SCANLON & ANOR v FC of T

Members:
E Fice SM

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2014] AATA 725

Decision date: 3 October 2014

E Fice (Senior Member)

1. Terence and Annabelle Scanlon, who are husband and wife, each held one ordinary share in a company called L & R Health Care Centre Pty Ltd ACN 007 000 731 (L & R Health). They were the only shareholders of the company and were its employees from about 25 November 1988 until about 12 February 2007. Mr and Mrs Scanlon were both appointed directors of L & R Health on 24 June 1988. Mrs Scanlon resigned as director on 21 March 2004 whereupon Mr Scanlon became the sole director/secretary of the company. Mr Scanlon resigned as a director on 12 February 2007.

2. In about July 2006 L & R Health received preliminary interest from potential purchasers of the company. Some discussions followed with a potential purchaser, Lifehealthcare Pty Ltd (Lifehealthcare), after which, on about 22 November 2006, Lifehealthcare wrote a letter to L & R Health titled Offer to purchase 100% of L & R Health Care Centre Pty Ltd. The letter stated that the offer was made by Lifehealthcare or nominee company. On or about 24 November 2006 Mr and Mrs Scanlon signed the

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letter from Lifehealthcare indicating they were in agreement with the offer set out in that document. Whether this document represents a legally binding agreement is contested in these proceedings.

3. On or about 15 December 2006 Mr Scanlon, in his capacity as sole director of L & R Health, signed a document expressed to be a Board Resolution made under Rules 18 and 20 of the Constitution of L & R Health in which it was stated that the company approved an eligible termination payment (ETP) to be paid to each of Mr and Mrs Scanlon on the termination of their employment. It was proposed that Mr Scanlon receive $1,925,000 and Mrs Scanlon $825,000. L & R Health formally advised Mr and Mrs Scanlon of these arrangements in writing on or about 15 December 2006. On or about 8 January 2007 Mr and Mrs Scanlon wrote to Lifehealthcare confirming that upon termination of their employment and payment of their entitlements they would execute a Deed of Termination.

4. Mr and Mrs Scanlon executed a Share Purchase Agreement with Lifehealthcare on 8 January 2007. They were both to receive $2.375 million, a total of $4.75 million which was said to be the purchase price payable for their shares in L & R Health. In addition, the purchaser was required, on completion, to procure that L & R Health repaid a loan to Brencorp No. 2 Pty Ltd (Brencorp) in the amount of $6,500,000 as well as interest on that loan in full. L & R Health was required to pay any ETPs and meet all of its obligations to its employees. Mr and Mrs Scanlon executed a Deed of Termination, terminating their employment with L & R Health on 12 February 2007.

5. In their income tax returns lodged for the 2007 income years, both Mr and Mrs Scanlon returned $93,749 in the form of a capital gain. On 10 August 2009 the Commissioner of Taxation (the Commissioner) wrote to Mr and Mrs Scanlon indicating that he was conducting an audit in respect of a capital gain in the amount of $2,374,998 each of them had made on the disposal of capital gains tax assets during the 2007 income year.

6. In a letter dated 16 September 2009 PKF Chartered Accountants & Business Advisers (PKF) informed the Commissioner they were engaged to act on behalf of Mr and Mrs Scanlon. They then detailed the calculation of the amount of capital gain for the 2007 income year which included applying the 50% General discount; the 50% Active Asset reduction; and the Retirement Exemption. The figures were identical for Mr and Mrs Scanlon.

7. Following the receipt of submissions made on behalf of Mr and Mrs Scanlon and further documents being lodged with the Commissioner, on 7 July 2010 the Commissioner determined that Mr and Mrs Scanlon did not qualify for the small business CGT concessions under s. 152-205 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the capital gain which was realised in the 2007 income year because both did not meet the maximum net asset value test in s. 152-15. The Commissioner also determined that an administrative penalty should be imposed on Mr and Mrs Scanlon at the base rate of 25% for lack of reasonable care. Mr and Mrs Scanlon were issued with notices of amended assessment on 22 July 2010. Mr Scanlon's assessment was amended to include a capital gain of $2,149,999 and Mrs Scanlon's assessment was amended so that her taxable income became $1,617,278.

8. On 28 October 2010 Mr and Mrs Scanlon lodged objections to the amended assessments and administrative penalty assessments. On 30 April 2013 the Commissioner provided Mr and Mrs Scanlon with his objection decision disallowing their objections. Although Rigby Cooke Lawyers, on behalf of Mr and Mrs Scanlon, lodged further objections on 14 June 2013, the Commissioner determined those objections to be invalid as they were outside the time allowed for the lodgement of objections. Nevertheless, the Commissioner administratively reviewed the grounds raised and determined that the objection decisions in both cases should stand.

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There are three principal issues which I am required to determine in this matter. They are as follows:

(a) whether Mr and Mrs Scanlon each satisfied the maximum net asset value test in s. 152-15 of ITAA 1997, that is, whether each of their CGT assets, being their share in L & R Health, did not exceed $5,000,000 just before the CGT event, and that includes:
- (i) establishing when CGT event A1 occurred in each case;
- (ii) whether L & R Health had a liability to pay the ETPs to Mr and Mrs Scanlon just before the time of CGT event A1;
- (iii) if L & R Health had the liability referred to in (ii) above, whether it was related to the assets of L & R Health; and
- (iv) whether Mr and Mrs Scanlon's right to receive their respective ETPs should be disregarded because the right was used solely for their personal use and enjoyment;
(b) whether the amount of the ETP received by each Mr and Mrs Scanlon should be included in their capital proceeds for CGT purposes; and
(c) were Mr and Mrs Scanlon liable to an administrative penalty in the event that I were to find that they did not satisfy the maximum net asset value test and that the ETP received by each of them ought to have been included in their capital proceeds for CGT purposes.

WHEN DID CGT EVENT A1 OCCUR

10. Given that in this case, the event with which we are concerned is the disposal by Mr and Mrs Scanlon of their respective share in L & R Health, there was no issue between the parties that the CGT event was A1 as that event is described in s. 104-5 of ITAA 1997. That section describes the time of the event as: when disposal contract is entered into or, if none, when the entity stops being asset's owner. It also refers to s. 104-10 which relevantly provides:

104-10 Disposal of a CGT asset: CGT event A1

(1) CGT event A1 happens if you *dispose of a *CGT asset.

(2) 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. However a change of ownership does not occur:

(a) if you stop being the legal owner of the asset but continue to be its beneficial owner; or

(b) merely because of a change of trustee.

(3) The time of the event is:

(a) when you enter into the contract for the *disposal; or

(b) if there is no contract - when the change of ownership occurs.

11. There was no dispute between the parties that the shares in L & R Health were CGT assets as that expression is defined in s. 108-5 of ITAA 1997.

12. The history of events that led to the sale of Mr and Mrs Scanlon's shares in L & R Health is set out in their respective witness statements which were taken into evidence. Mr Scanlon testified that he was first approached at some time in late 2005 by Mr Darren McKennay, representing Lifehealthcare, about selling L & R Health. He said that he and his wife had not considered selling at that stage and simply said they would think about it. Later, in about February 2006, Mr Danny Driscoll of Invacare Australia also approached Mr Scanlon about the possibility of acquiring L & R Health.

13. Following those discussions, Mr and Mrs Scanlon decided that they would sell, provided they received an acceptable offer. Otherwise, they would continue to run the business.

14. In about July 2006 Mr McKennay again approach Mr Scanlon, following up from earlier discussions. Mr Scanlon then began to discuss the possibility of a sale with his accountants, PKF. He also had numerous discussions with his brother, Mr Peter Scanlon, who had lent the company a substantial sum of money to enable it to operate. Those moneys were provided through Mr Peter Scanlon's company, Brencorp. Mr Scanlon also testified that he asked his brother Peter if he would act on their

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behalf in the sale transaction, and he agreed to do so. There was no dispute between the parties that Mr Peter Scanlon acted as agent for Mr and Mrs Scanlon in facilitating the sale of the business from L & R Health to Lifehealthcare.

15. Mr Peter Scanlon provided a letter to the directors of Lifehealthcare on or about 17 November 2006 in which he set out the conditions upon which Mr and Mrs Scanlon were prepared to sell the business of L & R Health. In the opening paragraph, Mr Peter Scanlon said:

1. Purchase Price

Consideration is to be $14m of cash at completion on February 1^st, 2007. At this stage we envisage this consideration to be apportioned as follows, however we are waiting on final advice re these matters: -

• $4,750,000 for all the share capital of L & R Healthcare Centre Pty Ltd (L&R)

• $6,500,000 to repay the Brencorp loan to L&R

• $2,750,000 to L & R to enable it to pay this amount as a non deductible termination payment to the superannuation fund of Mr T. Scanlon.

As advised previously there is no commitment or intention by us to any future negotiation re-variation to the total consideration. Obviously however we are willing to discuss the breakup and the method of the consideration if there are ways of benefiting both parties.

16. At paragraph 5, under the heading Conditions Precedent, were listed a number of matters which appear to have been the subject of questioning by the intending purchaser in a letter dated 6 November 2006. I did not have a copy of that letter in evidence (in his witness statement Mr Scanlon explained that on 6 November 2006 Lifehealthcare made a written proposal for the purchase of L & R Health which Mr Peter Scanlon then discussed with Mr McKennay. He said he no longer had a copy of the letter and upon enquiry with his solicitors, no person was able to locate that letter). Under the heading Exclusivity, there was the following paragraph:

A period of exclusivity is acceptable. However on the basis of the above timetable this would commence on agreement to this memo (adjusted to incorporate the other matters in your memo.) Until 25/12/06 unless there is a verbal agreement to complete documentation at that time, in which case it would remain until the planned completion date of February 1^st 2007.

17. At paragraph 6, under the heading Timetable, there was the following:

We agree that completion should be February 1, 2007. To this end due diligence would need to be completed prior to Christmas. Also we are of the view that draft legal documentation should proceed concurrently during this period.

