]
• (c) Key Employees Retention Amount. The Key Employees Retention Amount will be paid to the Key Employees in accordance with and subject to the terms and conditions of their respective Key Employee Employment Agreements.
• (d) Founders Retention Amount. The Founders Retention Amount will be retained and held back by Purchaser for a period of thirty (30) months after the Closing. The said amount shall be released to the Founders and paid by the Purchaser or any of its Affiliates in accordance with the following provisions.
  • (1) Subject to the terms and conditions of this Section 2.02(d) , each of the Founders will receive the retention amount in the gross amount of up to US$900,000 (nine hundred thousand US dollars) (the "Retention Amount"), payable in three instalments as follows:
    • (i) The first instalment in the gross amount of US$400,000 (four hundred thousand US dollars) will be paid within thirty (30) days following the completion of the 18^thmonth after the Closing if such Founder is still employed by the Company or such Founder's other employing entity within the [A group] at that time;
    • (ii) The second instalment, in the gross amount of US$250,000 (two hundred and fifty thousand US dollars) will be paid within thirty (30) days following the completion of the 24^thmonth after the Closing if such Founder is still employed by the Company or such Founder's other employing entity within the [A group] at that time;
    • (iii) The third instalment in the gross amount US$250,000 will be paid within thirty (30) days following the completion of the 30^thmonth after the Closing if such Founder is still employed by the Company or such Founder's other employing entity within the [A group] at that time;
  • (2) If either Founder resigns or their employment is terminated for Cause (as defined below) before the applicable payment date referred to in Section 2.02(d)(1), such Founder will cease to be entitled to any further instalment of the Retention Amount (regardless of the date on which such Founder's employment actually terminates).
  • (3) If either Founder's employment is terminated by such Founder's employing company without Cause (as defined below) before the applicable payment date referred to in Section 2.02(d)(1), such Founder will be entitled to be paid the remaining instalments of the Retention Amounts in one lump sum payment within thirty (30) days of the date such Founder's employment terminates.
  • (4) The Retention Amount (if payable) is an additional and separate payment to the Founders' salary and will not be considered to be part of such Founder's salary for any purpose whatsoever, including for the purpose of any additional accumulative social benefits or rights which derive from their salary, save as otherwise required by applicable law.
  • (5) The Retention Amounts [sic] will not confer on either Founder a right to continue in the employment of the Company or other employing entity within the [A group] or limit in any way the Company's or other employing entity within the [A group] right to terminate either Founders [sic] employment. The Retention Amounts stated to be payable is the gross amount before any applicable tax withholdings and other statutory or voluntary deductions. It is further agreed the Retention Amounts is in consideration of and in reliance on the Founders full compliance with any non-competition, non-solicitation and confidentiality provisions in any documents which the Founder has signed or will sign with the Company or other employing entity within the [A group].

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    ATC 8555

    "Cause" means the violation of any material term of the relevant Founder employment agreement or of any company policy, dishonesty, gross misconduct, violent conduct, harassment or bullying or discrimination of any kind, unauthorised use of or disclosure of confidential information, material or repeated subordination, neglect, fraud/ fraudulent activity and criminal acts (excluding motoring offences for which a custodial sentence is not imposed) committed by such Founder, whether or not related to his employment.

22. Section 2.03 was entitled "Tax Consequences and Withholding Tax". Section 2.03(a) provided:

Tax Consequences . The parties intend the Transactions hereunder to be a taxable sale of the Company Shares by the Sellers. Purchaser makes no representations or warranties to any of Company's shareholders regarding the Tax treatment of the Transactions hereunder, or any of the Tax consequences to any Company's shareholder of this Agreement or any of the Transactions or agreements contemplated hereby.

23. Section 4.01 was entitled "Title to Purchased Shares" and provided:

Such Seller has good and valid title to, and is the sole lawful owner, beneficially and of record, of all of the Purchased Shares set forth opposite the name of such Seller in Exhibit K, which constitute the entire issued and outstanding Purchased Shares held by such Seller, free and clear of any and all Liens.

24. Article I contained the definitions of terms used in the agreement. Relevantly:

"Earnout Amount" means an amount of up to US $7,900,000.

"Founders" means the [Applicant and JH].

"Founders Retention Amount" shall mean US $1,800,000 (US $900,00 for each Founder).

"Purchase Price" means an amount of up to US $23,500,000 … (comprising of the Closing Amount, the Escrow Amount and the Earn Out Amount, together the "Initial Amount"), plus the Founders Retention Amount less the sum of (A) the Working Capital Shortfall (as defined below), if any, and (B) the Closing Company Net Debt Deduction, if any, (C) Options Purchase Price (as defined below in Section 2.04(b)(1)(viii) with respect to all outstanding options), and (D) 49% of the [UA] Working Capital Shortfall … (as shall be defined in the [UA] Agreements), if any, plus the sum of (E) Working Capital Excess, if any and (F) the Closing Company Net Debt Addition, if any ….

"Transactions" means the purchase of the Purchased Shares by the Purchaser and all the other transactions contemplated by this Agreement and the other Transaction Documents.

"Transaction Documents" means this Agreement, its exhibits and schedules and any and all other Contracts, certificates and documents contemplated to be delivered or executed in connection with this Agreement and the Transactions, including, without limitation, the Escrow Agreement, the [UA] Agreements, the Subsidiaries' Plan, the Founders Employment Agreement and the Key Employees Employment Agreements.

"[UA] Agreements" means (i) the asset purchase agreement and/or share purchase agreement, as the case may be, in each case between the Company, UA and ASI, for the purpose of vesting in the Company all rights, title and interest in the UA Assets ….

