Edited version of private advice

Authorisation Number: 1052139033526

Date of advice: 10 July 2023

Ruling

Subject: CGT - disposal of an asset

Question

Did CGT event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) happen to the Seller in the 2023 income year in relation to the disposal of its Sale Shares to the Buyer pursuant to the Share Purchase Deed?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 2022

Income year ended 30 June 2023

Relevant facts and circumstances

In the 2022 income year the Sellers sold 100% of their shares in Company A and (to the extent any were held) 50% of their shares in Company B to Company C (the Buyer) under a Share Purchase Deed (the Contract).

The Contract included the following defined terms (at clause 1.1):

•         Completion meaning completion of the sale and purchase of the Sale Shares pursuant to the Contract.

•         Completion Date meaning the later of:

•         1 July 2022;

•         the date which is the last Business Day of the month in which all the Conditions have been satisfied (or waived under clause 2.3), or if that date is less than 10 Business Days before the end of the month, the last Business Day of the following month; or

•         such other date as the Sellers and the Buyer agree in writing.

•         Condition meaning each condition specified in clause 2.1.

•         Sunset Date meaning 31 August 2022 or any other date the parties agree on in writing before that date.

Clause 3 of the Contract requires (among other things) the Sellers to sell and the Buyer to purchase the Sale Shares for the Purchase Price at Completion on the terms and conditions of the Contract and clause 5 of the Contract sets out the obligations on the parties on or before Completion.

However, pursuant to clause 2.1 of the Contract, clauses 3 and 5 of the Contract will not be binding on the parties and Completion will not take place until each of the Conditions precedent listed in the table at clause 2.1 have been either satisfied or waived in accordance with clause 2.3.

Clause 2.1 of the Contract lists nine Conditions precedent including the following Condition, which the Buyer and the Sellers have the right to waive:

ACCC: Any of the following occur (the ACCC Condition):

(a) (ACCC no intention notice): the Buyer having received notice in writing from the ACCC stating words to the effect that the ACCC does not have any concerns or objection to, and/or does not intend to oppose, or take any action to prevent, the proposed transfer of the Sale Shares to the Buyer, either on an unconditional basis or subject to undertakings and those undertakings being acceptable to the Buyer (acting reasonably);

(b) (Authorisation): either

(i) the ACCC has made a final determination to authorise the proposed transfer of the Sale Shares either on an unconditional basis or subject to conditions which are reasonably acceptable to the Buyer and Sellers (each acting reasonably);

or

(ii) the Australian Competition Tribunal has made a final determination to authorise the proposed transfer of the Sale Shares either on an unconditional basis or subject to conditions which are reasonably acceptable to the Buyer and Sellers (each acting reasonably); or

(c) (Federal Court of Australia declaration): the Buyer having obtained a declaration from the Federal Court of Australia that the proposed transfer of the Sale Shares to the Buyer would not result in a contravention of section 50 of the Competition and Consumer Act 2010 (Cth) and a valid application for review of the declaration has not been lodged.

The parties were to use their best endeavours to procure the due fulfilment of the Conditions listed in clause 2.1 of the Contract as soon as practicable after the Execution Date (the date on which the last of the parties executed the Contract) and on or before the Sunset Date (clause 2.2 of the Contract).

Clause 2.3 of the Contract allows for the Conditions to be waived:

Each of the Conditions is for the benefit of the parties identified in Column B of the table in clause 2.1 and may only be waived by those parties in writing. To the extent the Condition is for the benefit of both the Buyer and the Sellers, then the Condition may only be waived with the written consent of both the Buyer and the Sellers.

If any of the Conditions are not satisfied or waived by the Sunset Date, clause 2.4 of the Contract provides that the Contract:

... may be terminated by the party entitled to the benefit of that Condition by giving notice to all other parties, provided that the terminating party has complied with its obligations under clause 2.2 and is not otherwise in breach of this document. For the avoidance of doubt, either the Sellers or the Buyer is entitled to terminate this document in circumstances where the relevant Condition is for the benefit of both of them.

The Buyer can also terminate the Contract pursuant to clause 2.5 of the Contract:

...at any time before Completion by notice to the Sellers' Representative if:

(a) the Sellers breach this document, including if any Sellers' Warranty is found to be materially incorrect or misleading during that period;

(b) a receiver, receiver and manager, Controller, provisional liquidator, liquidator or other officer appointed by a court is appointed to a Group Company or a Seller; or

(c) a Material Adverse Change occurs.