We envisage, completion of due diligence and confirmation of both parties intent by Christmas with draft documentation available for both parties.

A more detailed timetable be drawn up between us prior to due diligence.

If you are agreeable to the above we can draw up one letter combining the relevant points of your letter of 6^th November 2006 and this letter for signature of the appropriate people from both parties.

18. It appears that Lifehealthcare took up the invitation set out in the final paragraph of the letter I have referred to above, addressing the matters set out under the Conditions Precedent paragraph. On 22 November 2006 Lifehealthcare appears to have sent that letter to L & R Health, addressed to Mr Scanlon. In the opening paragraph, the writer states that the letter comprises an offer by Lifehealthcare Pty Ltd or nominee company to purchase 100% of the equity in L & R Health. The significant aspects of that letter, including its subject matter, are as follows:

Re: Offer to Purchase 100% of L&R Health Care Centre Pty Ltd ("L&R")

…

By signing below you indicate your acceptance of the Offer, and agree that the terms of this letter will be legally binding.

…

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1. Purchase Price

As per our discussions, our Offer is to purchase L&R (as described below) for $14 million. That Offer is based on the following conditions to be confirmed by LHC [Lifehealthcare Pty Ltd] during due diligence:

• The maintainable FY 07 EBIT of the business is at least the level contained in section 2 of your letter dated 17 November 2006; and

• That the Net Tangible Assets (net tangible assets prior to formal debt, shareholders loans and cash on hand) are at least $4,000,000 and represent sufficient capital to operate the business in the normal course. For the sake of clarity, the Net Tangible Assets of the business transferred to LHG at completion will not contain any outstanding interest owing.

…

The total net consideration will be apportioned as directed by you immediately prior to completion however we acknowledge the preliminary apportionment advised in your letter dated 17 November 2006.

…

4. Conditions Precedent

LHC's decision to proceed with the Investment outlined in the Offer is dependant (sic) upon the following conditions precedent:

[these conditions effectively set out those referred to in paragraph 5 Mr Peter Scanlon's letter of 17 November 2006]

…

6. Exclusivity

By signing below the shareholders of L&R irrevocably agree, subject only to the buyer being prepared to pay $14 million on the terms (including the conditions) outlined in this term sheet, to sell L&R to LHC for $14 million in accordance with the terms set out in this letter.

…

On behalf of LHC, we require that L&R's shareholders grant to it an exclusive period in which to conduct remaining due diligence and complete the transaction. By accepting this Offer, you (both in your own capacity and as a representative of the shareholders of L&R) and L&R agree, during the period from the date of this letter until 1 February 2007 (the "Exclusive Period"), not to directly or indirectly solicit any investment proposal, or cooperate with, furnish or cause to be furnished any information concerning L&R to any other person, or enter into or continue or finalise any discussion, negotiation, agreement or understanding concerning any acquisition proposal with any other person, unless approved by LHC in writing. As used in this section, "investment proposal" shall mean any proposal, offer or indication of interest, in writing or otherwise, for the acquisition of all or any portion of L&R, its assets, or its business or any investment into the business.

If you are in agreement with the Offer outlined above, please sign below to indicate your acceptance.

We are very strongly of the belief that we can complete within the stipulated period of time and look forward to completing on the terms described.

19. The first matter which I need to determine is whether the exchange of correspondence to which I have referred above resulted in the disposal of a CGT asset as that event is described in s. 104-10 of ITAA 1997. In particular, I need to determine whether by accepting the Offer set out in the letter of 22 November 2006 from Lifehealthcare, L & R Health and Mr and Mrs Scanlon entered into a contract for the disposal of a CGT asset. The CGT asset of Mr and Mrs Scanlon was the respective share each held in L & R Health. As the authors of Ford's Principles of Corporations Law, 14^th Ed., 2010 state at [17.140]:

A share can be associated with a sum of money in various ways: by reference to issue price, assets value or market value.

20.

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The first and possibly obvious point to make is that the subjective intention of parties cannot determine the question regarding whether there was a legally binding contract for the sale of L & R Health at the time the offer set out in the letter of 22 November 2006 was accepted.

21. In his witness statement Mr Scanlon said that he did not understand the letter of 22 November 2006, which he had signed as accepting the offer contained therein, compelled him to sell his share to Lifehealthcare. Mr Scanlon said that he accepted Lifehealthcare could walk away if it did not accept the outcome of the due diligence enquiry, or if it chose not to agree to legal documentation. In fact Mr Scanlon said that he and his wife might choose not to agree and therefore they could choose not to sell. He considered the legally binding parts of the agreement to be the confidentiality clause and the exclusivity clause.

22. In her witness statement Mrs Scanlon also said she did not consider the business of L & R Health to have been sold at the time she executed the 22 November 2006 offer letter.

23. Plainly, the views held by Mr and Mrs Scanlon are their subjective views regarding their intention at that time, expressed after they had executed and accepted the offer letter. While the circumstances surrounding the execution of that letter need to be considered, whether or not the parties were legally bound at that time to proceed with the sale of the business of L & R Health must be determined objectively from the documents in accordance with legal precedent.

24. This was clearly explained by the Supreme Court of New South Wales, Court of Appeal (Kirby P, Glass JA and McHugh JA) in
G R Securities Pty Ltd v Baulkham Hills Private Hospital Pty Ltd (1986) 40 NSWLR 631 at 634 where McHugh JA, with whom Kirby P and Glass JA agreed, said:

However, the decisive issue is always the intention of the parties which must be objectively ascertained from the terms of the document when read in the light of the surrounding circumstances:
Godecke v Kirwan (1973) 129 CLR 629 at 638;
Air Great Lakes Pty Ltd v KS Easter (Holdings) Pty Ltd (1985) 2 NSWLR 309 at 332-334, 337. 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.

25. The often quoted authority on the topic of intention to create legal relations is the High Court of Australia decision in
Masters v Cameron (1954) 91 CLR 353. In that case, which involved a contract for the sale of land, there was a memorandum which had been signed by the seller and the purchaser. The memorandum set out a detailed description of the property and the purchase price. The only clause in the memorandum which was of concern to the Court was a statement which said:

This agreement is made subject to the preparation of a formal contract of sale which shall be acceptable to my solicitors on the above terms and conditions, and to the giving of possession on or about the Fifteenth Day of March 1952.

26. The Court (Dixon CJ, McTiernan and Kitto JJ) had no doubt that the parties had agreed that there should be a sale and purchase and that the price and the date of possession were all clearly settled. Their Honours said, at 360:

All the essentials of a contract are there; but whether there is a contract depends entirely upon the meaning and effect of the final sentence in that portion of the document which the appellant signed.

27. I should also refer to a decision of the Supreme Court of Western Australia (Pidgeon, Ipp and Anderson JJ) in
Anaconda Nickel Ltd v Tarmoola Australia Pty Ltd (2000) 22 WAR 101 where Ipp J said, at 111:

… The relevant circumstances may include prior negotiations and subsequent conduct:… In accordance with the general rule, however, direct expressions of intent, made after the contract was arrived at, are not admissible.

28. The Court in
Masters v Cameron suggested that where parties who have been in negotiations reach agreement on terms of a contractual nature but also agree that the matter

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of their negotiation shall be dealt with by a formal contract, the case may belong to any of three classes. The Court said, at 360:

…It may be one in which the parties have reached finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect. Or, secondly, it may be a case in which the parties have completely agreed upon all the terms of their bargain and intend no departure from or addition to that which their agreed terms express or imply, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document. Or, thirdly, the case may be one in which the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract.

29. The Court said that in each of the first two cases, there was a binding contract. That was because:

… in the first case a contract binding the parties at once to perform the agreed terms whether the contemplated formal document comes into existence or not, and to join (if they have so agreed), in settling and executing the formal document; and in the second case a contract binding the parties to join in bringing the formal contract into existence and then to carry it into execution.

30. The Court explained that the third class of cases is fundamentally different. Their Honours said, at 361-362:

… They are cases in which the terms of agreement are not intended to have, and therefore do not have, any binding effect of their own: … The parties may have so provided either because they have dealt only with major matters and contemplate that others will or may be regulated by provisions to be introduced into the formal document, as in
Summer-greene v Parker (9) or simply because they wish to reserve to themselves a right to withdraw at any time until the formal document is signed. These possibilities were both referred to in
Rossiter v Miller (1). Lord O'Hagan said: "Undoubtedly, if any prospective contract, involving the possibility of new terms, or the modification of those already discussed, remains to be adopted, matters must be taken to be still in a train of negotiation, and a dissatisfied party may refuse to proceed. But when an agreement embracing all the particulars essential for finality and completeness, even though it may be desired to reduce it to shape by a solicitor, is such that those particulars must remain unchanged, it is not, in my mind, less coercive because of the technical formality which remains to be made" (1)

31. Referring to the clause in the memorandum dealing with the formal contract of sale, the Court said, at 362:

The question depends upon the intention disclosed by the language the parties have employed, and no special form of words is essential to be used in order that there shall be no contract binding upon the parties before the execution of their agreement in its ultimate shape:
Farmer v Honan (4). Nor is any formula, such as "subject to contract", so intractable as always and necessarily to produce that result: cf.
Filby v Hounsell (5).

32. Later cases, such as the
Baulkham Hills Private Hospital Pty Ltd v G R Securities Pty Ltd (1986) 40 NSWLR 622, suggest there is a fourth class of case in addition to the three mentioned in
Masters v Cameron. McLelland J said, at 628:

There is in reality a fourth class of case additional to the three mentioned in
Masters v Cameron, as recognised by Knox CJ, Rich J and Dixon J in
Sinclair, Scott & Co v Naughton (1929) 43 CLR 310 at 317, namely, "… one in which the parties were content to be bound immediately and exclusively by the terms which they had agreed upon whilst expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms". Their Honours refer to the speech of Lord Loreburn, in
Love & Stewart v S Instone & Co (1917) 33 TLR 475 at 476, where his Lordship said that:

"It was quite lawful to make a bargain containing certain terms which one was content with, dealing with what one

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regarded as essentials, and at the same time to say that one would have a formal document drawn up with the full expectation that one would by consent insert in it a number of further terms. If that were the intention of the parties, then a bargain had been made, none the less that both parties felt quite sure that the formal document would comprise more than was contained in the preliminary bargain."

