Edited version of private advice

Authorisation Number: 1051969819328

Date of advice: 14 April 2022

Ruling

Subject: Pre-CGT asset - verbal contract

Question

Will the capital gain made by the Trust on the disposal of the Company shares be disregarded under paragraph 104-10(5)(a) of the Income tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

ABC Pty Ltd (the Company) was incorporated on XX XX XX.

The initial shareholders of the Company were:

The Company operates the 'X' business.

At inception of the Company, Shareholder 2 had limited financial resources to invest and grow the business and sought financial assistance from their father, Person A.

At the time of incorporation of the Company, Person A was under a contractual restraint of trade (the Restraint) in relation to the sale of their interest in another entity in XX. The Restraint prevented Person A from owning shares in a business similar to that conducted by the Company.

In or around XX XX a verbal business arrangement (Share Grant Agreement) was entered into:

•         As consideration for Person A to provide or procure finance (Finance) up to $X for the Company, the shareholders of the Company and Person A (Stakeholders) agreed that the Company would grant shares in the Company to Person A's nominee, the X Trust (Trust), over X% of the share capital of the Company when the Restraint ended.

•         The parties intended to be legally bound by the Share Grant Agreement.

•         The agreement was between family members and Shareholder 1 who did not want to incur unnecessary legal expenses of putting it in writing at the time.

The Finance was provided or procured by Person A in three stages:

•         Person A provided a guarantee on XX XX XX for a $X credit facility with a bank secured over assets of the family trust.

•         After that, Person provided some cash to help the business, and

•         when the business required further financing to fund working capital, the credit facility with the bank was extended and, as the family trust assets were insufficient security, Person A provided a further guarantee on XX XX XX using the Family Home as security.

There was no additional consideration provided for the XX XX extension to the credit facility, as the original agreement was for the assistance in securing credit up to $X.

There were no changes to the original Share Grant Agreement or any other subsequent agreements or contracts entered into for the issue of the Company shares to the Trust.

At the same time that the Share Grant Agreement was entered into, the Stakeholders also agreed that the Company would issue additional ordinary shares in the capital of the Company to Shareholder 1 when the shares were issued pursuant to the Share Grant Agreement in order for Shareholder 1 to maintain a X% shareholding in the Company (Top-Up Agreement)

The Restraint ended in late XX and:

•         in accordance with the Share Grant Agreement, the Trust was issued X ordinary shares in the capital of the Company, and

•         in accordance with the Top-Up Agreement, Shareholder 1 was issued with an additional X Ordinary shares in the capital of the Company in accordance with the Top-Up Agreement.

Given the age of these events and the changing of offices and/or advisers over a number of decades, the relevant Stakeholders do not have any documentary records of the Share Grant Agreement or the Top-Up Agreement.

The current shareholders of the Company are:

Shareholder Number of Shares Percentage of Shares

Shareholder 1 X X%

Shareholder 2 X X%

The Trust X X%

The shareholders of the Company are in the process of negotiating a share sale in relation to the Company.

CGT event A1 will happen when the Trusts disposes of the Company shares.

The Trust's capital proceeds from the disposal of the Company shares will be more that the Trust's cost base for the shares.

CGT event K6 will not happen when the Trust disposes of the Company shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 paragraph 104-10(5)(a)

Income Tax Assessment Act 1997 Division 109

Income Tax Assessment Act 1997 Item 2 of the table in section 109-10

Reasons for decision

All references are to the Income tax Assessment Act 1997 unless otherwise specified.

Section 104-10 sets out how to work out if you have made a gain or loss from CGT event A1.

Paragraph 104-10(5)(a) provides that any capital gain or capital loss you make on disposal of an asset acquired before 20 September 1985 (pre-CGT) is disregarded.

The time of acquisition of the shares is determined in accordance with Division 109.

When a company issues or allots shares, the time of acquisition of the shares is when the contract is entered into or, where there is no contract, when the shares are issued or allotted (item 2 of the table in section 109-10).

A contract is a legally binding agreement between two or more parties and is required to have the attributes prescribed by common law for the formation of a contract, including an offer, acceptance, consideration, and an intention to create legal relationships.

The time when a contract is entered into is the time when it comes into existence for general law purposes. Generally, a binding contract is entered into where one party communicates unconditional acceptance of an offer made by the other party.

The relevant contract is the contract that is the source of the obligation to make a specific issue or allotment of shares.

An oral contract may be a contract, provided it has the attributes required by common law. In construing the oral agreement, all the relevant facts must be looked at objectively in order to identify the terms of the contract (Re Combined Security Systems & Designs Pty Ltd; Hawthorne v. Harris (Unreported, QG 3026 of 2994, Federal Court of Australia, Drummond J, 28 February 1995); Handbury v. Nolan (1977) 13 ALR 339).

In or around January 1985 a verbal Share Grant Agreement was entered into under which:

•         Person A procured Finance for the Company,

•         in exchange for that finance, the Stakeholders agreed that, when Person A's Restraint ended, the Company would grant shares in the Company to the Trust equal to over 30% of the share capital of the Company.

While the agreement was not in writing, a number of facts that are consistent with the terms of the agreement can be independently verified from third party sources, including:

•         At the time of incorporation of the Company, Person A was under a Restraint that commenced in XX and ended in XX.

•         Person A procured a credit facility for the Company through guarantees and using personal and an associated trust's assets as security, in XX XX and again in XX XX

•         The Trust obtained a X% shareholding in the Company after the Restraint ended.

Given the amount of the Finance at the time, Person A was taking a significant financial risk in providing assets in his control as security for the Company's business.

While Person A had a familial connection with the majority shareholder of the Company, given the risk he was taking on the new company being a success, it would be reasonable to conclude that Person A would have sought something in return, like an equitable interest in the business.

However, at the time Person A was under a Restraint that acted as a barrier in holding shares in the type of business the Company conducted until its end in XX.

Accordingly, the mismatch in the timing between the guarantees provided for the Company's Finance and the Trust being issued Company shares is explicable by the Restraint period.

It is reasonable to conclude that based on the facts there was an agreement entered into between the Stakeholders to issue the Company shares in return for the consideration of procuring the Finance.

The completion of the terms of the agreement supports the parties' intention to be legally bound by the agreement.

The Share Grant Agreement contains all the other elements of a contract, i.e., an offer, consideration and acceptance.

As the first guarantee occurred in XX XX, it is reasonable to conclude the Share Grant Agreement would have occurred on or before the timing of this guarantee, being on or before XX XX XX.

As there were no changes to the original Share Grant Agreement or any other subsequent agreements or contracts entered into for the issue of the Company shares to the Trust, the contract that is the source of the obligation to issue Company shares to the Trust is the Share Grant Agreement.

Accordingly, the Trust's Company shares are taken to be acquired before 20 September 1985 and any capital gain made by the Trust on the disposal of these shares is disregarded under paragraph 104-10(5)(a).