Edited version of your written advice

Authorisation Number: 1012662333984

Ruling

Subject: Capital Gains Tax (CGT) - Sale of business and assets

Question 1

Do the partners in the Joint Venture Partnership (the JV Partnership) need to recognise the capital gain upon the sale of their business and assets to the subsidiary of Company D in the year ended 30 June 2014 pursuant to subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No, the capital gain would need to be recognised in the year ended 30 June 2013.

Question 2

Please confirm that the JV Partnership has made a capital gain of $x during the year ended 30 June 2013 regarding the option provided to Company D pursuant to subsection 104-40(1) of the ITAA1997.

Answer

No, the JV Partnership did not make a capital gain of $x during the year ended 30 June 2013 as CGT event D2 did not happen.

Question 3

Please confirm that because the option was exercised by the subsidiary of Company D during the year ended 30 June 2014, that the $x capital gain made by the JV Partnership will be disregarded pursuant to subsection 104-40(5) of the ITAA 1997 for the year ended 30 June 2013 and should also be included as part of the total disposal proceeds for the year ended 30 June 2014.

Answer

No, as subsection 104-40(1) of the ITAA 1997 is not satisfied, the exception in subsection 104-40(5) of the ITAA 1997 does not apply.

This ruling applies for the following period:

1 July 2012 to 30 June 2014

The scheme commenced in:

Year ended 30 June 2013

Relevant facts and circumstances

The following facts and contentions are based on information provided by the applicant.

Background

Company B is an Australian company that acts as the nominee for the JV Partnership for administrative ease.

The JV Partnership is a business involved in the organisation, staging and promotion of entertainment.

In recent years there have been a number of companies which have made enquiries to purchase the JV Partnership business, including Company D.

The JV Partnership business was recently purchased by Company D.

The JV Partnership has provided relevant clauses of their contract(s) which detail the obligations of the parties.

JV Partnership contentions

The JV Partnership contends the following:

1. After many months of back and forth negotiation a conditional agreement was reached between the parties that was not finalised until the year ended 30 June 2014, being when Company D exercised its option and obtained the required funds.

2. A number of contracts were entered into between the relevant parties during, approximately, a five month period.

3. The first contract (First Contract) was entered into in the year ended 30 June 2013. Company D paid the JV Partnership an option fee after execution of the contract. Subject to certain conditions and provided Company D decided to exercise its option, this contract provided that the JV Partnership would transfer its business and assets to Company D (or a subsidiary).

4. The First Contract was amended by a letter (Amendment 1) signed by all the parties approximately one month after execution of the first contract.

5. Amendment 1 provided for the transaction to close by a specific date. If this did not happen, then the entire deal was to be abandoned.

6. The contract was amended some two months later (Amendment 2). This amendment was to update the disclosure schedules to the contract.

7. The contract was then amended a month later for the final time (Amendment 3). The main changes were an increase in consideration payable to the JV Partnership, the provision for an Earn Out payment and a short extension to the closing date.

Letter from representative of Company D

The letter from the representative from Company D post completion of the sale included:

(a) the acquisition of the JV Partnership business was pursuant to an option which could be exercised by Company D (or a subsidiary) if the following two conditions were satisfied, being:

• the ability of Company D to raise the required finance for the acquisition of the JV Partnership business; and

• for the approval of the 30 June 2013 audited financial statements for the

• JV Partnership.

If these conditions had not been met, then Company D would have ".. . walked away from the deal".

(b) As far as we were concerned, this was an option agreement payment to Company B owners and there did not need to be any particular reason not to exercise the option.

Relevant legislative provisions

Income tax Assessment Act 1936 Former subsection 160U(3).

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Subsection 104-10(1).

Income Tax Assessment Act 1997 Subsection 104-10(2).

Income Tax Assessment Act 1997 Paragraph 104-10(3)(a).

Income Tax Assessment Act 1997 Paragraph 104-10(3)(b).

Income Tax Assessment Act 1997 Section 104-40.

Income Tax Assessment Act 1997 Subsection 104-40(1).

Income Tax Assessment Act 1997 Subsection 104-40(5).

Reasons for decision

All references are to the ITAA 1997 unless otherwise indicated.

Question 1

Summary

The capital gain would need to be recognised in the year ended 30 June 2013.

Detailed reasoning

Section 104-10 contains the rules dealing with CGT event A1.

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1)).You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law (subsection 104-10(2)). The time of the event is when you enter into the contract for the disposal (paragraph 104-10(3)(a)) or, if there is no contract, when the change of ownership occurs (paragraph 104-10(3)(b)).