"[UA] Purchase Price" means the purchase price (ie US $4,000,000) (the sum of US $4,000,000) shall be referred to herein as the [Al] Amount) payable in cash by the Company pursuant to the UA Agreements …

25. The SPA also included:

• (a) Confidentially, non-compete and non-solicitation clauses in section 7.04. Each Seller agreed to these "in further consideration for the payment of the Purchase Price". The non-compete period was 18 months from Closing for each Seller and was 30 months for each Founder.
• (b) An indemnification in Article X by each Seller in respect of such Seller's Pro

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  ATC 8556

  Rata Portion of the entirety of any Loss relating to any inaccuracy in or breach of any representation or warranty of the Company contained in any Transaction Document and the entirety of any Loss relating to any inaccuracy in or breach of any representation or warranty of the Seller contained in any Transaction Document. There was also an indemnification by each Seller in respect of such Seller's Pro Rata Portion of the entirety of any Loss relating to any breach of any covenant or obligation of the Company contained in any Transaction Document and the entirety of any Loss relating to any inaccuracy in or breach of any covenant or obligation of the Seller contained in any Transaction Document. For the purposes of the indemnity against breach of covenant, the reference to Transaction Document did not include the Founders' Employment Agreement or the Key Employees Employment Agreements. The maximum aggregate liability for breach of company or seller's representation was limited to an amount equal to 80% of the Initial Amount plus the [Al] Amount plus the Founders' Retention Amount. Section 10.03(b) also relevantly provided:
  • …. it is clarified and agreed that the for purposes of determining the applicable "maximum aggregate liability for Losses" … it shall be assumed that the entire Earn Out Amount and Founders Retention Amount has been paid to Sellers or the Founders (as applicable), provided however that to the extent any portion of the Earn Out Amount or the Founders' Retention Amount (as the case may be) which is required to cover Losses payable to Purchaser Indemnified Parties hereunder was not yet paid by Purchaser at the time of such determination, then until such time as such portion of the Earn Out Amount or the Founders' Retention Amount (as applicable) shall become due or payable, Purchaser shall not actually claim from the Sellers the payment of the Losses out of such portion but shall be entitled to retain, withhold from, and not pay to, the Sellers or the Founders (as applicable) such portion of the Earn Out Amount or the Founders' Retention Amount (as applicable) if and when it becomes due or payable (claim by set-off).
• (c) An entire agreement clause in section 12.01 provided that "this Agreement, the Transaction Documents and the Confidentiality Agreements constitute the entire Agreement between the parties with respect to the subject matter of this Agreement and supersede all prior agreements and understandings … (including without limitation any prior proposal, term sheet, letter of intent, memorandum of terms or expressions of interest). The letter of intent, dated May 26, 2013 among the Purchaser, Company, the Founders and the other parties thereto is hereby superseded by this Agreement".

26. Exhibit A to the SPA contained a list entitled "Sellers". The first name identified was the Applicant's. The fifth item contained two names - that of a company owned by JH and JH. JH's evidence was that the shares in UPL were owned by his company.

27. Exhibit K was in the form of a spreadsheet entitled "Spreadsheet; Pro Rata Portion; Wire Instructions" and comprised of 10 columns. The first column was entitled "name of seller". The first two Sellers listed were the Applicant and the company owned by JH. JH was not listed as a Seller in Exhibit K. The second column was entitled "Ordinary [sic] Number of Ordinary Shares". The total of that column was 403,044, corresponding to the number of ordinary shares as set out in the definition of Purchased Shares.

Employment Contract

28. On 12 September 2013, the Applicant signed an employment contract with a Singaporean subsidiary of the A group. The terms of that employment contract included:

• (a) As of Closing (as defined in the SPA between UPL and ADL) and subject to and conditional on Closing, the Applicant was to be employed by the Singaporean subsidiary.
• (b) "[i]n consideration of your continued employment, upon acceptance and on formal Closing, this Agreement shall supersede any prior terms and conditions of employment between [the Applicant] and [UPL] and/or the

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  ATC 8557

  [Singaporean subsidiary] …. This Agreement shall be the only legal binding agreement between [the Applicant] and [the Singaporean subsidiary] relating to [the Applicant's] employment by the [Singaporean subsidiary] on Closing".
• (c) The Applicant's title was to be "VP Mobile Payment Financial Services".
• (d) The terms of the Applicant's remuneration was to be "set out in a separate letter to be given to [the Applicant] by [the Singaporean subsidiary]". The Applicant's remuneration "includes all payments and benefits to which you are, or may become, legally entitled (including but not limited to, wages, overtime, allowances, penalty rates, loadings and payments of a like nature)".
• (e) The Applicant agreed that he would not "except in the proper performance of [his] duties or as required by law, disclose or use any confidential information or intellectual property" of the Singaporean subsidiary obtained during the course of employment. The obligation was to continue "indefinitely after termination". The Applicant could be "required to enter a separate Deed of Confidentiality, Intellectual Property and Restraint which supersedes this clause."
• (f) The agreement replaced "all previous written or oral negotiations, understandings, communications or agreements by or between the parties, except for the Remuneration and Benefits letter attached".

29. The letter entitled "Remuneration & Benefits" provided:

• (a) The "purpose" of the letter was to "set out [the Applicant's] remuneration" which was to "apply whilst employed by [the Singaporean subsidiary]".
• (b) For a Total Target Compensation, comprising of a base salary amount and variable compensation, to which the Applicant would become entitled depending on his performance. "The amount and [the Applicant's] entitlement to this compensation" would "depend on your achievement against pre-determined targets and performance objectives", as described in a signed "goal sheet".
• (c) For superannuation, car allowance, life insurance and salary continuance insurance.