33. The decision of McLelland J was upheld on appeal to the Court of Appeal. Dealing with the point I have referred to in the preceding paragraph, McHugh JA said, at 634-635:

Even when a document recording the terms of the parties' agreement specifically refers to the execution of a formal contract, the parties may be immediately bound. Upon the proper construction of the document, it may sufficiently appear that "the parties were content to be bound immediately and exclusively by the terms which they had agreed upon whilst expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms": Sinclair,
Scott & Co Ltd v Naughton (at 317).

… That decision was applied in
Godecke v Kirwan where a document signed by the vendor and the purchaser offered to buy the vendor's land at a specified price subject to the conditions of the Transfer of Land Act 1893 (WA) and eleven special conditions. Possession was to be taken "upon the signing and execution of a formal contract of sale within 28 days of acceptance of this offer". One of the special conditions provided for "a further agreement to be prepared… by (the vendor's) solicitors containing the foregoing and such other covenants and conditions as they may reasonably require". The High Court held that the document constituted a contract. Walsh J, with whose judgement Mason J agreed, said that the parties did not intend to make the execution of a formal contract a condition of the existence of a binding contract. He held (at 641) that "… there should be implied a promise by each of the parties that he would sign a formal contract within the twenty-eight days and would do everything necessary to enable this to be done within that time".

34. I should also point out that in the Baulkham Hills Private Hospital case before the Court of Appeal, the Court noted that the vendor, in a letter in which it accepted the offer made by the purchaser, said: On receipt of such written acceptance, our client would consider there to be a legally binding agreement in principle between yourself and it, until such time as formal Contracts were exchanged as aforesaid. Of that clause, McHugh JA said, at 635:

… Although the words "in principle" are curious, they cannot prevail against the conclusion to be drawn from the words "a legally binding agreement". Those words convincingly indicate that the parties intended to be bound immediately. Probably the phrase "legally binding agreement in principle" was intended to mean that the parties had reached agreement on the main matters and were content to be immediately bound.

35. In my opinion, the acceptance by Mr and Mrs Scanlon of the offer contained in the letter from Lifehealthcare on 22 November 2006 leaves little room for them to argue that legal consequences did not flow from them agreeing to the terms set out in that letter and their accepting the offer in those terms. The letter plainly states that it is an offer to purchase 100% (of the issued shares) of L & R Health. Furthermore, acceptance of the offer on its terms is expressly stated to be legally binding. The letter of offer was the result of negotiations between the parties regarding the terms upon which the sale would take place. The purchase price, $14,000,000, is stated and agreed. The consideration for the purchase was to be apportioned as directed by Mr and Mrs Scanlon while acknowledging the preliminary advice regarding apportionment in the letter of 17 November 2006. It contains terms on which Mr Scanlon would provide consultancy services to the purchaser to facilitate a handover of the business.

36.

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While the letter of offer is said to be subject to conditions precedent, it nevertheless sets out the fundamental terms upon which the takeover of the business of L & R Health would take place including dealing with existing employment contracts; the repayment of shareholder loans and the further drawings by shareholders for executive salaries; the payment of outstanding taxes and liabilities; the restriction on Mr and Mrs Scanlon not to compete with the business of L & R Health for three years from the time they cease to be involved in that business; the transfer of agency agreements to the purchaser; the continuation of existing contracts with customers; and the obtaining of credit approval from the purchaser's banking partners. The letter of offer sets out a proposed timetable, envisaging completion and settlement on 1 February 2007.

37. As in the
Masters v Cameron case, the essentials of the agreement are set out in the 22 November 2006 letter. Furthermore, the letter expressly states that the parties agree that the terms set out in the letter are legally binding. On signing the letter of offer, Mr and Mrs Scanlon irrevocably agreed to sell their shares in L & R Health to Lifehealthcare in accordance with the terms set out in the letter.

38. The remaining question is the effect of the stated Conditions Precedent and, in particular, the outcome of the purchaser conducting a due diligence examination of the business of L & R Health; and what is said to be appropriate legal documentation being negotiated and executed.

39. The fact that the letter of 22 November 2006 purports to contain Conditions Precedent does not necessarily indicate that no legally binding agreement for the sale of the assets of L & R Health could come into existence unless all of those so-called conditions precedent were satisfied. In commercial transactions, the courts have frequently indicated that they favour a construction which holds that despite the expression condition precedent being used in documents, a legally binding agreement has nevertheless been formed. The so-called condition precedent is usually held to be a condition precedent to the performance of the contract rather than its formation. This was the opinion of the High Court of Australia (Gibbs CJ, Stephen, Mason, Wilson and Brennan JJ) in
Perri and Another v Coolangatta Investments Pty Ltd (1982) 149 CLR 537. That case involved the sale of land which was subject to a special condition which provided that the contract for the sale of the land was subject to the purchasers completing a sale of their existing property. The position of the Court was succinctly stated by Mason J where he said, 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. Furthermore, it gives the courts greater scope in determining and adjusting the rights of the parties. 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.

40. I am mindful of the fact that the courts, in construing contracts or agreements in accordance with what was said in Perri's case, were dealing with the parties to the agreement and determining or adjusting rights inter partes. That is of course not the case in this matter where I only have before me evidence from the sellers. However, the same principles must apply and, in fact, it is probably more important to apply a strictly objective approach because I only have part of the evidence before me. I have no idea what the purchaser claims was its intention at the time the sellers accepted its offer in the 22 November 2006 letter.

41. In my opinion, the so-called conditions precedent set out in the 22 November 2006 letter are conditions precedent to the performance of the agreement rather than

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conditions precedent to the formation of an agreement. The letter clearly states that its terms are legally binding if the sellers should sign that letter. In fact, the letter states that by signing at the foot of that letter, the sellers accept the offer on the terms set out in the letter. It also states that, subject only to the buyer being prepared to pay $14,000,000 on the terms outlined in the letter, the sellers irrevocably agreed to sell the business of L & R Health. Quite plainly, the purchaser had already agreed to purchase at that price. Given that the terms set out in the letter were legally binding on all of the parties, the inescapable conclusion is that the parties had entered into a contract for the sale of all of the shares in L & R Health. While it is true that the agreement was subject to a satisfactory due diligence being performed, that does not change the nature of the agreement. Had the outcome of the due diligence caused concern to the purchaser, there is no question that it could have avoided the agreement it had entered into. That does not mean that there was no legally binding agreement at the time Mr and Mrs Scanlon signed the letter agreeing to its terms. It simply means that the legally binding agreement was voidable by the purchaser in particular circumstances.

42. Finally, the letter stated that appropriate legal documentation was to be negotiated and executed. The first thing to note about this term set out in the letter is that it does not state that a legally binding agreement is subject to formal legal documentation being drawn and executed. Nor does it indicate that any of the fundamental terms set out in that letter remained negotiable.

43. I find that this matter falls within the first class described in
Masters v Cameron. This is a case where the parties have reached finality in arranging all of the essential terms of the contract and they plainly intended to be immediately bound to the performance of those terms. They proposed that a formal document be drawn and executed but there is no suggestion that the terms would be any different to those set out in the letter. Undoubtedly the terms have been restated in a fuller or more precise form, but there was no indication that they would or might have an effect different to that stated in the letter. In fact, an examination of the formal document described as the Share Purchase Agreement dated 8 January 2007 shows that to have been the case.

44. Accordingly, I find that the requirements set out in s. 104-10(3) of the ITAA 1997 were met on the date on which the 22 November 2006 letter was executed by Mr and Mrs Scanlon, which, on their evidence, was on or about 24 November 2006. That is the date on which CGT event A1 happened.

45. The next issue with which I must deal is whether L & R Health had a liability to pay an ETP to Mr and Mrs Scanlon just before 24 November 2006. That may include determining whether the claimed liability related to the assets of L & R Health.

ETP LIABILITY

46. One of the basic conditions for relief from capital gains tax which applies to a small business entity is that it must satisfy the maximum net asset value test set out in s. 152-15 of ITAA 1997. Section 152-10(1) relevantly provides:

(1) A *capital gain (except a capital gain from *CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

…

(c) you satisfy the maximum net asset value test (see section 152-15);…

47. Section 152-15 relevantly provides:

152-15 Maximum net asset value test

You satisfy the maximum net asset value test if, just before the *CGT event, the sum of the following amounts does not exceed $5,000,000:

(a) the *net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities *connected with you;

(c) the net value of the CGT assets of any *small business CGT affiliates of yours or entities connected with your small business CGT affiliate's (not counting any assets already counted under paragraph (b)).

48. The meaning of the expression net value of the CGT assets is explained in s. 152-20 which relevantly provides:

Meaning of net value of the CGT assets

(1) The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the *market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

(i) provisions for annual leave;

(ii) provisions for long service leave;

(iii) provisions for unearned income;

(iv) provisions for tax liabilities.

(2) In working out the net value of the CGT assets of an entity:

(a) disregard *shares, units or other interests (except debt) in another entity that is *connected with the first-mentioned entity or with a *small business CGT affiliate of the first-mentioned entity; and

(b) if the entity is an individual, disregard:

(i) assets being used solely for the personal use and enjoyment of the individual, or the individual's *small business CGT affiliate (except a *dwelling, or an *ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and…

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49. The meaning of small business CGT affiliate is defined in s. 152-25 which, relevantly, provides:

(1) A person is a small business CGT affiliate of yours if:

(a) you are an individual and the person is your *spouse or *child under 18 years; or

(b) the person acts, or could be reasonably be expected to act, in accordance with your directions or wishes, or in concert with you.