The time of CGT event A1

The case of Federal Commissioner of Taxation v. Sara Lee Household & Body Care (Australia) Pty Ltd (2000) 201 CLR 520; [2000] HCA 35; 2000 ATC 4378 (Sara Lee) concerned the timing of the disposal of an asset under former subsection 160U(3) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of determining in what year a capital gain arose.

Former subsection 160U(3) of the ITAA 1936, the equivalent of subsection 104-10(3) of the ITAA 1997, read:

160U(3)[Acquisition or disposal under contract]

Where the asset was acquired or disposed of under a contract, the time of acquisition or disposal shall be taken to have been the time of the making of the contract.

Similar to the present circumstances, the changes to the contract in Sara Lee included an increase in the purchase price and a change to the assets and liabilities to be transferred under the agreement. In addition, there was a change in the purchaser and the number of employees to be retained.

The High Court determined that the contract to dispose of the assets of Sara Lee Household & Body Care (Australia) Pty Ltd (the Sara Lee Company) was made at the time of the original contract, not at the time of the amending agreement. This was on the basis that the amending agreement of 30 August 1991 was expressed to be pursuant to the agreement of 31 May 1991, as amended, and that the original agreement of 31 May 1991 had not been rescinded and replaced with the amended agreement.

This is similar to the facts in the present case where the amendments were expressed to be pursuant to the First Contract and specifically referred to that contract. For example:

• Amendment 1 provides that the amendment is subject to all of the terms, conditions and limitations set forth in an Article in the First Contract.

• Amendment 2 refers to the First Contract and provides that apart from the Disclosure Schedules amended herein; they shall remain unchanged and as delivered as of the date of the First Contract.

• Amendment 3 refers to the First Contract and Amendment 1 and provides:

(a) that the First Contract "remains in full force and effect"; and

(b) that the amendment is subject to all of the terms, conditions and limitations set forth in an Article in the First Contract.

In Sara Lee the High Court also considered that the words 'under a contract', in subsection 160U(3) of the ITAA 1936 directed attention to the source of the obligation which was performed by the transfer of assets which constituted the relevant disposal. In this regard, from 31 May 1991, until completion on 30 August 1991, there was a contractual obligation on the Sara Lee Company to dispose of its assets to the purchaser. The content of that obligation did not change. The price was varied, as were certain other terms and conditions of the sale, but the agreement of 31 May 1991 was the source of the obligation which the Sara Lee Company discharged by performance on 30 August 1991. As such, the High Court found the earlier date of 31 May 1991 to be the date the assets were disposed of.

In Tallerman & Co Pty Ltd v. Nathan's Merchandise (Victoria) Pty Ltd (1957) 98 CLR 93 at paragraph 144 Taylor J said:

"It is firmly established by a long line of cases... that the parties to an agreement may vary some of its terms by a subsequent agreement. They may, of course, rescind the earlier agreement altogether, and this may be done either expressly or by implication, but the determining factor must always be the intention of the parties as disclosed by the later agreement."

Amendments 1, 2 and 3 were expressed to be pursuant to First Contract, as amended. Further these amendments were referrable to the First Contract and in some instances where referrable to sections already expressed in the First Contract that suggested an amendment of that type may occur.

For example:

• Whilst Amendment 3 increased consideration payable, the First Contract provided for pre and post closing adjustment to this amount.

• Amendment 1 simply expanded the consequences for not closing by a certain date, that date was already specified in the First Contract.

In addition:

• The First Contract provided for amendments prior to closing; and

• The First Contract was not rescinded; rather the amendments were incorporated into the First Contract and nothing is contained within the subsequent amendments to suggest that these amendments would result in rescission of the First Contract.

As such, it is considered that the intention of the parties as disclosed by the later amendments illustrate that the First Contract was the source of the obligation concerning the sale of the JV Partnership business and assets to Company D. The amendments were not such that the First Contract was superseded by a later contract as the applicant contends.

In the recent decision of Case 2/2013 [2013] AATA 76 (Case 2/2013), the Tribunal considered when the taxpayer in question disposed of the CGT asset comprising his interest in the business. The question was whether, irrespective of what the agent intended to be the effect of the document, or for that matter, the subjective intention of the parties, the Heads of Agreement was a legally binding document between the vendors and the purchaser which bound the parties to the disposal and acquisition of the business. The Tribunal held that the disposal of the CGT asset occurred on 7 August 2008 when the Heads of Agreement was entered into. The Heads of Agreement left little room for doubt that the parties to that document had agreed to the sale and purchase of the business in question. The essentials of the agreement were set out in the document. The document also expressly stated that the parties agreed to be bound by the terms of that document.