30. Attached to the letter of employment was a Deed of Confidential Information, Intellectual Property and Restraint.

UA Asset Purchase Agreement

31. The SPA related only to the shares in UPL. There was a separate Asset Purchase Agreement in relation to the assets of UA.

32. The UA Agreements in their original form were not before the Tribunal. The Applicant's evidence was that the UA Agreements included an Asset Purchase Agreement and an Earnout Undertaking which provided for the Company's shareholders to pay ASI USD 2 million of the Earnout that the shareholders received from the purchaser of the Company's shares. The Company's shareholders executed a written direction (a copy of which was before the Tribunal), whereby "if there is a payment of any part of the Earn Out Amount [as defined in the Share Purchase Agreement]… then 25.32% of any amount of the Earn-Out Amount that is actually paid ("the Relevant Earn-Out Payment") shall be paid directly to UA or its assigns on behalf of the [Company's Shareholders]".

33. In November 2013, there was a renegotiation of the terms of the Asset Purchase Agreement. The Applicant's evidence was the Purchase Price was increased from USD 4 million to USD 5 million and the Earnout Undertaking was to be terminated, thus relieving the Company's shareholders from the obligation to on-pay to ASI part of the Earnout amount they receive.

Amendment of SPA and Asset Purchase Agreement

34. In around December 2013, the terms of the SPA were amended as a consequence of the change in the terms of the Asset Purchase Agreement. The Earnout Amount payable under the SPA was to be reduced by USD 1.7 million and the FRA was to be increased by USD 200,000. According to the Applicant, he was prepared to accept the changes to the components of the Purchase Price because he considered the FRA to be a "guaranteed component" rather than a "contingent component". The relevance of this statement is discussed below.

35.

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ATC 8558

By letter dated 5 January 2014, the Earnout undertaking was terminated and ADL and UA released the other parties to the Earnout Undertaking from any obligations they had under that Undertaking.

36. As of 6 January 2014, the Asset Purchase Agreement between UPL as Purchaser, UA as Seller and ASI as Shareholder, was amended and restated. The restated agreement was before the Tribunal. Pursuant to clause 3.1 of that agreement, the Purchaser paid to the Seller a Base Purchase Price of USD 2,600,000 plus an amount of up to USD 500,000 for the Purchased Assets and Assumed Liabilities. The Purchaser also paid to the Shareholder (ASI) a Non-Compete Purchase Price as "consideration for the entry by the Shareholder into the Non-Compete Covenant". The Non-Compete Purchase Price was USD 2,200,000. It was also a term of the Asset Purchase Agreement that at Closing the Purchaser would transfer to ASI all of its shares in UA. As a result of the Agreement, UPL agreed to acquire certain assets and liabilities of UA, and ASI agreed to acquire UPL's shares in UA.

37. Also on 6 January 2014, a First Amendment to the SPA was entered into, pursuant to which:

• (a) The definition of Earnout Amount was defined to mean USD 6,200,000.
• (b) The definition of UA Purchase Price was defined to mean the Purchase Price (i.e. USD 5,500,000) payable in cash by the Company pursuant to the UA Agreements.
• (c) The definition of Purchase Price was amended to refer to the amount of USD 21,800,000 rather than USD 23,500,000.
• (d) The terms on which the Earnout Amount was payable as set out in section 2.02(a)(ii)(2) were amended.
• (e) The definition of Founders Retention Amount was amended to mean USD 2,000,000 (USD 1,000,000 for each Founder).
• (f) Under clause 2.2 of the First Amendment, section 2.02(d) was deleted and replaced with the following:
  • " Founders Retention Amount. The Founders Retention Amount will be retained and held back by Purchaser for a period of thirty (30) months after the Closing. The said amount shall be released to the Founders and paid by the Purchaser or any of its Affiliates in accordance with the following provision:
    • (1) Subject to the terms and conditions of this Section 2.02(d), each of the Founders will receive the retention amount in the gross amount of up to US$1,000,000 (one million US dollars) (the "Retention Amount"), payable in three instalments as follows:
      • (i) The first instalment in the amount US$440,000 (four hundred and forty thousand US dollars) will be paid within thirty (30) days following the completion of the 18^thmonth after the Closing if such Founder is still employed by the Company or such Founder's other employing entity within the [A group] at that time;
      • (ii) The second instalment in the amount US$280,000 (two hundred and eighty thousand US dollars) will be paid within thirty (30) days following the completion of the 24^thmonth after the Closing if such Founder is still employed by the Company or such Founder's other employing entity within the [A group] at that time;
      • (iii) The third instalment in the amount US$280,000 (two hundred and eighty thousand US dollars) will be paid within thirty (30) days following the completion of the 30^thmonth after the Closing if such Founder is still employed by the Company or such Founder's other employing entity within the A group at that time.
• (g) There was an entire agreement clause whereby it was agreed that the provisions in the Share Purchase Agreement were "hereby amended as set forth herein. Except as specifically stated herein, the Share Purchase Agreement shall continue in full

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  ATC 8559

  force and effect in accordance with the provisions hereof".