Clause 2.6 of the Contract states:

(a) If a notice of termination is issued pursuant to clause 2.4 or clause 2.5 then in addition to any other rights, powers or remedies under Law:

(i) subject to the provisions of clause 2.6(b), this document will be of no further effect and no party will be liable to any other party except in respect of any breach of this document occurring before that termination, and each party is released from its obligations to perform under this document; and

(ii) each party retains the rights it has against any other party concerning a past breach of this document.

(b) Clause 2.6(a) does not apply to a party's obligations of confidentiality as set out in clause 13.1, which survives termination of this document.

Clause 4 of the Contract sets out pre-Completion obligations in the period between the Execution Date and Completion (subject to earlier termination of the Contract), and requires the Sellers, among other things, to take all necessary actions to allow the Buyer to have access to Business Records, and ensure that the Group carries on the Business properly and efficiently, notifies the Buyers of all material decisions concerning the Business and preserves the value of the goodwill of the Business.

Clause 5.5 of the Contract outlines the procedure if there is a failure to Complete the Contract on the Completion Date. The non-defaulting party is entitled to make a Claim against the defaulting party for any Loss suffered or incurred as a result of or in connection with the failure of the defaulting party to Complete on the Completion Date.

Clause 20.3 of the Contract allows for the variation of the Contract and clause 20.6 of the Contract states:

(a) A single or partial exercise or waiver of a right relating to this document does not prevent any other exercise of that right or the exercise of any other right.

(b) No party will be liable for any loss or expenses incurred by another party caused or contributed to by the waiver, exercise, attempted exercise, failure to exercise or delay in the exercise of a right.

ACCC Notice

In respect of the Condition at item 1(a) of the table at clause 2.1 of the Contract, the Australian Competition & Consumer Commission (ACCC) concluded in a letter dated during the 2023 income year, based on the information provided to it by the Buyer and Company A during the 2022 income year, that:

...the ACCC does not intend to conduct a public review of the proposed acquisition pursuant to section 50 of the Competition and Consumer Act 2010 (Cth).

Nevertheless, should new information come to the ACCC's attention, or should it become aware that any information upon which it has based its view is incorrect or incomplete, the ACCC reserves the right to reconsider this decision.

Section 50 of the Competition and Consumer Act 2010 prohibits the acquisition of shares or assets that would have the effect, or likely effect, of substantially lessening competition in a market.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 section 108-5

Competition and Consumer Act 2010 section 50

Reasons for decision

Summary

CGT event A1 happened at the time the Seller entered into the Contract to dispose of its Sale Shares as the conditions precedent referred to in clause 2.1 of the Contract are conditions which are precedent to a party performing their part of the Contract (not precedent to the formation or existence of the Contract).

Detailed reasoning

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. Shares are a CGT asset (section 108-5 of the ITAA 1997).

Under section 104-10 of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(3) of the ITAA 1997 provides that the time of the event is when you enter into the contract for the disposal or, if there is no contract, when the change of ownership occurs.

The meaning of the phrase 'entered into', as referred to in subsection 104-10(3) of the ITAA 1997, is not defined in the legislation. However, under the general law, the time when a contract is entered into is the time when the contract comes into existence. The existence of a contract occurs when a binding contract is formed upon the establishment of an agreement between parties (in the form of an offer and acceptance of that offer) where consideration passes, or will pass, from one party to another and the parties intend to be legally bound by this agreement.

It is recognised that there may be matters that affect the formation of a contract; namely, where there are conditions precedent to the formation of the contract.

The Sellers entered into the Contract during the 2022 income year for the sale of the Sale Shares to the Buyer. The Contract contains Conditions, listed at clause 2.1 under the heading 'Conditions precedent'. It is therefore necessary to determine whether the Conditions under the Contract resulted in the formation of the Contract on a date later than the date on which the Contract was executed.

Taxation Determination TD 2002/4[1] (at paragraph 5) relevantly draws a distinction between a condition which is precedent to the formation or existence of a contract and a condition which is precedent to performance of a contract. It provides that the non-fulfilment of a condition precedent to the formation of a contract prevents a binding contract from coming into existence, that is, no contractual rights enforceable by the parties to the contract are created unless and until the condition is fulfilled. This can be contrasted with a condition precedent to the obligation of a party to perform their part of the contract. That is, a binding contract exists which creates rights capable of enforcement, though the obligation of a party (or both parties) to perform their part of the contract depends on fulfilment of that condition and non-fulfilment of the condition entitles one or both parties to terminate the contract.

