Tax Files: paying tax on profit-making transactions – By Andrew Shaw

No gain without pain – paying tax on profit-making transactions

ANDREW SHAW, SHAW LAWYERS

“The best things in life are free, but you can give them to the birds and bees, I want money (that’s what-I-want), I want money (that’s what-I-want), just give me money (what-I-want), that’s what I want.” – Bradford & Gordy, “Money (That’s What I Want)” (1959)

Arecent decision of the Administrative Appeals Tribunal in XPQZ, KYZC, DHJP v Commissioner of Taxation is a reminder that gains made on the sale of shares may be taxable as income according to ordinary concepts, rather than as capital gains. 1 As a result, the discounted basis of taxation applicable to capital gains is not available. 2 Further, such income cannot be offset against current or carry forward capital losses.

It is important to bear these rules in mind in any transaction intended to produce a profit, even if the transaction is not in the course of carrying on a business. An obvious example is buying up listed shares while stock markets are depressed in anticipation of making quick profits as they recover post-COVID.

BACKGROUND

The trustee of a trust (Trustee) acquired shares in Doyles Creek Mining Pty Ltd (Doyle’s Creek). In 2007 Doyle’s Creek acquired land in the Hunter Valley and sought an exploration licence by direct allocation (i.e. without participating in a tender process). When the exploration licence was allocated to Doyle’s Creek, the value of Doyle’s Creek increased greatly.

The Trustee sold some shares in Doyle’s Creek in October, 2009. In February, 2010 the Trustee exchanged its remaining shares for shares in NuCoal Resources Pty Ltd. The sole shareholder and director of the Trustee (Mr Poole) was also a director of Doyle’s Creek and NuCoal.

The gains on disposal of the shares were almost $17 million. The Trustee treated the gains as on capital account. The gains were therefore taxed on a discounted basis (50% discount) in the hands of beneficiaries of the Trust.

The Commissioner of Taxation issued assessments which treated the gains as income under ordinary concepts, rather than as discounted capital gains. The Commissioner also assessed penalties equal to 50% of the primary tax on the basis that the Trustee’s treatment of the gains on capital account was “reckless”.

BURDEN OF PROOF

A taxpayer has the burden of proving on the balance of probabilities that an assessment is excessive, and in what amount the assessment should have been made. 3 If a taxpayer succeeds in “weighing down [the] scales ever so slightly in his favour then he has discharged the burden he carries”. 4 It was therefore up to the Trustee to convince the Tribunal that the gains should properly be taxable on capital account.

GENERAL PRINCIPLES

A gain made on sale of property will be on revenue account on two alternative bases, known as the first and third limbs identified by the High Court in the leading authority of Commissioner of Taxation v The Myer Emporium Limited (1987) 163 CLR 199, namely: • The gains were made in the ordinary course of carrying on a business of buying and selling property; or • The property generating the gain was acquired in “a business operation or commercial transaction” for the purpose of profit-making by the means giving rise to the profit (i.e. by sale of the property).

The profit or gain must be associated with a “scheme, business operation or commercial transaction”, and must also be accompanied by the relevant purpose of profitmaking at the time of the acquisition. Where a transaction occurs outside the scope of ordinary business activities, it is necessary to find, not only that the transaction is “commercial”, but also that there was, at the relevant time, the intention or purpose of making a relevant profit “in the manner contemplated by the taxpayer”. 5

Professor Parsons described the features which are necessary to give a transaction the character of a business deal or of a trade of dealing on a single occasion as including “an elusive factor that is more than purpose to profit”. Parsons opined that “the transaction must be the sort of thing a business man or man of trade does…”. 6

An acquisition of property for longterm investment does not have the quality of a business operation or commercial transaction even if there is a hope or expectation of eventual gain on sale. In WestfieldLimited, the Full Federal Court held that a profit from sale of land by a

taxpayer who had acquired the land with the intention of developing it, and not to realise a profit by resale, was not part of a profit-making scheme. It was therefore a gain of a capital nature, rather than income in ordinary concepts:

“While a profit-making scheme may lack specificity of detail, the mode of achieving that profit must be one contemplated by the taxpayer as at least one of the alternatives by which the profit could be realised. Such was the case in Steinberg. But, even if that goes too far, it is difficult to conceive of a case where a taxpayer would be said to have made a profit from the carrying on, or carrying out, of a profit-making scheme, where, in the case of the scheme involving the acquisition and resale of land, “there was, at the time of acquisition, no purpose of resale of land, but only the possibility (present, one may observe, in the case of every acquisition of land) that the land may be resold”. 7

The fact that an owner decides not to persist with an income producing activity, but instead to sell the property, does not mean that the proceeds of realisation necessarily become taxable as ordinary income. The profit is assessable as ordinary income only if it arises from the carrying on of the business or a profitmaking undertaking or scheme. In Statham v FCT (1989) 89 ATC 4070 the Full Federal Court observed:

“It is well established by the reported cases, including those mentioned above, that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from the carrying on of a business or a profitmaking undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant matter to be taken into account in determining the nature of the realisation, i.e. in determining whether the facts establish a mere realisation of a capital asset or a business or profitmaking undertaking or scheme.” 8

DECISION IN THE PRESENT CASE

It was not suggested that the Trustee was carrying on business as a share trader, or any business at all. The Tribunal noted:

“However, it is well established that gains on disposal of property acquired otherwise than in the course of a business but in a “business operation or commercial transaction” for the purpose of disposal at a profit, by the means giving rise to the gains, are on revenue account and therefore ordinary income under s 6-5 of the Income Tax Assessment Act 1997 (Cth). It is not necessary for profit-making to be the sole or even dominant purpose; it is sufficient if it is a “not insignificant purpose” of the acquisition”. 9

The Trustee contended that, when it acquired the shares, it did not have as its state of mind an intention that they be disposed of at a profit. Rather, the Trustee saw Doyle’s Creek “as a long-term and speculative play” with the aim of getting the exploration licence with minimal upfront consideration “to see where the exploration and proving of the resource would develop”. 10

The Tribunal noted that a “long-term and speculative play” is not inconsistent with an intention that shares be disposed of at a profit where the activities designed to increase shareholder value to obtain profit inevitably require an extended period. A profit-making scheme may take many years to complete, especially where the planned activities are substantial. The Tribunal referred to the decision of the Full Federal Court in Grieg v Commissioner of Taxation in which Steward J acknowledged that where shares are acquired by an individual for the purposes of obtaining a dividend yield and for long-term growth, any gain on a subsequent sale of the sales is likely to be on capital account. Steward J also observed that:

“… some profit-making schemes can take many years to complete… It is not antithetical to a profit-making undertaking for a taxpayer to wait for the profit to become realisable, so long as that was the profit the taxpayer planned to secure. Waiting, without more, will not convert the profit eventually realised into an affair of capital.” 11

The Tribunal concluded that the “clear and undisputed plan” of the Trustee and Mr Poole was that the value of Doyle’s Creek would be substantially increased by the obtaining of the exploration licence and potentially the proving of the resource. There was an inescapable inference that, at the time of acquisition of the shares, the Trustee had a “not insignificant purpose” of disposing of the shares at a profit. It “would defy common sense to suggest that Mr Poole or the Trustee had no contemplation at the time of the Trustee’s acquisitions that the shares would be disposed of at a profit at an opportune time once the value of Doyle’s Creek had been increased through pursuit of the activities planned when the shares were acquired”. A substantial profit was in fact