38. It was apparent that the reference to section 2.02(d) being "deleted and replaced" was an error. The evident intent of the parties was to delete and replace section 2.02(d)(1) rather than the entirety of section 2.02(d), and it is inferred that the omission of the reference to subparagraph (1) was entirely accidental. The deletion of section 2.02(d) in its entirety would lead to absurdity and the objective intention of the parties is self-evident. For example, the deletion of the entirety of 2.02(d) would result in the Founders ceasing to be entitled to instalments of the FRA, if their employment were to be terminated without Cause. It is clear from the parties' conduct and the Mutual Separation Letter that the parties did not intend to remove the entitlement of the Founders to the FRA if their employment were to be terminated without Cause. Nor did they intend to delete the definition of "Cause". There was also evidence from the Applicant that he discussed the issue with the in-house lawyer at A group, who confirmed that there was no intention to delete sections 2.02(2) to (5). The Tribunal was provided with copies of correspondence between A group and the Applicant from August and November 2016. The Tribunal considers that the reference in the First Amendment Deed to section 2.02(d), rather than section 2.02(d)(1), was an inadvertent typographical error and accepts that the reference in the First Amendment Agreement to section 2.02(d) should be construed as a reference to section 2.02(d)(1). As explained most recently by the Full Federal Court in
Federal Commissioner of Taxation v The Michael Hayes Family Trust [2019] FCAFC 226 at [34]-[52], the issue is one of construction of the First Amendment Deed and not rectification (which is not a matter for this Tribunal).^[1] cf Simic v NSW Land and Housing Corporation (2016) 260 CLR 85 which concerned the terms of a performance bond issued by a third party bank.

Subsequent Events

39. The Applicant received the first tranche of the FRA in the form of a deposit made to his AUD denominated bank account, and not the USD bank account he had nominated for receiving the purchase price under the SPA. The payment had been made by his employing entity. The Applicant raised the issue with A group's lawyers.

40. The Applicant's employment was terminated with effect from 31 January 2017. The Applicant received a letter dated 4 January 2017 from his employer entitled "Mutual Separation", which stated:

"It is clarified and agreed that this mutual separation agreement does not change, amend, supersedes or otherwise have any effect with respect to the Share Purchase Agreement dated September 12, 2013…. and subsequent amendments, agreement, letters and/or arrangements with respect to the Share Purchase Agreement ("SPA"); including, but not limited to: (i) The payment of the second and third instalments of the Founders Retention Amount pursuant to the SPA, as amended by that First Amendment to the SPA ("First Amendment) Section 2, are deferred at your request …. such payments shall otherwise be in accordance with and subject to the terms of the SPA and First Amendment ….

It is clarified and agreed that notwithstanding your acceptance of the terms and condition of this mutual separation agreement as full and final satisfaction of any claims or demands that you might have with respect to your employment and termination of employment as aforesaid, by signing this letter you are not waiving your entitlement and rights with respect to the SPA and subsequent amendments, agreement, letters and/or arrangements with respect to the SPA".

LEGAL PRINCIPLES

41. Whether a payment is received on the income or capital account is to be determined by its character in the hands of the recipient:
Scott v Federal Commissioner of Taxation (1966) 117 CLR 514 at 526;
GP International Pipecoaters v Federal Commissioner of Taxation (1990) 170 CLR 124 (GP International Pipecoaters) at 136.

42. The High Court in GP International Pipecoaters said at 138:

"To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the

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ATC 8560

character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment."

43. Proceeds received as the result of a mere realisation of a capital asset will be of a capital nature. Here, it was not disputed that the shares owned by the Applicant were a capital asset.

44. Payments received as a reward for services have an income character. In
Reuter v Federal Commissioner of Taxation (1993) 111 ALR 716; 93 ATC 4037, Hill J said at 730 :

"Perhaps the most usual usage of the word `income' in ordinary speech is to describe that which comes in as a reward for services. Amounts such as salary, wages, commission, tips and the like, are universally regarded as income and it is immaterial whether they are paid under or pursuant to a contract of service or services on the one hand, or gratuitously on the other. So, too, for income tax purposes, it would be immaterial whether an amount which is a reward for services is paid to the taxpayer in advance of the services being performed (eg, a signing-on fee) or after the services have been performed, or whether the payment is made by the person for whom the services are performed or by some other person. It will also be generally immaterial whether the amount paid is paid periodically or in a lump sum. What will matter is the character of the payment as a reward for services or, as it was put by Fullagar J in
Hayes v FC of T [1956] HCA 21;
(1956) 11 ATD 68 at 74;
[1956] HCA 21;
(1956) 96 CLR 47 at 57-58, whether the receipt is a `product' of the taxpayer's services."

45. The decision of Hill J was affirmed on appeal. The issue was whether the receipt of the payment is so connected with the provision of services by the recipient of the payment as to be a product of those services:
Reuter v Federal Commissioner of Taxation 93 ATC 5030 at 5,037.

46. If the payment is really incidental to employment, it does not matter if the payment comes from the employer or from somebody else:
Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540 at 556.

47. What is truly represented by an amount received is, absent a sham, ordinarily gleaned from the terms agreed between the parties. The "how and why" of the receipt are ordinarily determined by that agreement, and in particular by the nature of the consideration for which, according to the agreement, the money was paid:
Federal Commissioner of Taxation v CSR Ltd (2000) 104 FCR 44. As Brennan J said in
Federal Coke Co Pty Ltd v Federal Commissioner of Taxation (1977) 15 ALR 449; 34 FLR 375, in a passage approved by the Full Court in
Allied Mills Industries Pty Ltd v Federal Commissioner of Taxation (1990) 20 FCR 288;
[1988] FCA 357 at 401-402 and in JB
Chandler Investment Co Ltd v Federal Commissioner of Taxation (1993) 47 FCR 588:

"When a recipient of moneys provides consideration for the payment, the consideration will ordinarily supply the touchstone for ascertaining whether the receipt is on revenue account or not. The character of an asset which is sold for a price, or the character of a cause of action discharged by a payment will ordinarily determine, unless it be a sham transaction, the character of the receipt of the price or payment. The consideration establishes the matter in respect of which the moneys are received. The character of the receipt may then be determined by the character, in the recipient's hands, of the matter in respect of which the moneys are received."