50. The meaning of the expression connected with is set out in s. 152-30 which, relevantly, provides:

(1) An entity is connected with another entity if:

(a) either entity controls the other entity in the way described in this section; or

(b) both entities are controlled in that way by the same third entity.

Control of entity: 40% or more of rights

(2) An entity (the first entity ) controls another entity if the first entity, its *small business CGT affiliates or the first entity together with its small business CGT affiliates:

(a) except where the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive at least 40% (the control percentage ) of any distribution of income or capital by the other entity; or

(b) if the other entity is a company - beneficially own, or have the right to acquire beneficial ownership of, shares in the company that carry between them the right to exercise, or control the exercise of, at least 40% (the control percentage ) of the voting power in the company; or…

(3) If the control percentage in subsection (2) or (5) is at least 40%, but less than 50%, then the Commissioner may determine that the first entity does not control the other entity if the Commissioner is satisfied, or thinks it reasonable to assume, that the other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its*small business CGT affiliates.

51. Mr and Mrs Scanlon contended that, irrespective of whether the CGT event A1 happened on execution of the offer letter or in January 2007 upon execution of the Share Purchase Agreement, L & R Health had a liability to pay Mr and Mrs Scanlon an ETP just before the CGT event arose.

52.

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According to Mr Scanlon's testimony, he was advised by PKF that he and his wife should consider arranging to take an ETP upon the sale of the business. He said he relied on that advice and in the handwritten letter to Mr Peter Scanlon on 17 October 2006, he told his brother that he and his wife, if and when they eventually retired from the business, would have L & R Health pay an ETP to each of them which would then be paid into their superannuation account. At that time, it seems that the amount of the ETP payments had not been established as Mr Scanlon suggested possibly around $3,000,000; $2,000,000 for himself and $1,000,000 for his wife. Mr Scanlon also said that the ETP figure might be higher if he and his wife did not retire for another five years. He then said that he would not ask his accountant to record that in the accounts as it will make the financials look silly.

53. In the 17 November 2006 letter written by Mr Peter Scanlon to Lifehealthcare, he suggested the payment of $2,750,000 to L & R Health to enable it to pay that amount as a non-deductible termination payment to the superannuation fund of Mr Scanlon. Mr Scanlon said that by that date, he and his wife had agreed to the sum of the ETP payment ($1,925,000 for his ETP and $825,000 for his wife's ETP). It formed part of the $14,000,000 consideration to be paid on the sale of the business of L & R Health. The remaining two elements are as set out in paragraph [15] above.

54. Although it was contended for Mr and Mrs Scanlon that Mr Scanlon, as the sole director of L & R Health, passed a resolution approving what was described as a one-off golden-handshake on or before the date of Mr Peter Scanlon's letter of 17 November 2006 to Lifehealthcare, that is not what the documents disclose. According to the documents in evidence before me, L & R Health approved the ETP to Mr and Mrs Scanlon in a resolution passed on 15 December 2006.

55. In my opinion, if there was in fact a liability, legal or equitable, it could not have arisen prior to L & R Health passing the resolution to pay Mr and Mrs Scanlon an ETP in the amounts I have set out above.

56. There is also a question about whether the passing of a resolution by the directors of a company, of itself, creates a liability if that resolution is that the company make a payment of money to persons.

57. There is no issue about the fact that a sole director of a company, or the directors acting as a board, manage the business of the company. Section 198A of the Corporations Act 2001 (the Corporations Act) provides:

(1) the business of a company is to be managed by or under the direction of the directors.
(2) The directors may exercise all the powers of the company except any powers that this Act or the company's constitution (if any) requires the company to exercise in general meeting.

58. As the authors (Roman Tomasic, Stephen Bottomley and Rob McQueen) of the text Corporations Law in Australia, state, regarding the division of power between the board and the general meeting at 12.2.1:

Corporate law recognises only two sites of decision-making power within the corporation: the general meeting of members and the meetings of directors, usually constituted as a board.

59. A resolution passed by the directors at a board meeting is simply an expression of the board's decision. In the case of companies with a single director, s. 248B of the Corporations Act provides:

(1) The director of a proprietary company that has only 1 director may pass a resolution by recording it and signing the record.

60. However, and most importantly, the passing of a resolution by the Board of Directors of a company cannot, by itself, create a legal or equitable liability which is enforceable against the company by persons who stand to benefit should the company act in accordance with the resolution. The resolution simply authorises the company to take particular action. Therefore, a company may be

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authorised by resolution to enter into a contract with a particular person or persons for a particular purpose. However, unless there is an enforceable agreement between the company and, for example, its employees regarding certain payments, no liability can arise.

61. While I did not have before me the company's constitution, there was no issue regarding whether Mr Scanlon, as the sole director of L & R Health, could pass a resolution by recording it and signing the record agreeing to have the company make ETP payments for himself and his wife under rule 18 and 20 of the Constitution of the company. I accept that was within his powers. However I had no document which evidenced an agreement made between the company and its employee directors creating the company's liability to make such a payment.

62. I did have in evidence two letters written by L & R Health to Mr and Mrs Scanlon respectively on 15 December 2006 regarding the proposed ETP's. These letters simply confirm what I have said about the effect of the resolution passed by L & R Health on that day. The letters are identical save for the amounts proposed to be paid to each of them. The relevant passages state:

The purpose of this letter is to confirm the proposed arrangements in relation to the eligible termination payment to be paid upon termination of your employment with L & R Health Care Centre Pty Ltd (L & R).

If you are happy with the terms set out below, please sign and return copy of this letter.

In consideration of your services to L & R you will be entitled to a one-off "golden handshake" payment of… upon termination of your employment with L & R for any reason (the ETP).…

L & R agrees to pay the ETP as soon as practicable following receipt of the completed ETP Pre-payment Statement.

63. Although the Commissioner submitted that L & R Health's liability to pay the ETPs was created by contracts between L & R Health and Mr and Mrs Scanlon on 15 December 2006, I respectfully disagree. The letters of 15 December 2006 stated that consideration for the payment was their respective services to L & R Health. That is, services which had already been provided. As the authors of Cheshire & Fifoot, Law of Contract state at 4.19:

The rule that past consideration is no consideration is linked to the rule that consideration must move from the promisee. This latter maxim embodies the idea of a contemporaneous and mutual exchange. A promisee who has already provided something does not satisfy this rule. If the defendant makes a promise, subsequent to and independent of the transaction, or promises to reward someone for a past kind deed, it is regarded as a mere expression of gratitude for past favours or as a gift, and no contract will arise.

64. As the Commissioner submitted, the payment of an ETP to Mr and Mrs Scanlon has the hallmarks of a gratuitous payment. That is so in my opinion because that is what it was. The services provided by Mr and Mrs Scanlon constitute past consideration and, accordingly, no consideration moved from them as promisee to L & R Health, the promisor. The letters Mr and Mrs Scanlon received on 15 December 2006 did not create a liability enforceable in law or equity against L & R Health. Accordingly, I find that L & R Health did not have a liability to pay an ETP to Mr and Mrs Scanlon either immediately before executing the letter of offer from Lifehealthcare dated 22 November 2006 or immediately before executing the Share Purchase Agreement on about 8 January 2007.

65. In any event, in case I am wrong about that, assuming that a liability was created just before disposition of the CGT assets in question, I will examine whether that liability was related to the CGT assets.

66. The expression related to is plainly broad and has been so described by the courts. In the Full Court of the Federal Court of Australia case
HP Mercantile Pty Ltd v Commissioner of Taxation (2005) 143 FCR 553, Hill J when dealing with the expression relates to making supplies that would be input taxed, said, at 563:

ATC 6524
It was common ground that the words "relates to" are wide words signifying some connexion between two subject matters. The connexion or association signified by the words may be direct or indirect, substantial or real. It must be relevant and usually a remote connexion would not suffice. The sufficiency of the connexion or association will be a matter for judgement which will depend, among other things, upon the subject matter of the enquiry, the legislative history, and the facts of the case. Put simply, the degree of relationship implied by the necessity to find a relationship will depend upon the context in which the words are found. So much appears from the various cases referred to by the Tribunal when discussing the meaning of these words:…

67. The High Court of Australia (Brennan CJ, McHugh, Gummow, Kirby and Hayne JJ) dealt with the expression relates to and statutory construction in general in
Project Blue Sky Inc and others v Australian Broadcasting Authority (1998) 194 CLR 355. When dealing with conflicting statutory provisions, the plurality said, at 381:

The primary object of statutory construction is to construe the relevant provision so that it is consistent with the language and purpose of all the provisions of the statute (45). The meaning of the provision must be determined "by reference to the language of the instrument viewed as a whole" (46). In
Commissioner for Railways (NSW) v Agalianos (47), Dixon CJ pointed out that "the context, the general purpose and policy of a provision and its consistency and fairness are surer guides to its meaning than the logic with which it is constructed". Thus, the process of construction must always begin by examining the context of the provision that is being construed (48).

68. In construing the words relate to in the context of the Australian Broadcasting Authority being required to determine standards that relate to the Australian content of programs, the plurality said, at 387:

The words "relate to" are "extremely wide" (60). They require the existence of a connexion or association (61) between the content of the Standard and the Australian content of programs. What constitutes a sufficient connexion or association to form the required relationship is a matter for judgement depending on the facts of the case. No doubt the association or connexion must be a relevant one in the sense that it cannot be accidental or so remote that the Standard has no real effect or bearing on the Australian content of programs.

69. I should also refer to the High Court of Australia decision in
Travelex Ltd (ACN 004 179 953) v Commissioner of Taxation (2010) 270 ALR 253. French CJ and Hayne J said, at 259:

It may readily be accepted that "in relation to" is a phrase that can be used in a variety of contexts, in which the degree of connexion that must be shown between the two subject matters joined by the expression may differ. It may also be accepted that "the subject matter of the enquiry, the legislative history, and the facts of the case" are all matters that will bear upon the judgement of what relationship must be shown in order to conclude that there is a supply "in relation to" rights.