The preference of the courts is to construe a contract as containing conditions precedent to performance, as opposed to formation. This is based on Perri v Coolangatta Investments Pty Ltd (1982) 149 CLR 537 (Perri), where Mason J (although dissenting in the ultimate conclusion) stated at 552:

Generally speaking the court will tend to favour that construction which leads to the conclusion that a particular stipulation is a condition precedent to performance as against that which leads to the conclusion that the stipulation is a condition precedent to the formation or existence of a contract. In most cases it is artificial to say, in the face of the details settled upon by the parties, that there is no binding contract unless the event in question happens. Instead, it is appropriate in conformity with the mutual intention of the parties to say that there is a binding contract which makes the stipulated event a condition precedent to the duty of one party, or perhaps of both parties, to perform. For these reasons the 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. [emphasis added]

It is clear from the words of Mason J that the language of a contract is critical when determining whether a condition in the contract is intended by the parties to be a condition precedent to formation or performance of the contract.

It is likely that, if a contract can progress or be enforced without a condition being satisfied, the contract is already in existence and is valid and binding on the parties, and it will follow that the condition is a condition precedent to performance of some obligations under the contract, as opposed to the contract's formation. The condition discussed in Perri, which was held to be a condition precedent to the performance of the contract, was a condition that the parties could waive.

In Scott v Rania [1996] NZLR 527, McCarthy J (who formed part of the majority of the New Zealand Court of Appeal in that case) stated at paragraph 535 in obiter that "with a condition subsequent [meaning a condition precedent to the performance of a contract] it may be easier to find waiver or election." By inference, where the contract does not provide for, or the general law does not allow for, the waiver of the condition, it is more likely to be construed as a condition precedent to the formation of the contract.

Application to your circumstances

The Conditions under clause 2.1 of the Contract are conditions precedent to the performance of the Contract (and not conditions precedent to the formation of the Contract). This is evident in the language of the Contract which shows the parties' intentions to be bound by the Contract from the time of its execution and regardless of the Conditions having been met (as demonstrated by the following examples).

Clause 2.3 of the Contract allows for the Conditions in clause 2.1 to be waived by written consent from the party or parties benefiting from the Condition. A waiver would only be able to be exercised by a party if an existing enforceable right exists. Therefore, the ability of the parties to waive the Conditions under the Contract suggests that the proper construction of the conditions precedent clause of the Contract is as conditions precedent to performance of the Contract.

If any Condition under clause 2.1 of the Contract is not satisfied or waived in accordance with clause 2.3 of the Contract by the Sunset Date then the Contract may be terminated pursuant to clause 2.4 by the party entitled to the benefit of that Condition (or by either of the parties entitled to the benefit of that Condition) if the terminating party has complied with its obligation (under clause 2.2) to use their best endeavours to fulfill the Conditions after the Execution Date and on or before the Sunset Date. The Buyer can also terminate the Contract pursuant to clause 2.5 where one of the events listed under that clause happens at any time before Completion.

This means that from the date the Contract is executed binding obligations are created between the parties that may be terminated under clause 2.4 or 2.5. The termination rights are in existence, notwithstanding that the conditions precedent may not yet be met, and this too suggests that the proper construction of the conditions precedent clause of the Contract is as conditions precedent to performance of the Contract.

Clause 4 of the Contract sets out the pre-Completion obligations of the Seller, as required to be satisfied between the Execution Date and Completion (subject to earlier termination of the Contract). This acknowledges the need to govern rights and obligations from the date the Contract is executed until Completion, regardless of the conditions precedent being met and also suggests that the proper construction of the conditions precedent clause of the Contract is as conditions precedent to performance of the Contract.

Conclusion

The case law has established 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. When the Contract is viewed as a whole there are clauses that do not support a conclusion that the clause containing conditions precedent needs to be met before the formation of a contract between the parties.

It cannot be said that the Contract, when read as a whole, plainly compels the conclusion that the conditions precedent are to be construed as a condition precedent to the formation of a contract. The Conditions in clause 2.1 of the Contract are conditions precedent to performance.

Given the above, the Sellers entered the Contract during the 2022 income year, when they executed the Contract. For the purposes of subsection 104-10(3) of the ITAA 1997, the CGT event A1 to dispose of the Sale Shares happened when the Seller entered the Contract in the 2022 income year.

[1] Income tax: capital gains: what is the first element of the cost base and reduced cost base of a share in a company you acquire in exchange for a share in another company in a takeover or merger?