48. That is not to say that the terms of a contract are not to be understood in light of the entirety of the circumstances. The rights and liabilities of parties under a provision of a contract are determined objectively by reference to its text, context (the entire text of the contract as well and any contract, document, statutory provision referred in the text of the contract) and purpose:
Mount Bruce Mining Pty Ltd v Wright Prospecting (2015) 256 CLR 104 (Mount Bruce) at [46]. The matter is required to be determined having regard to the matrix of events and not necessarily and solely in the terms of the transaction document describing the payment:
Reuter v Federal Commissioner of Taxation 93 ATC 5030 at 5,036-7.

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ATC 8561

49. As the Applicant submitted, the terms of a contract are to be construed by asking what a reasonable businessperson would have understood those terms to mean. But that inquiry is not made in vacuum. As the High Court of Australia said in Mount Bruce at [47], it requires "consideration of the language used by the parties in the contract, the circumstances addressed by the contract and commercial purposes or objects to be secured by the contract." Furthermore, sometimes it is necessary to have recourse to events, circumstances and things external to the contract to identify the commercial purposes or objects of the contract where that task is facilitated by an understanding of the genesis of the transaction, the background of the contract and the market in which the parties are operating: Mount Bruce at [49].

CONTENTIONS

50. The Applicant contended that:

• (a) The FRA was a portion of the "Purchase Price" as defined in the SPA.
• (b) An ordinary business person would have understood the term "Purchase Price" in an agreement for the sale of shares as the consideration that the purchaser is required to pay, and the seller is entitled to receive for those shares. A contrary interpretation would result in the SPA making "commercial nonsense".
• (c) The "Purchased Shares" were sold subject to the terms and conditions of the SPA.
• (d) Sections 2.02(a)(1) and (2) do not, on their own, define what consideration was payable for the Purchased Shares, but instead identified the "mechanics" for how certain components of the Purchase Price were to be paid. That is, the clauses addressed the mechanics for the payment of those components of the Purchase Price that were payable at Closing. The exclusion of the FRA from the clauses was because the FRA was not payable at Closing, and was not payable to all the Sellers.
• (e) The "mechanism that adjusts the Purchase Price" provided for in section 2.02(b) permits an adjustment in the Purchaser's favour to be deducted from any succeeding payment, and thus permits an adjustment in the Purchaser's favour to be "repaid" from the FRA. An adjustment to the Purchase Price in the Purchaser's favour could impact the FRA and "illustrates that the FRA is part of the consideration paid for the shares", and that receipt of the full FRA was conditional on no indemnity claim by the Purchaser.
• (f) The fact that the Purchaser was entitled to retain some or all of the FRA in the event of a breach of warranty also "illustrates that the FRA is part of the consideration paid for the shares", and that receipt of the full FRA was conditional on no Purchase Price adjustment in favour of the Purchaser.
• (g) The terms of the LOI and the course of negotiations show that the FRA was part of the price that the Purchaser offered to pay for the UPL shares.
• (h) The FRA was a lump sum amount payable in three instalments and was not periodic, ongoing or recurring.
• (i) But for the sale of the UPL shares and the entry into the SPA, the Applicant would not have been entitled to receive the FRA. The Applicant's entitlement to the FRA arose in his capacity as vendor and not as an employee.
• (j) The FRA was not calculated by reference to the Applicant's salary, and the FRA was increased as part of a renegotiation of the components of the Purchase Price.
• (k) The Applicant was rewarded for his services by way of salary and bonuses. The FRA was not a "top-up" for an inadequate salary or a payment on which the Applicant relied on to support himself. The SPA was to be construed on the basis that paragraphs (2)-(5) of the SPA were not deleted. Section 2.02(4) provided that the FRA was not to be considered part of the Applicant's salary for any purpose

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  ATC 8562

  whatsoever.
• (l) Continued employment was not a condition for receipt of the FRA. The condition was that the Applicant would not resign nor have his employment terminated for Cause. The Applicant was not required to perform services in a particular way in order to be entitled to the FRA. The fact that the Applicant's employment could be terminated at any time meant that the Purchaser "could not have attributed any value to the duties the Applicant would perform when it agreed to pay the FRA".
• (m) In any case, it was erroneous to characterise the FRA by reference to the conditions precedent for the payment, rather than by reference to what the payment is actually for.
• (n) It followed that in both substance and in form, the FRA was received by the Applicant as consideration for the sale of his UPL shares (a capital asset), and was not a reward or compensation for services.

ANALYSIS

51. The issue is whether the receipt of the payment is so connected with the services provided by the recipient of the payment as to be a product of those services and therefore have an income character (
Reuter v Federal Commissioner of Taxation (1993) 93 ATC 5030 at 5,037), or whether the FRA was to be characterised as the proceeds of realisation of a capital asset and therefore of a capital nature.

52. Much of the evidence given by the Applicant related to his subjective reasons, intentions, expectations or hopes, many, if not all of which, was not communicated to the Purchaser at the time the contract was entered into. The Tribunal gains little, if any, assistance from that evidence. The issue before the Tribunal is not determined by seeking to identify an agreement which the Applicant might have hoped, expected or even subjectively intended to make:
Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) 149 CLR 337. It is determined by the terms of the agreement in fact made and the objective framework of facts that within which the contract came into existence.

53. Counsel for the Commissioner relied heavily on the proposition that the amounts the Founders received on a per share basis exceeded the amount received by other shareholders for the same shares that had the same rights, and therefore "as a matter of logic" it ought to be inferred that the excess was received by the Founders for something else. Such a submission is unhelpful and the Tribunal rejects the contention. The Tribunal accepts that in certain circumstances a premium may be paid by a purchaser for a particular parcel or parcels of shares. This may be the case for example, if the particular parcel of shares results in the purchaser acquiring control of the company.