70. The context in which the expression related to appears in s. 152-20(1) of ITAA 1997 was the subject of consideration by the Full Court of the Federal Court of Australia in
Bell v Commissioner of Taxation [2013] FCAFC 32. In that case, the appellant was the trustee of the Bell Family Trust (the Bell trust) and was presently entitled to income from the trust. The Bell trust had a recorded debt owed to another company (BPH) which was the trustee of the BPHT trust. The question the Court was required to answer was whether that debt related to the CGT assets of the Bell trust. The CGT event in that case was the sale by the Bell trust of units which it held in the BPHT trust. At the time in question, the trustee of the Bell trust resolved to distribute $2,018,000 from the capital of that trust to himself in order to make a contribution to his own superannuation fund and to provide his partner with funds to enable her to pay out a debt on their residence which was in her name. The Bell trust did not have sufficient cash to make that payment at it therefore needed to borrow money in order to make the payment the appellant sought.

71.

ATC 6525

BPH had a facility with Macquarie Bank which advanced the $2,018,000 to BPH, which in turn lent that money to the Bell trust. The moneys were in fact disbursed directly by the bank to the appellant's superannuation fund and to the mortgage account of his partner. Therefore, following that transaction, the Bell trust owed $2,018,000 to BPH which in turn, in its capacity as trustee of the BPHT trust, owed the money to the bank. The question for the Court to determine was whether the Bell trust's liability of $2,018,000 related to its CGT assets. The appellant argued that because the Bell trust had an obligation to pay the capital distribution resolved to be made to the appellant, an obligation attached to the whole of the trust fund. The liability related to the CGT assets of the Bell trust because the loan preserved and freed up those assets.

72. The Court explained that the issues it was required to consider were somewhat compromised by the fact that where money is borrowed, the asset may well, and usually will, have been added to the general cash assets of the entity in question. It then gave the following example, at [38], in an attempt to clarify that position:

The position presents more clearly if it be assumed that the borrowing was for the purpose of acquiring a tangible asset, say a motor vehicle. Its indebtedness under the borrowing would then be a liability which related to the vehicle. If the vehicle were traded in on a second vehicle (assuming, perhaps unrealistically, that this was a straight swap without money changing hands), it might then be the case that the liability to the original lender related to the second vehicle. However, if, instead of trading in the first vehicle, the Trust sold it and used the cash to make a distribution to a beneficiary under cl 12.7(a), the asset to which the loan liability had originally related would no longer exist. It could not then be said that the liability related to the assets of the Trust.

73. Applying the rationale set out in the above example, the Court said, at [39]:

It follows from the above discussion that we do not agree with the primary judge that a liability would forever relate to assets of the Trust by reason only of having been undertaken to preserve existing assets of the Trust, in the sense of having been necessary to avoid the need for the Trust to spend its existing cash on a particular outlay. If the outlay, made with borrowed funds, was to purchase an asset, then the liability represented by the borrowing would relate to the asset, but only for so long as that asset was held by the Trust. If the borrowing was for another purpose, such as to discharge an income tax obligation (and was immediately and identifiably used only for that purpose), the corresponding liability would not, in our view, relate to any asset of the Trust.

74. According to Mr and Mrs Scanlon, the liability of L & R Health to pay to each of them an ETP relates to the assets of L & R Health as a whole or, alternatively, specifically to the goodwill of the business of L & R Health. According to Mr Scanlon, the reason for the ETP payments was that he and his wife together only drew salaries in the order of $130,000 per annum from the 2002 financial year up until the termination of their employment in February 2007. In his opinion, the company could not have hired a competent person to fulfil those roles for anything like that salary. Other than Mr Scanlon's evidence about that, I had no objective evidence regarding what a reasonable salary for a person in his and his wife's position might be.

75. In any event, Mr and Mrs Scanlon contended that L & R Health resolved to make the ETP payments in recognition of their contribution as employees in building up the value, including the goodwill, of the company. Therefore, the liability to make those ETP payments to Mr and Mrs Scanlon related to the business assets of L & R Health generally or, alternatively, specifically to the goodwill of the company. In fact, Mr and Mrs Scanlon pointed out that Lifehealthcare was prepared to purchase the two shares inL & R Health for $4,750,000 despite the fact that L & R Health's balance sheet as at 30 June 2006 disclosed a negative net assets position of $2,278,427.

76. The first thing which needs to be said about Mr and Mrs Scanlon's claim that they had drawn minimum salaries as employees of the

ATC 6526

company is that does not take into account the fact that they also received dividends as shareholders. In fact, the cash flow statement prepared for the 2006 financial year discloses they were paid $408,000. The second point to make is that the ETPs are most likely misdescribed in the context in which those payments were made to Mr and Mrs Scanlon.

77. It is, in my opinion, productive to examine with some care what was said by Lifehealthcare in its 22 November 2006 letter. The offer to purchase 100% of the equity in L & R Health was for the sum of $14,000,000. That is in fact the purchase price for the business assets of L & R Health as a going concern. The letter states that the purchase price is based on conditions yet to be confirmed during the due diligence examination. It then sets out the two elements which form the basis for calculating the purchase price. They are the maintainable FY 07 EBIT (earnings before interest and tax) of L & R Health previously provided to Lifehealthcare; and net tangible assets (NTA) in the amount of at least $4,000,000. It also provides for an adjustment to the purchase price in the event that at the time of completion of the contract, the NTA exceeds $4,500,000. The letter then states that the valuation and purchase consideration is based on an Enterprise Value and therefore net debt and taxes payable will need to be paid out/adjusted at the time of purchase. It says nothing about how the purchase moneys are to be applied by the Sellers although it does state:

The total net consideration will be apportioned as directed by you immediately prior to completion however we acknowledge the preliminary apportionment advised in your letter of 17 November 2006.

78. What the offer letter in fact discloses is that L & R Health was valued at $14,000,000 by Lifehealthcare based on NTA value and the disclosed 2007 financial year EBIT. This is not unusual. In fact the High Court of Australia in
Hepples v The Commissioner of Taxation of the Commonwealth of Australia (1992) 173 CLR 492, when dealing with CGT in the context of s. 160ZO(1) of the Income Tax Assessment Act 1936, described in some detail the nature of the concept of goodwill. McHugh J said, at 542:

In Inland Revenue Commissioners v. Muller & Co.'s Margarine Ltd. [[1901] A.C. 217] Lord Macnaghten said that goodwill "is the attractive force which brings in custom". Lord Lindley said (84):

"Goodwill regarded as property has no meaning except in connexion with some trade, business, or calling. In that connexion I understand the word to include whatever adds value to business by reason of situation, name and reputation, connexion, introduction to old customers, and agreed absence from competition, or any of these things, and there may be others which do not occur to me. In this wide sense, goodwill is inseparable from the business to which [it] adds value, and, in my opinion, exists where the business is carried on."…

It will be seen from the statements in
Inland Revenue Commissioners v Muller that goodwill is the collective name for various intangible sources of the earnings of a business which are not able to be individually quantified and recorded in the accounts as assets of the business. The goodwill may be constituted by sources internally generated by the business entity or "from the combination or inter-relationship of entities or groups of assets (synergistic benefits)" or both (86). Goodwill, therefore, is "inherently inseverable from the business to which it relates" (87). It does not survive the cessation of the business and cannot be dealt with independently of that business "88". Although goodwill is commonly valued by capitalising the expected future net profits or by estimating the worth of purchasing several years of the past profits of the business, it may exist even though the business has not made any profits and is unlikely to do so for some time.

79. Because goodwill is essentially an accounting concept, I have briefly mentioned below the way in which accountants characterise and deal with goodwill. I have included this simply to assist in understanding the concept.

80. It is normal accounting practice to attribute the difference between the market value of net assets and the price paid on

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acquisition to unidentified assets labelled as goodwill (see Issues in Financial Accounting, Henderson and Peirson, page 386). Goodwill is usually based on an average operating profit and a rate of return which a purchaser requires on its investment. It is sometimes referred to as super-profit. Just how the sellers in this matter intended to allocate the purchase price was of no particular interest to the purchaser. The fact that L & R Health had outstanding liabilities, which of course a purchaser would want discharged on completion, is also dealt with in the letter of offer and it expressly states that those liabilities will need to be paid out/adjusted at the time of purchase.

81. Significantly, the letter of offer of 22 November 2006 says nothing about the termination of Mr and Mrs Scanlon's employment with L & R Health. In fact, it contemplates Mr Scanlon continuing to assist the new senior management team for approximately 6 months to enable a smooth handover to take place. It states that it would require Mr Scanlon to be available on a full-time basis during at least the start of that period. It suggests this could be done under a consultancy agreement. Furthermore, judging by what Mr Scanlon said to his brother in the handwritten letter of 17 October 2006, he, at least, was contemplating retirement from the workforce at that time.

82. It appears to me that, in the context of determining the net value of CGT assets, liabilities related to those assets must be a reference to expenditure incurred by the entity in obtaining those assets. The assets disposed of by L & R Health as a consequence of its sale agreement with Lifehealthcare included shares and goodwill. Those items are described in s. 100-25(2) and (3) of the ITAA 1997. In working out whether a capital gain has arisen, the factors involved in that calculation are set out in s. 100-40 of the ITAA 1997. In essence, it involves subtracting from the capital proceeds (the amount received as a consequence of the CGT event) the cost base or, if there is a capital loss, the reduced cost base.

83. In my opinion, the evidence clearly discloses that the consideration to be provided for the purchase of all of the issued shares of L & R Health was based on Enterprise Value. It included NTA and a multiple of EBIT based on the 2007 financial year. The calculation of NTA took into account the fact that all of L & R Health's liabilities needed to be discharged. That included repaying all outstanding loans, formal debts and corporate tax related to the period prior to completion. Furthermore, the purchaser made it clear that it was not concerned about how payment of the consideration was to be dealt with by the sellers, Mr and Mrs Scanlon. Therefore, I find that the consideration received by Mr and Mrs Scanlon for the sale of the business of L & R Health, which included control of that company via their respective shares, was $14,000,000.