Similarly, in the present circumstances the essentials of the agreement between the JV Partnership and Company D is set out in the First Contract. The First Contract also expressly states that the parties agree to be bound by the terms of the First Contract.

In this respect the introduction to the First Contract provides:

"……in consideration of the foregoing and the mutual representations, warranties, covenants and agreements herein contained, and intending to be legally bound herby, the Parties agree as follows:".

Further, a clause in the First Contract provides:

"This agreement, the Transaction Documents and the ancillary agreement related thereto constitute the entire agreement between the parties with respect to the subject matter hereof and supersede all prior agreements, understandings and negotiations, both written and oral, between the parties with respect to the subject matter of this Agreement."

Additionally, the schedules attached to the First Contract identify with precision the essentials of the agreement.

In Case 2/2013, the Tribunal noted with approval the decision in Air Great Lakes Pty Ltd v. KS Easter (Holdings) Pty Ltd (1985) 2 NSWLR 309 at paragraph 332-334 that:

"If the terms of a document indicate that the parties intended to be bound immediately, effect must be given to that intention irrespective of the subject matter, magnitude or complexity of the transaction."

It is considered that the JV partnership executed a contract for the sale of their business and assets to Company D by way of the First Contract. Therefore, CGT event A1 occurred in the year ended 30 June 2013 unless the First Contract was, as the JV Partnership contends, subject to a condition precedent to formation which delayed entry into the contract or, alternatively, the First Contract was only for the grant of an option and the contract was formed once that option had been exercised by Company D.

Condition precedent or subsequent

The JV Partnership contends that the parties did not execute a contract in the year ended 30 June 2013 as it was subject to the following conditions precedent:

• preparation of the 30 June 2013 accounts for JV Partnership to the satisfaction of Company D; and

• the obtaining of finance to fund the acquisition by Company D.

In addition, the First Contract was then amended three times.

The JV Partnership considers that when a contract is conditional on both of these conditions and is then subsequently amended to key clauses such as consideration payable, this lends itself to a conclusion that these are conditions precedent as to the formation of a contract - not just conditions subsequent.

A condition precedent is one which must be satisfied prior to an agreement becoming operative as a contract, whereas a condition subsequent is one which must be satisfied after the contract is formed, but before the contract can be completed.

As noted by Mason J in Perri v. Coolangatta Investments (1982) 149 CLR 537 (Perri), courts will generally tend to favour a construction which leads to the conclusion that a particular stipulation is a condition precedent to performance, rather than a condition precedent to the formation or existence of a contract.

In Perri, the court noted that conditions precedent to formation of a contract is such that no contractual rights are enforceable by either party until the condition is satisfied. The court distinguished this with conditions precedent to performance, where a binding contract does exist, but the obligations of either party to perform depend on the fulfilment of the condition(s). In such a case the condition does not prevent the creation of the contract; rather, where a condition is not fulfilled either one or both parties may be entitled to terminate the contract.

Mason J went on to state in Perri at paragraph 552 that a condition "will not be construed as a condition precedent to the formation of a contract unless the contract read as a whole plainly compels this conclusion."

It is considered that the First Contract read as a whole does not compel a conclusion that the two conditions identified by the applicant, being the 30 June 2013 financial accounts for the JV Partnership and the obtaining of finance by Company D are conditions precedent to formation. Nor do the subsequent amendments compel such a conclusion. The language used in the two conditions and the amendments themselves evidence that the parties intended to be bound by the First Contract from the date of execution.

The First Contract:

• contains the necessary essential elements regarding the sale of the JV Partnership business and assets;

• expresses that the parties agree to be legally bound by the First Contract,

• was not rescinded; and

• the amendments formed part of and were to be read in conjunction with the First Contract.

In Meehan v. Jones (1982) 149 CLR the High Court indicated that a contractual condition, such as obtaining approval for finance by the vendor, will not be a condition precedent to the formation of the contract but rather a condition precedent to the performance of the contract or a condition subsequent, which in either case the contract is valid from the time the contract is made.

In terms of variation in consideration, in Sara Lee at paragraph 47 the High Court dismissed the Full Federal Court's finding that the "variation in consideration …. was of particular significance" in determining the date of the contract. The High Court also confirmed at paragraph 40:

"In order for there to be a disposal under a contract for the purposes of s 160U(3) it is not necessary that the contract be unconditional or specifically enforceable. What is relevant is the time of the making of the contract, not the time when it became unconditional, or specifically enforceable."