54. The Tribunal also rejects the Commissioner's contention that the FRA was a periodical payment. It was not. Rather it was a lump sum payable in instalments. However, in this case, the manner of its payment does not determine its character.

55. The Tribunal considers that the matter can only be resolved by examining the totality of the terms of the agreement and the circumstances in which it was executed. In this respect, the Tribunal notes that both parties referred to the terms of the LOI in support of their position. The Tribunal has not had reference to the specific terms of the LOI for the purpose of construing the language of the SPA. As clause 12.01 of the SPA provides, the terms of the SPA were intended to supersede the terms of the LOI. However, the existence of the LOI does assist in informing the Tribunal of the general background to the SPA and the nature of the market in which the parties were operating.

The Terms of the SPA

56. The SPA represented a negotiated outcome between parties acting at arm's length. There was no suggestion of a sham. As both parties contended, the starting point in determining the issue is the terms of the SPA. Those terms are to be construed by reference to the text, context and purpose of that agreement.

57. There are difficulties with the way in which the SPA has been drafted. The difficulties in this case have partly arisen because the Applicant was referred to in the SPA in three capacities: as a seller who was an owner of Purchased Shares, as the Sellers' Representative and as a Founder. Although the Founders were not separately

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ATC 8563

specified as parties to the SPA, both of the named Founders were referred to in the schedule of Sellers notwithstanding that one of the Founders (namely JH) was not the owner of any of the Purchased Shares.

58. As the Applicant contended, the recitals to the SPA inform the commercial purpose and object of the SPA. The terms of the recitals demonstrate that the SPA was part of a transaction which extended beyond a sale of the Purchased Shares. The SPA expressly acknowledged that it was a part of a series of Transaction Documents that included the Employment Agreements. The recitals evidence that, as an inducement for the Purchaser to enter into the SPA, the Founders (as defined) were entering into new employment agreements. The LOI also evidences the communication by the Purchaser to the Applicant of the importance to the Purchaser of retaining the services of the Founders post acquisition because of the nature of UPL's business.

59. It is clear that the FRA formed part of the "Purchase Price" as that term is defined in the SPA. However, as Counsel for the Applicant acknowledged, the SPA does not contain a clause providing that the Purchased Shares are sold for the Purchase Price.

60. The term "Purchase Price" is not used in the SPA in its ordinary sense but as a specially defined term. The SPA in turn defines the term "Purchaser" as referring to ADL or any of its Affiliates. Having regard to the totality of the circumstances, the Tribunal concludes that the term "Purchase Price" as used in the SPA was drafted from the perspective of the Purchaser and referred to the amounts which under the terms of the SPA were to be paid by the Purchaser or the Purchaser's affiliates.

61. The term "Purchase Price" did not refer to the amount received by sellers of shares in consideration for the sale of those shares. In this respect, the term "Sellers" as used in the operative terms of the SPA refers to the named persons in Exhibit A of the Agreement. However, as is apparent from the terms of section 4.01 and Exhibit K, not all of the persons named as Sellers were the lawful owners of the Purchased Shares. In particular, the Sellers included JH who was not himself the owner of Purchased Shares and two of the persons named in Exhibit A were directors of companies that were the shareholders. This supports a conclusion that merely because a payment was made by the Purchaser to a person named in Exhibit A as a "Seller", it does not necessarily follow that the payment was received by those named Sellers as consideration for the sale and transfer of Purchased Shares. Some of those named as Sellers did not have any shares to sell.

62. This interpretation of Purchase Price is also consistent with the manner in which the SPA defines the UA Purchase Price. As set out above, the UA Purchase Price was defined to be the amount payable in cash by the Company (i.e. by UPL) pursuant to the UA Agreements. Under the terms of the Asset Purchase Agreement in relation to the assets of UA, the amount payable in cash by the Company was made up of two elements - one of which was the consideration payable to UA for the transfer of the assets and the other was the consideration payable to ASI as shareholder of UA for a non-compete clause. The term "[UA] Purchase Price" in the SPA does not refer to the Purchase Price paid for the assets of UA.

63. In these circumstances, to fasten on the label of "Purchase Price" as determining the character of each component of the amount received by the Applicant is as unhelpful in characterising the receipt as fastening on the label of "Retention Amount". It is not the label attaching to the payments but what the payments are received for that determines their character in the hands of the recipient. As Hill J said in Federal Commissioner of Taxation v Broken Hill Pty Co Ltd
(2000) 179 ALR 593; 45 ATR 507 (albeit in the context of the characterisation of a payment from the point of view of the payer):

"The true position is that the label that a party uses to characterise a payment … will not be determinative, although it may have some relevance: cf NM Superannuation Pty
Ltd v Young [1993] FCA 91; (1993) 41 FCR 182 at 198-9 … . What that relevance may be will depend on the particular circumstances of the case. A licence does not become a lease because the parties chose to call it one, if it is in truth a licence:
Radaich v Smith [1959] HCA 45; (1959) 101 CLR 209. A person does not cease to be an employee and become an independent contractor because the parties use the latter description: Hannan & Allen v Australian Mutual Provident Society (unreported, Supreme Court of Victoria, 15 November 1996). So, it may be said that an amount payable does not become interest, if the parties chose to adopt that word, if in law it is not."

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ATC 8564

64. These principles are equally applicable to section 2.03 which provide that the parties intend the Transactions hereunder to be "a taxable sale of the Company Shares by the Sellers." The parties cannot by agreement bestow a character on an arrangement which it does not otherwise have. It is noted that the "Transactions" as defined included "all the other transactions contemplated by this Agreement and the other Transaction Documents". Those Transaction Documents included the Founders Employment Agreement and the Key Employees Employment Agreement.