84. In calculating the net value of L & R Health's CGT assets, its liabilities must be subtracted. There was no issue about the Brencorp loan. Those loan moneys were used by L & R Health in the acquisition of its assets, including its goodwill, which is a collective description of unidentified intangible assets. Goodwill comprises of that value which is attributed to the business as a going concern which is not accounted for by its NTA. As Henderson and Pierson explain in their text, while goodwill can be sold or purchased as part of the firm as a whole, it is not a separate asset. It is based on predicted future earnings and what a willing buyer is prepared to pay given its required rate of return on its investment. One cannot therefore attribute any specific input to the price paid by a purchaser for goodwill. It is simply an estimated value based on expected future earnings. Given that it is in fact a monetary sum attributed to expected future earnings and that the ETPs were said to have been a payment in recognition of the past work put in by Mr and Mrs Scanlon, it is difficult to envisage how any such payment could be related to a specific CGT asset. That view is reinforced by the fact that in working out the Enterprise Value of L & R Health, the purchaser did not take into account the liability of L & R Health to make ETP payments to Mr and Mrs Scanlon. The amount subsequently claimed by Mr and Mrs Scanlon as ETP payments was simply an allocation made by

ATC 6528

them from the consideration provided by the purchaser. The payments are more appropriately described as a gratuitous payment or a golden handshake. Those payments cannot be related to the CGT assets.

85. Furthermore, the money used to make the ETP payments was obtained from the purchaser on conclusion of the sale of the business of L & R Health. It was an allocation of part of the total consideration made by Mr and Mrs Scanlon for the purported purpose of enabling L & R Health to discharge its obligation pursuant to the resolution passed on 15 December 2006. It was not a payment made to the shareholders for the sale of the shares and business interests of L & R Health. Nor can it properly be described as a liability incurred in relation to the CGT assets. It was, as the Commissioner contended, a gratuitous payment to Mr and Mrs Scanlon to enable L & R Health to meet the expectations of its shareholders regarding an ETP. It had nothing to do with the acquisition of any CGT assets (as undoubtedly did the moneys received from Brencorp which, in accordance a loan agreement between Mr and Mrs Scanlon and Brencorp, were used by Mr and Mrs Scanlon to purchase the shares in L & R Health); nor did it represent a payment for the goodwill of L & R Health.

86. Given my findings regarding the nature of the ETP payments made to Mr and Mrs Scanlon, the net asset value position of L & R Health was as follows:

Funds received for CGT assets	$14,000,000
Less related liabilities:
	Brencorp No 2 loan	$6,500,000
	Accrued Interest payable on loan	$833,854.35
		$7,333,854.35
Net asset value	$6,666,145.65

87. It was not in dispute that as far as Mrs Scanlon is concerned, to satisfy the maximum net asset value test in s. 152-15 of the ITAA 1997, the net value of Mr Scanlon's assets must be taken into account because he is a small business CGT affiliate of hers pursuant to s. 125-25(1). In addition, the value of the assets of L & R Health must also be taken into account because that entity is connected with Mrs Scanlon as she controls 50% of the shares in L & R Health and therefore falls within s. 152-30(1) and (2) of the ITAA 1997. The same of course applies to Mr Scanlon. Accordingly, the net asset value which must be attributed to each of Mr and Mrs Scanlon at the time of disposal of their CGT assets is $6,666,145.65. I find that they do not satisfy the maximum net asset value test in s. 152-15 and therefore are not eligible for relief under Subdivision 152-A of the ITAA 1997.

ASSETS BEING USED SOLELY FOR PERSONAL USE AND ENJOYMENT EXEMPTION

88. The next issue raised by the parties related to assets which should be disregarded in working out the net value of the CGT assets of an entity (s. 152-20(2)) of ITAA 1997). Mr and Mrs Scanlon contended that their rights to receive an ETP were assets used solely for their personal use and enjoyment.

89. Both parties agreed that this issue only arose if L & R Health had a liability to pay an ETP to Mr and Mrs Scanlon just before CGT event A1. It was not disputed that if Mr and Mrs Scanlon had a right to enforce a contractual obligation to have L & R Health pay to each of them an ETP, that right constituted a CGT asset in accordance with s. 108-5 of ITAA 1997. In fact, under the examples provided in Note 1 under s. 108-5(2)(d) is included: a right to enforce a contractual obligation. However, because I have found that, contrary to the contentions made by both parties, no contractual liability arose between L & R Health and Mr and Mrs Scanlon regarding the payment of an ETP, there was no right, either

ATC 6529

legal or equitable, capable of being enforced. Nevertheless, in the event that I am wrong about that and the right to an ETP by Mr and Mrs Scanlon was enforceable, I will examine whether that right was solely for the personal use and enjoyment of each of them.

90. It is important when considering this issue to bear in mind that we are concerned here with the right to receive an ETP rather than the use to which the proceeds following the exercise of that right might be put. Both parties agreed that simply holding such rights could amount to those assets being used. I confess to having difficulty in accepting that concept. While I have no doubt that rights or contractual rights in general may be an asset which can be disposed of, for example, by way of assignment, I cannot understand how a right to receive the payment can be used by an individual simply by holding it. The word use when used as a verb, means: 1 cause to act or serve for a purpose; bring into service; avail oneself of… (The Australian Concise Oxford Dictionary). In my view, one cannot use a right to enforce a contract without exercising that right or disposing of it. In exercising that right, one could not properly describe the right as being used. Once it is exercised, it ceases to exist. Particular attention needs to be paid to the fact that the statutory expression is couched in the present tense, that is, assets being used. A right to receive an ETP, simply by the fact of its existence, does not indicate that it is being used. That does not satisfy the present tense used in s. 152-20(2)(b) of ITAA 1997.

91. Both parties referred to what was said by Branson J in
Favaro v Federal Commissioner of Taxation (1996) 34 ATR 1, when determining whether Italian currency held by Mr Favaro in an Italian bank account, which was subsequently closed and brought to Australia, was used or kept primarily for personal use. Her Honour said that the evidence of Mr Favaro was that he kept the Italian currency for the purpose of exchanging it for Australian currency at a favourable rate. Branson J was satisfied that the money, or a significant portion of it, was invested in some way which she was unable to identify. She found that the Italian currency was not used or kept primarily for personal use. Her Honour explained, at 15:

In my view the Italian currency was not "used or kept primarily for personal use" of the applicants within the meaning of s. 160B of the ITAA. I accept the submission made on behalf of the respondent that the expression "personal use" is used in s. 160B of the ITAA in contradistinction to use for business or profit making purposes. I conclude that the exchange gain made by the applicants upon exchanging their Italian currency for Australian currency is an assessable capital gain under Pt IIIA of the ITAA.

92. In my opinion, Favaro's case does not assist either party in determining this issue. Her Honour determined that the Italian currency, when brought to Australia by Mr Favaro, was not used or kept primarily for personal use because she was satisfied that the evidence disclosed that it or a substantial portion of it was subsequently invested. She found that the exchange gain made by exchanging Italian currency for Australian currency was an assessable capital gain.

93. In the case before me, I do not have the benefit of determining whether the right to receive an ETP should be disregarded by examining what happened after the CGT event in question. Because the exemption is couched in the present tense, and the maximum net asset value test must be applied just before the CGT event, the only question I need to determine is whether at that time the right to receive an ETP was being used solely for the personal use and enjoyment of Mr and Mrs Scanlon. In my opinion, while I accept that such a right could be regarded as a CGT asset, it cannot be said that the asset was being used. It simply existed.

94. Therefore, I find that if the right to an ETP held by Mr and Mrs Scanlon is an enforceable legal or equitable right and, for that reason, is a CGT asset, it cannot be disregarded on the grounds that it is being used solely for Mr and Mrs Scanlon's personal use and enjoyment.

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CAPITAL PROCEEDS FROM A CGT EVENT

95. Just what constitutes the capital proceeds resulting from a CGT event is set out in s. 116-20(1) of ITAA 1997, which provides:

(1) The capital proceeds from a *CGT event are the total of:
- (a) the money you have received, or are entitled to receive, in respect of the event happening; and
- (b) the *market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

96. The Commissioner contended that an amount equal to the ETPs received by Mr and Mrs Scanlon was included in each of their capital proceeds from the CGT event A1. It was put that:

(a) payment of the ETPs was part of the consideration which moved the transfer by Mr and Mrs Scanlon of the L & R Health shares to Lifehealthcare; or, alternatively
(b) Lifehealthcare's promise to procure that L & R Health meet its obligations to pay the ETPs formed part of the consideration for the sale of each share such that the value of that promise to each seller should be included in his or her capital proceeds.

97. Again, this analysis is conducted on the assumption that my findings regarding L & R Health's liability to provide Mr and Mrs Scanlon with an ETP are incorrect. If no such liability arose, as I have found, the payment of the ETPs must have formed part of the consideration which moved from Lifehealthcare to each of Mr and Mrs Scanlon. It simply formed part of the moneys received by Mr and Mrs Scanlon in respect of CGT event A1 happening. In other words, it was part of the consideration in accordance with what the Commissioner contended in [96(a)] above.

98. As I understood the Commissioner's first contention, even if the consideration provided by Lifehealthcare included an amount of $2,750,000 for the payment of the ETPs, that sum should nevertheless be treated as consideration paid for the disposal of the shares and business of L & R Health. The Commissioner relied on an analogous case concerning the transfer of shares in a company where the vendor and purchaser had agreed that before completion, the vendor would cause the company to declare a dividend and the purchase price would be reduced by the amount of the dividend the purchaser had to fund to allow the company to make that payment.