In Case 2/2013, the Tribunal determined that the special conditions in the Heads of Agreement did not have the effect of negating a binding agreement until such time as the formal contract of sale was executed. The fact that the parties contemplated a formal agreement containing similar terms and the conditions to those set out in the Heads of Agreement was not an obstacle to finding that the Heads of Agreement constituted a binding legal agreement. With reference to Masters v Cameron (1954) 91 CLR 353, the Tribunal held that the Heads of Agreement document made it very clear that the vendors and the purchaser had agreed to the sale of the business as the document expressly stated that to be the case. Furthermore, they had agreed to the sale on the terms and conditions set out in the first schedule. Relevantly, the document also stated that the parties agreed to be bound by the terms of the Heads of Agreement.

Similarly, in the present circumstances, as previously mentioned, the parties agreed to the sale and purchase of the JV Partnership business and assets on the terms and conditions set out in the First Contract and agreed to be bound by the First Contract. It is considered that the subsequent amendments to the First Contract were not conditions precedent to the formation of the contract, particularly given the First Contract was not rescinded, no other contract was entered into between the parties for the sale of the JV Partnership business and assets and the amendments were incorporated into the First Contract.

Therefore, it is considered that the two conditions identified by the applicant and the subsequent amendments to the First Contract, if one accepts the applicant's description of these amendments as being conditions, are conditions subsequent to performance of a contract. Therefore a contract for the sale of the JV Partnership business and assets was executed in the year ended 30 June 2013 by way of the First Contract.

Is the First Contract correctly categorised as an option agreement?

Alternatively, the applicant contends that the First Contract and various amendments up to and including Amendment 3 are correctly categorised as an option agreement either:

• acquired by Company D during the year ended 30 June 2013 and then exercised during the year ended 30 June 2014; or

• granted to Company D during the year ended 30 June 2014 (because of the various amendments) and not exercised until the year ended 30 June 2014.

The applicant refers to the letter from the representative of Company D provided post completion of the sale which states that Company D regarded the First Contract (and the subsequent amendments thereto) as in essence, an option contract with an amount of $x payable to the JV Partnership vendors.

The applicant also states that other information provided clearly states that the subsidiary of Company D was not to be consolidated with Company D until the date it exercised its option.

However, the First Contract specifies that the amount of $x payable to the JV Partnership is a deposit and part payment of the cash payment. In no way does the First Contract imply that that contract or the $x payment is an option, nor do any of the subsequent amendments.

The stated intention of the representative for Company D does not accord with what is set out in the First Contract. The objective evidence available does not support any such contention.

Whilst the parties may have had an intention for the sale and purchase of the JV Partnership business and assets to be in the form of an option, as stated in Case 2/2013 at paragraph 60 "where those intentions are not reflected in the executed document they cannot be relied upon because the document supplants whatever may have been in contemplation prior to its execution". Similarly to the Heads of Agreement document in Case 2/2013, the First Contract is not ambiguous. The First Contract clearly sets out that the $x payment is s a deposit and part payment of the cash payment.

In respect of the other information provided, it is noted that information does not state the payment of $x is the grant of an option; rather, it states the payment was an advance to the JV Partnership. In addition, the extract does not mention an option agreement and refers to the contract being 'consummated', not an option being exercised.

Therefore, it is considered that the First Contract and various amendments up to and including Amendment 3 cannot be categorised as an option agreement.

Conclusion

It is considered that the JV Partnership entered into a contract for the sale of their business and assets to Company D by way of the First Contract. Therefore, CGT event A1 occurred in the year ended 30 June 2013 and the JV Partnership would need to recognise the capital gain in that year pursuant to section 104-10.

Question 2

Summary

The JV Partnership did not make a capital gain of $x during the year ended 30 June 2013 as CGT event D2 did not happen.

Detailed reasoning

In accordance with subsection 104-40(1), CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted.

As per the reasoning provided in Question 1, it is considered that the First Contract and various amendments up to and including Amendment 3 cannot be categorised as an option agreement.

Therefore CGT event D2 did not happen and consequently, the JV Partnership did not make a capital gain of $x during the year ended 30 June 2013.

Question 3

Summary

As subsection 104-40(1) is not satisfied, the exception in subsection 104-40(5) does not apply.

Detailed reasoning

In accordance with subsection 104-40(5), a capital gain or capital loss you make from the grant, renewal or extension of the option is disregarded if the option is exercised.

However as per the reasoning provided at Question 2, as subsection 104-40(1) is not satisfied, the exception in subsection 104-40(5) does not apply.