65. The SPA deals with the FRA in a manner that is different from the other elements of the Purchase Price. The FRA is expressly excluded from section 2.02(1) which commences with the phrase "[i]n consideration of the sale, assignment, transfer and delivery of the Purchased Shares to the Purchaser at the Closing…."

66. The Applicant contends that section 2.02(1) should be interpreted as providing only for the mechanics of payment of those parts of the Purchase Price payable at closing to each of the Sellers, and the exclusion of the FRA from section 2.02(1) is explicable because it is not a payment to be made at closing and was not payable to all of the Sellers. This is reinforced by the fact that section 2.02 refers to Exhibit K, which sets out wire instructions for payment of the Closing Amount. The Applicant thus contends that the section should not be construed as in any way limiting which parts of the Purchase Price are to be regarded as consideration for the sale of the Purchased Shares.

67. The Tribunal does not accept that construction of section 2.02(1) for the following reasons:

• (a) The construction does not give effect to the opening words of section 2.02(1) "in consideration of the sale, assignment, transfer and delivery of the Purchased Shares to the Purchaser at Closing under the terms and conditions of this Agreement".
• (b) The exclusion of the FRA from section 2.02(1) cannot be explained on the basis that it is a payment that is not made "at Closing". The Earnout amount was not payable at Closing and was not referred to in Exhibit K, yet was not excluded from section 2.02(1).
• (c) The exclusion of the FRA from section 2.02(1) cannot be explained on the basis that it is a payment in consideration for the Purchased Shares but is not made to each of the Sellers. That is because one of the persons entitled to the FRA was JH. Both JH and the Applicant were entitled to the FRA. JH was a Founder entitled to the FRA but was not a holder of the Purchased Shares.

68. Under clause 2.02(d), unlike the other elements of the Purchase Price, the FRA is to be released to the Founders and paid by either the Purchaser or any of its Affiliates (emphasis added). As explained above, the Founders are not simply a subset of the owners of the shares that are the subject of sale. Furthermore, unlike the other elements of the Purchase Price, the FRA could be paid by either the Purchaser or any of its Affiliates.

69. The Tribunal accepts that clauses 2.02(d)(2)-(5) were not intended to be deleted and the terms of the First Amendment Agreement are to be construed as being limited to the deletion and replacement of clause 2.02(d)(1). Indeed, the terms of the Mutual Separation letter can only be understood by reference to clause 2.02(d)(3). It thus follows that the Tribunal accepts that the character of the FRA is to be determined in having regards to the entirety of clause 2.02(d).

70. Based on the entirety of clause 2.02(d), it is apparent that notwithstanding that the FRA was not payable pursuant to the terms of the Employment Agreement between the Applicant

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ATC 8565

and his employer, the terms relating to the FRA relate to the continuance of the employment of the Applicant as a Founder thus:

• (a) The FRA would be released to the Applicant in three instalments if he was still employed by UPL or "such Founder's other employing entity within the [A] group at that time": clause 2.02(d)(1).
• (b) The Applicant ceased to become entitled to the FRA if he resigned or his employment was terminated for cause: clause 2.02(d)(2).
• (c) If the Applicant's employment was terminated by "such Founder's employing company without Cause" before the applicable payment date, the Founder was to be entitled to be paid the remaining instalments of the FRA in one lump sum payment within thirty days of the date such Founder's employment terminates: clause 2.02(d)(3). The trigger for entitlement to payment in these circumstances is the actions of the employing company, not the Founder or the Purchaser.
• (d) The FRA was expressed to not confer on either Founder a right to "continue in the employment of the Company or other employing entity within the [A group]" or "limit in any way the Company's or other employing entity within the [A group] right to terminate either Founder's employment": clause 2.02(d)(5). The clause appears predicated on there being a connection between the FRA and the continuation of the Founder's employment and seeks to identify the limits of the connection.
• (e) The FRA was expressed in clause 2.02d(5) to be " in consideration of and in reliance on the Founders full compliance with any non-competition, non-solicitation and confidentiality provisions in any documents which the Founder has signed or will sign with the Company or other employing entity within the [A group] (emphasis added). Clause 2.02(d)(5) specifies the matters in respect of which the FRA was agreed to be paid and received.

71. In accordance with clause 2.02(d)(4), the parties did not intend that the FRA form part of the Founder's "salary" and accordingly may not have been taken into account in determination of the quantum of entitlements that depend on the amount of the Applicant's salary (for example, depending on the terms of the policy, the quantum of salary continuance benefits). However, it does not follow that the payment of the FRA was not received by the Applicant as a Founder and as a product of his employment. It is apparent from the decision of Northrop J in
McLean v Federal Commissioner of Taxation (1996) 66 FCR 106 that a payment may be a product of employment (and thus ordinary income) without necessarily being "salary and wages." In that case, having determined that the payments in issue constituted ordinary income and were a product of the income-earning activity on the part of each taxpayer, Northrop J nonetheless left open the question of whether the payments were "salary and wages." The issue of whether the payments in that case constituted "salary and wages" was the matter decided by Merkel J in
McLean v Federal Commissioner of Taxation (1997) 37 ATR 52 and is not an issue which arises here.

72. The Tribunal acknowledges that the facts and the subject of the decision of Merkel J in McLean
(1997) and the decision of Northrop J McLean (1996) may be distinguished on the basis that the taxpayers in that case were not parties to an agreement that provided for the sale of shares, and the payments made in that case were not made by a purchaser in the context of an acquisition of shares by the purchaser. Furthermore, the lump sum payments in that case had been calculated by reference to the taxpayers' salary. Here, there was no suggestion that the FRA was calculated by reference to the Applicant's salary.