99. Mr de Wijn referred to the High Court of Australia decision in
Chief Commissioner of State Revenue (New South Wales) v Dick Smith Electronics Holdings Pty Ltd (2005) 221 CLR 496. The plurality, Gummow, Kirby and Hayne JJ, said at 519:

The consideration which moved the transfer by the Vendors to the Purchaser of the Shares which they owned in the Company was the performance by the Purchaser of the several promises recorded in the Agreement in consequence of which the Vendors received the sum of $114,139,649. It was only in return for that total sum (paid by the various steps and in the various forms required by the Agreement) that the Vendors were willing to transfer to the Purchaser the bundle of rights which their shareholding in the Company represented.

Noticing the several steps which the Agreement required to be undertaken in order to achieve that result must not be permitted to obscure that the amount of monetary consideration for the transaction of the sale and transfer of the Shares was the sum identified. That part of the amount was to come as a dividend from the Company, the Vendors' shares in which were being sold, rather than immediately from the Purchaser, does not deny that proposition.

100. I agree with the submissions made by Mr de Wijn on this point. The consideration which Lifehealthcare was prepared to pay for the business of L & R Health as a going concern was $14,000,000. That purchase price allowed for the discharge of formal debts. It allowed for discharge of the Brencorp loan and it was calculated on the basis of an NTA of at least $4,000,000 and the maintenance of the 2007 financial year EBIT. The purchaser was unconcerned by the way in which the sellers intended to apportion consideration on

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completion of the sale. While it is correct to say, as was submitted by Mr Bearman, that the Share Purchase Agreement provided that Lifehealthcare was required to procure that L & R Health met all its obligations to its Employees, if that was intended to cover the proposed ETPs to Mr and Mrs Scanlon, I would have expected it to expressly state that to be the case. Furthermore, clause 13 of Schedule 6 relevantly states:

13 Employees

(a) List of Employees: Schedule 7 comprises a complete list of the employees of the Company as at the date of this agreement.

(b) Employment terms: Each employee

(i) has been paid in full by the Company all amounts due to it other than the payments and benefits listed in Schedule 7; and

(ii) can be lawfully terminated as an employee on 3 months' notice or less without payment of damages or compensation, including severance or redundancy payments.…

101. Schedule 7 to the Share Purchase Agreement sets out the names of all employees of L & R Health as well as its outstanding obligations to those persons. While Mr and Mrs Scanlon are listed in Schedule 7, along with their salaries and other allowances, there is no mention there of them being owed an ETP. In fact, the Share Purchase Agreement provides a definition for the expression Completion Debt which includes the total financial indebtedness of L & R Health excluding, amongst other things, any ETP, as at the completion date. As I understand that, because of the arrangement to have Lifehealthcare pay Mr and Mrs Scanlon their claimed ETPs directly, thereby bypassing a payment to L & R Health, those amounts said to be owing were not considered to be debts of L & R Health. The Brencorp loan and interest on the Brencorp loan also fall under this provision.

102. I find that even if, contrary to my view, there was an obligation on L & R Health to make ETP payments to Mr and Mrs Scanlon, the consideration received by Mr and Mrs Scanlon for the transfer of their shares in L & R Health included the ETP amounts. As in the Dick Smith case, the payment of consideration was made on the understanding that Mr and Mrs Scanlon transfer the bundle of rights which their shareholding in L & R Health represented. That part of the purchase price may have been paid notionally to L & R Health to enable it to pay the claimed ETPs does not change the nature of that payment. Just how Mr and Mrs Scanlon apportioned that consideration was of no concern to Lifehealthcare. In fact, consistent with the offer letter of 22 November 2006 which was accepted by Mr and Mrs Scanlon, the Share Purchase Agreement makes no mention of the discharge of L & R Health's purported obligations to pay Mr and Mrs Scanlon an ETP and in fact expressly excludes them as debts of L & R Health as at the completion date.

103. While the expression ETP is defined in Schedule 1 (page 22) as an eligible termination payment to be paid in accordance with an agreement or agreements disclosed to the Buyer in the Disclosure Materials (which is also defined as an item of information, communication or disclosure contained in the documents referred to in Attachment C and the Disclosure Letter), that appears to be inserted in the Share Purchase Agreement for the purpose of satisfying what was said in the offer letter of 22 November 2006 regarding the apportionment of the consideration at the direction of Mr and Mrs Scanlon. Effectively, it permitted Lifehealthcare to discharge its obligations to pay the purchase price by allocating the consideration directly as requested by Mr and Mrs Scanlon rather than making the payment to L & R Health.

104. The alternative proposition put by Mr and Mrs Scanlon is based on the assumption that under the Share Purchase Agreement, Lifehealthcare promised to ensure that L & R Health fulfilled its obligation to pay the ETPs. Contrary to the Commissioner's contention that the promise was property for the purposes of s. 116-20(1)(b), Mr and Mrs Scanlon contended that the promise was not property for the purposes of s. 116-20(1)(b). Mr Bearman submitted that not all of the rights and obligations set out in a contract constituted consideration. The promise by Lifehealthcare to procure that L & R Health paid ETPs to Mr and Mrs Scanlon was a term and condition of the

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contract but not part of the consideration of the sale of the shares. Furthermore, there was no basis on which to treat that obligation differently to Lifehealthcare's obligation to procure that L & R Health repaid the Brencorp loan.

105. Assuming, contrary to my findings, that Lifehealthcare under the Share Purchase Agreement promised to ensure that L & R Health fulfilled its obligation to pay an ETP to Mr and Mrs Scanlon, Mr de Wijn submitted that the promise given by Lifehealthcare was part of the consideration or capital proceeds for the purposes of s. 116-20(1)(b) of ITAA 1997. In support of that submission he referred to the High Court of Australia decision in
The Commissioner of Taxation of the Commonwealth of Australia v Orica Limited (1998) 194 CLR 500. One of the issues with which the Court was confronted in that case was whether, in making an agreement described as the Principle Assumption Agreement, the taxpayer acquired an asset and whether, when the Melbourne and Metropolitan Board of Works (MMBW) (the assumption party) performed its obligations under that agreement, a change occurred in the ownership of the asset. At that time, an asset was defined in s. 160A as any form of property and it included: an option, a debt, a chose in action, any other right, goodwill and any other form of incorporeal property. The plurality (Gaudron, McHugh, Kirby and Hayne JJ) said, at 536 - 537:

We have no doubt that the rights acquired by the taxpayer against MMBW under the Principle Assumption Agreement are an asset for the purposes of Pt IIIA.… The conclusion that the taxpayer's right against MMBW was only a right to compel MMBW to specifically perform its obligations appears to have been founded in the proposition, adopted by the primary judge, that "no conceivable assignees would have any interest in enforcing MMBW's obligation which was to discharge [the taxpayer's] obligation to the debenture holders" (117).… The question is whether the rights are capable of assignment, not whether anyone is interested in taking an assignment.…

In any event, we do not accept that there is "no conceivable assignee" who would have an interest in taking an assignment from the taxpayer of its rights against MMBW.… It follows that the rights which the taxpayer had against MMBW under the Principle Assumption Agreement are an asset for the purposes of Pt IIIA.

106. Given that contractual rights are CGT assets for the purposes of ITAA 1997 (s. 100-25(3)), they are plainly property for the purposes of the CGT provisions to which a market value can be attached. Accordingly, assuming that the Share Purchase Agreement embodied a promise given by Lifehealthcare that L & R Health would make ETP payments to Mr and Mrs Scanlon from the purchase price paid for their shares, I would find that promise constituted capital proceeds from a CGT event in accordance with s. 116-20(1)(b) of ITAA 1997.

PENALTIES

107. As is the case where a taxpayer considers that the assessment is excessive, so to where the Commissioner determines to impose a penalty on the taxpayer, the taxpayer has the burden of proving that such decision should not have been made. This is set out in s. 14ZZK(b)(iii) of the Taxation Administration Act 1953 (the Administration Act) which provides:

(b) the applicant has the burden of proving that:

(i) if the taxation decision concerned is an assessment (other than franking assessment) - the assessment is excessive; or

(ii) if the taxation decision concerned is a franking assessment - the assessment is incorrect; or

(iii) in any other case - the taxation decision concerned should not have been made or should have been made differently.

108. Section 284-75 of the Administration Act deals with liability to penalty. As at February 2007, it provided:

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284-75 Liability to penalty

(1) You are liable to an administrative penalty if:

(a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under a *taxation law; and

(b) the statement is false or misleading in a material particular, whether because of things in it or omitted from it; and

(c) you have a *shortfall amount as result of the statement.

(2) You are liable to an administrative penalty if:

(a) you or your agent makes a statement to the Commissioner or to an entity that is exercising powers or performing functions under an *income tax law; and

(b) in the statement, you or your agent treated an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable; and

(c) you have a *shortfall amount as a result of the statement; and…

109. In their Statement of Facts, Issues and Contentions, Mr and Mrs Scanlon conceded that if they had incorrectly disclosed their net capital gain in the 2007 income tax returns, they made false or misleading statements. Given my findings regarding whether the small business concessions in Subdivision 152-A applied to Mr and Mrs Scanlon, it follows that they failed to disclose income in the form of capital gains thus exposing them to liability to an administrative penalty.

110. The expression shortfall amount is defined in s. 284-80(1) of the Administration Act. At the relevant time, it provided:

284-80 Shortfall amounts

(1) You have a shortfall amount if an item in this table applies to you. That amount is the amount by which the relevant liability, or the payment or credit, is less than or more than it would otherwise have been.

Shortfall amounts

Item You have a shortfall amount in this situation:

1 A *tax-related liability of yours for an accounting period, or for a *taxable importation, worked out on the basis of the statement is less than it would be if the statement were not false or misleading

111. Given the significant increase in both Mr and Mrs Scanlon's tax liabilities due to the inapplicability of the small business CGT concessions (Mr Scanlon an increase of $2,056,250 in taxable income and Mrs Scanlon an increase of $1,506,251), there can be no question that both taxpayers have a shortfall amount.

