In our October 2018 Tax Flash, we discussed a recent Federal Court case where a taxpayer unsuccessfully challenged the Commissioner of Taxation’s decision to deny his claim of share losses on revenue account. In a more recent case, another taxpayer also lost her case, albeit this time the taxpayer unsuccessfully argued that the gains made on the sale of her shares were on capital account.
Therefore, the Commissioner has successfully argued that losses on the sale of shares were capital losses in one case and then gains on the sale of shares were income in another case.
Both cases demonstrate that the area is still fraught with difficulties for taxpayers and their tax advisers despite some “well-established principles”. The issue of the capital and revenue distinction goes back to old English common law. It was Lord Greene M.R. who said of the distinction between capital and revenue that “there have been many cases which fall on the borderline. Indeed, in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons.”
In light of the recent cases, we can safely say that nothing much has changed since Lord Greene made that remark in 1938.
The taxpayer acquired just over 300,000 shares in Doyles Creek Mining Pty Ltd (DCM) at a cost of almost $320,000 between February 2007 and October 2009. Her husband was a director of DCM.
In December 2008, DCM was granted an Exploration Licence allowing the company to prospect, subject to conditions, on the Doyles Creek tenement for a term of 4 years. The grant was subject to special conditions.
It was intended that a training mine be established on the site and a draft contract for the training mine between DCM and a subsidiary of a related company (ResCo Services Pty Ltd) had been prepared.
In November 2009, DCM undertook a backdoor public listing through NuCoal Resources NL (NuCoal). Under the agreement, NuCoal would acquire all of the shares in DCM in return for the shareholders of DCM being issued shares in NuCoal in proportion to their shareholdings in DCM. NuCoal would then raise at least $10 million in share capital, which was to be used to fund exploration and drilling programs on the Doyles Creek tenement and would then be re-listed on the Australian Stock Exchange.
In February 2010, the taxpayer received 46,529,778 shares in NuCoal fully paid at $0.20 per share in exchange for her shareholding in DCM. The taxpayer contended that the exchange of her shares in DCM for shares in NuCoal satisfied the necessary conditions to allow her to choose the scrip-for-scrip roll-over relief under Subdivision 124-M of the Income Tax Assessment Act 1997 (ITAA97).
The taxpayer then disposed of her NuCoal shares in various tranches between March and September 2010 and received a total of just over $10 million. The taxpayer treated the gains from the sale of shares in DCM and NuCoal as capital gains and applied the 50% CGT discount for the 2010 and 2011 income years.
The Commissioner, however, issued amended assessments for 2010 and 2011 on the basis that the profits on the sale of the DCM and NuCoal shares were assessable income and not a capital gain. An administrative penalty of 50% for the 2010 year was also imposed.
The Tribunal found that the taxpayer acquired the DCM and NuCoal shares as part of a business or commercial operation in which she and her husband were involved as equal partners. In particular, the essence of the relevant business or commercial operation or transaction to which the taxpayer was a party was a scheme to establish a company or companies in which she was a shareholder and her husband a director and manager, for the purpose of the company or companies obtaining directly allocated exploration licences.
The Tribunal also found that the taxpayer’s shares were acquired with the purpose of profit by sale. Her shares would increase in value as a result of the exploration licences and this would enable her to realise a profit by sale “as and when and in the manner most opportune”.
The Tribunal did not accept the taxpayer’s submission that “the taxpayer’s activities were limited to acquiring, passively holding of shares in DCM and then Nucoal, reading information provided to shareholders and then disposing of the shares, and was not involved in day to day management”.
Accordingly, the Tribunal held that the DCM and NuCoal shares were acquired on revenue (not capital) account and the profit she made on their sale is assessable as ordinary income. It also followed that the scrip-for-scrip rollover relief was not available to the taxpayer as the shares were on revenue account.
The Tribunal upheld the 50% administration penalty imposed by the Commissioner for recklessness. In particular, the Tribunal found that the taxpayer’s failure to provide her tax agent with complete and accurate information to enable him to prepare the 2010 return was a relevant factor. In the case, the taxpayer only gave her tax agent the documents he requested and failed to provide him with full details about her intentions and the profit-making commercial operation to properly account for the sale of the shares.
It is not uncommon for shareholders and directors of a company to also be actively involved in the day-to-day management of the company. However, this does not mean that there will necessarily be a business or commercial operation with a profit-making intention on the acquisition of the shares in that company. Each case should be decided on its own facts and circumstances. In this case, the husband’s activities with DCM clearly tainted the Tribunal’s view on the basis upon which the shares were held.
As the case demonstrates, tax advisers should not just accept the bare minimum information provided by our clients and rely on checklists to ensure compliance with the tax law. With the benefit of hindsight, if the tax agent had understood his client’s (and her husband’s) business affairs better and had taken more steps in addressing those issues (either during the preparation of the return or ATO review), at least the taxpayer could have had a better chance in arguing that she had taken reasonable care and/or had a reasonably arguable position, ensuring she did not get a 50% penalty on top of an already significant amended tax bill.