73. However, neither of those points of distinction lead to a conclusion that the FRA here was not received by the Applicant as a product of his employment. In a single instrument (such as the SPA) one may find separate considerations given for separate and distinct covenants: Beak (Inspector of Taxes) v Robson
(1943) AC 352. Here, the FRA was payable to the Founders, one of whom was not the holder of shares in UPL (but was a director of a company which was a shareholder), and by the terms of the SPA, the FRA was consideration for specific covenants given by the Founders in circumstances where the conditions to the receipt of the FRA were the continued employment of the Founders and where the parties to the SPA were aware of the importance of the continuation of the provision of the Founders' services to the Purchaser. Furthermore, the character of a payment is not determined by the manner of its calculation:
Tinkler v Federal Commissioner of Taxation (1979) 29 ALR 663; (1979) 40 FLR 116;

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ATC 8566

Glenboig Union Fireclay Co Ltd v Commissioners of Inland Revenue (1921) 12 TC 427, at p 464.

74. Counsel for the Applicant contended that the only thing disposed of by the Applicant in exchange for the receipt of the FRA was the shares in the Company and that but for the sale of the shares, the Applicant would not have been entitled to the FRA. However, it may equally be said that the Applicant would not become entitled to the FRA unless they agreed to enter into an employment arrangement with the Company or another employing entity. To qualify for the FRA, it was necessary for the Applicant to not only sell the shares, but to also agree to provide services to his employer company for a retention period or if he were to cease to provide services, the reasons for the cessation could not be for "Cause". Although the "Causes" purport to extend beyond matters related to the Applicant's employment, they largely related to the manner in which services would be provided and, in any case, they did not relate to his capacity as a former shareholder. The continuance of the employment relationship was at the heart of the FRA.

75. The Applicant sought to draw a distinction between the consideration for a receipt, on the one hand, and the satisfaction of a condition precedent, on the other hand. This distinction is one of form and not substance in circumstances where the condition precedent to a receipt is the performance by the recipient of some act or activity. Viewed from the perspective of the recipient of the payment, a payment made to them on the condition that (or if) they perform some act may be regarded, as a matter of commercial substance, as a receipt by that person for the performance of that act. Contrary to the submissions for the Applicant, this reasoning does not compel a conclusion that the Earnout Amount would be income of the Applicant because it is based on UPL meeting revenue targets. That is because the condition to the receipt of the Earnout amount by the Applicant is the financial performance of UPL, and not the performance by the Applicant of some act or activity.

76. Contrary to the submissions for the Applicant, the Applicant's "entitlement" to the FRA was not conditional on the absence of a purchase price adjustment in favour of the Purchaser or the absence of claim by the Purchaser under the indemnity. Rather, the effect of section 2.02(b)(7) and section 10.03(b) of the SPA was to set-off any FRA owed by the Purchaser against amounts owed to the Purchaser. The Purchaser's obligation to pay the FRA could be discharged, and the entitlement of the Applicant satisfied, by the set-off. This is consistent with the terms of section 10.03(b). Discharge of an obligation by set-off operates as a payment: Re Harmony and Montague Tin and Copper Mining Co (Spargo's Case)
(1873) LR 8 Ch App 407.

77. For these reasons, the Tribunal does not accept that the FRA was no more than an element of a purchase price received by the Applicant in consideration for the transfer of his shares. A substantial reason for the payment was the continuance of an employment relationship of the Applicant with the Company (or other employing entity). There was an evident connection between the continuance of that employment relationship (or if was to be terminated, the termination had to be without Cause). The continuation of the employment relationship was more than a cause for the payment of the FRA but went to the character of the FRA when received by the Applicant as a Founder, with the result that in substance and reality the FRA received by the Applicant was the product of his income-earning activity. The FRA was made to the Applicant as an individual who, together with JH, had been a Founder of UPL, in relation to the continuation of his employment and for the non-compete and confidentiality obligations related to that capacity, rather than a payment received by the Applicant because he was a transferor of shares in UPL.

78. In correspondence after the hearing, the Tribunal was referred by the Applicant to the decision in Miley and the Commissioner of

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ATC 8567

Taxation
[2019] AATA 5540. The Tribunal makes the following observations in respect of that decision. First, unlike this case, the contract in that case did not identify an amount paid to the taxpayer in consideration for the restrictive covenants. Rather, the taxpayer in that case was seeking to go behind the terms of the contract of sale to allocate value as part of a valuation exercise. Secondly, insofar as one ought to have regard to commercial reality, as the Tribunal in its reasons for decision in Miley recognised at [44], the existence of the restrictive covenants justified the purchaser in that case paying a higher price for the shares than would have been paid in the absence of the covenants. Here, although both the existence of the restrictive covenants given by the Founders and the Founders' agreement to continue as employees may well have enhanced the value of the Purchased Shares, they would not have enhanced the value of the shares held by the Applicant alone and would not explain why the Applicant's shares alone were worth more than the shares of any of the other Sellers. The Tribunal relies upon the terms of the SPA and the context in which it was executed. As evidenced by the terms of the SPA, the parties to the SPA wanted to achieve a sale of the Purchased Shares and secure the Founders' agreement to continue to provide services. On the basis of the terms of the SPA as a whole, the Tribunal here concludes that the FRA was paid to the Applicant in respect of the continuation of his employment.

DECISION

79. Having regard to the totality of the terms of the SPA and the matrix of circumstances, the Tribunal is of the view that the objection decision should be affirmed.