112. The Commissioner has imposed a 25% base penalty on the shortfall amount on the grounds that Mr and Mrs Scanlon or their agent failed to take reasonable care to comply with a taxation law or, alternatively, that the shortfall amount or part of it resulted from them treating an income tax law as applying to a matter or identical matters in a particular way that was not reasonably arguable (s. 284-90).

Failure to take reasonable care

113. Miscellaneous Taxation Ruling MT 2008/1 (the Ruling), which is an expression of the Commissioner's opinion about the way a relevant provision applies, binds the Commissioner if a taxpayer relies on the ruling. It deals with administrative penalties. At paragraph 28, the Ruling provides:

The reasonable care test requires an entity to take the same care in fulfilling their tax obligations that could be expected of a reasonable ordinary person in their position. This means that even though the standard of care is measured objectively, it takes into account the circumstances of the taxpayer.

114. The Ruling states that the appropriate standard of care in making a statement must take account of the particular characteristics of the person concerned. That requires a decision maker to take into account:

• personal circumstances (such as age, health, and background);

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• level of knowledge, education, experience and skill; and
• understanding of the tax laws.

115. Greenwood J dealt comprehensively with the meaning of the expression reasonable care as appears in Division 284 of the Administration Act in
Aurora Developments Pty Ltd v Federal Commissioner of Taxation (No 2) (2011) 196 FCR 457. His Honour said, after referring to the Revised Explanatory Memorandum to the 2000 Bill, at 465 - 466:

It follows as a matter of principle that the reasonable care test calls upon a taxpayer to exercise the care that a reasonable person would be likely to have exercised in the circumstances of the taxpayer in fulfilling the taxpayer's tax obligations. The test looks to whether such a person would have foreseen, as a reasonable probability or reasonable likelihood, the prospect that the action or step or the failure to act or take an affirmative step would result in a shortfall amount and in determining that question, a relevant factual enquiry is whether the taxpayer made the reasonable attempts a person in the position of the taxpayer ought to have taken so as to comply with the provisions of a taxation law. At para 1.75 of the Explanatory Memorandum, the observation is made that a taxpayer who prepares his or her own Business Activity Statement would usually be taken to have exercised reasonable care if the taxpayer relies upon the advice of an accountant or lawyer (or both) whom the taxpayer could reasonably expect to provide competent advice on the relevant matter in issue.

At para 1.76, the observation is made that a taxpayer would be at risk of a penalty if the taxpayer was careless (that is to say, did not act reasonably) in presenting all of the relevant facts to an adviser and such a failure materially affected the advice upon which the taxpayer sought to rely.

116. His Honour also provided two observations from authorities which he said might usefully be noted. The first was from the Federal Court decision in
North Ryde RSL Community Club Ltd v Federal Commissioner of Taxation (2002) 121 FCR 1 where Spender, Finn and Merkel JJ referred to the fact that the Administrative Appeals Tribunal did not identify any other step that the taxpayer ought to have taken but did not take, or any step it did take that it ought not to have taken. He said, at 466:

…Therefore, one question to be answered in determining whether the taxpayer and its advisers took reasonable care is whether, on the facts, there are steps that the taxpayer ought to have taken but did not take or steps that it did take that it ought not to have taken.

117. The second observation made by Greenwood J was from the Federal Court decision in
MLC Ltd v Deputy Commissioner of Taxation (2002) 126 FCR 37, a decision of Hill J. His Honour said, at 466:

… Hill J observed at [53] that "a taxpayer who relies upon expert advice as here where the advice is held generally in the industry and does not conflict with any statement made by the Commissioner… is not required to obtain a ruling to guard against an allegation that the taxpayer has not exercised due care".

118. MT 2008/1 also states that a failure to respond to every foreseeable risk will not necessarily mean that reasonable care is absent. In each case, the seriousness of the risk must be weighed against the cost of guarding against it. Paragraph 92 then states:

The size of a shortfall or the proportion of the shortfall to the overall tax payable, arising from making a false or misleading statement, are indicators pointing to the magnitude of the risk involved in making the statement. An entity dealing with a matter that involves a substantial amount of tax or involves a large proportion of the overall tax payable will be required to exercise a higher standard of care because the consequences of error or misjudgement are greater. However, all the individual circumstances leading up to the making of the false or misleading statement are to be weighed up in deciding whether reasonable care has been taken.

119.

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Mr Scanlon testified that in about July 2006, when a representative of Lifehealthcare had approached him regarding the possibility of the sale of the business of L & R Health, he began to discuss the possible sale with the accountants, PKF Charted Accountants & Business Advisers (PKF). PKF has since ceased to exist as a firm. Mr Scanlon said that PKF advised him that he and his wife should consider arranging to take an eligible termination payment upon the sale of the business. He said he relied on that advice. In her affidavit, Mrs Scanlon said that she had no idea what a reasonable price for L & R Health was or what amounts would be reasonable for her and her husband to receive as termination payments. Although informed by her husband, she makes no mention of seeking the advice of PKF prior to proceeding with the sale of the business of L & R Health. She did however say that prior to the sale proceeding, together with her husband, they met with Mr Peter Scanlon and discussed the amount which would be appropriate to be paid as termination payments as well as arrangements for repayment of the loan made by Brencorp.

120. Mr and Mrs Scanlon contended that their tax agent took reasonable care to comply with taxation laws. They said that they engaged PKF Melbourne specifically to calculate the capital gains arising on disposal of the shares in L & R Health including any applicable CGT discount and CGT small business concessions as well as the ability to make contributions into a superannuation fund on their behalf. Mr and Mrs Scanlon also contended that Price & Co, as their tax agents, prepared and lodged their income tax returns based on the calculations prepared by PKF Melbourne.

121. In fact, following a letter from the ATO to Mr Scanlon, C/- Price & Co, dated 10 August 2009 informing him of an audit for the 2007 income year, it appears Mr Scanlon advised the ATO on 1 September 2009 that he had engaged the services of a partner at PKF Melbourne to act as his agent in respect of the audit. In a facsimile dated 4 September 2009, Price & Co wrote to the ATO stating that the people who arranged the original documentation in relation to the Capital Gain were in the process of providing the information the ATO sought.

122. PKF responded in a letter dated 16 September 2009 providing documents in support of the information given. That would seem to indicate that PKF was in fact responsible for preparing the documentation in respect of the sale of L & R Health including documents relating to their ETPs. PKF provided details in that letter regarding the resignation of Mr and Mrs Scanlon as directors of L & R Health and copies of the board resolution together with the letters written on 15 December 2006. It appears that a firm describing itself as Corporate Lawyers, Brian Ward & Partners Pty Ltd, acted for Mr and Mrs Scanlon on the settlement of the Share Purchase Agreement. Furthermore, the letters dated 15 December 2006 from L & R Health to each of Mr and Mrs Scanlon confirming the arrangements for the proposed ETPs and the Board Resolution made on that day appear to have been drafted by Brian Ward & Partners as the footer on those documents is identical. However there was no evidence that Ward & Partners provided any legal advice in respect of that transaction.

123. I have carefully examined all of the documents which were taken into evidence on the hearing of this matter but I was unable to locate any document from PKF which so much as suggested that the accounting firm advised Mr and Mrs Scanlon regarding the sale of the business of L & R Health and the ETP payments. The only evidence before me regarding the controversial ETP payments suggests that this information may have come from Mr Peter Scanlon. In the letter dated 17 October 2006 from Mr Scanlon to Mr Peter Scanlon, Mr Scanlon, after referring to discussions on the previous day, said: We agree that we are underpaying ourselves. This belief, according to Mr Scanlon, formed the basis for the decision to pay ETPs. Mr Scanlon then went on suggesting he agreed that L & R Health could pay an ETP into his and his wife's superannuation fund. He does not mention that he took advice from PKF.

124. Following that discussion, in his letter of 17 November 2006 to Lifehealthcare, Mr Peter Scanlon said: Obviously however we are willing to discuss the breakup and method of the consideration if there are ways of benefiting both parties. I understand that to mean that Mr

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and Mrs Scanlon were prepared to apportion the allocation of the $14,000,000 consideration in ways which would minimise their and possibly Lifehealthcare's taxation liability. The allocation of a substantial portion of the consideration to the payment of ETPs to Mr and Mrs Scanlon would of course achieve that purpose.

125. In his witness statement Mr Scanlon said he began to discuss the possibility of a sale of the business of L & R Health with his accountants, PKF. It appears that Mrs Scanlon was unaware of those discussions because in her witness statement she only refers to discussing the possible sale of L & R Health at meetings she and her husband attended with Mr Peter Scanlon.

126. Following the appointment of PKF to deal with queries raised by the ATO as a consequence of the audit, that firm corresponded with the ATO and copies of their letters were in evidence before me. There is no suggestion whatsoever in any of that correspondence indicating that PKF were Mr and Mrs Scanlon's business advisors in relation to the sale of the L & R Health business. In fact, in the letter Mr Scanlon wrote to the ATO on 1 September 2009 stating he had appointed Ms Sharon Burke, a partner of PKF Melbourne to act as his agent in respect of the audit, he gives no indication whatsoever of PKF's prior involvement in the sale. The letter from Price & Co dated 4 September 2009 to the ATO regarding the audit simply states that the people who arranged original documentation in relation to the Capital Gain were in the process of supplying the information requested.

127. The first letter drafted by PKF and sent to the ATO on 16 September 2009 in response to the queries raised regarding the sale transaction make no reference whatsoever to the total consideration ($14,000,000) supplied by Lifehealthcare for the purchase of L & R Health's business. It refers only to the capital gain relating to the proceeds of sale of the shares for $2,375,000 each. In fact Ms Burke states: The taxpayers entered into a contract to dispose of the 2 shares under a Share Purchase Agreement (SPA), dated 8 January 2007, for a total consideration price of $4,750,000 to an unrelated party. Ms Burke focuses on the 50% general discount; the 50% active asset reduction; and the retirement exemption in relation to the capital proceeds said to have been received on the sale of the shares. The only reference to Brencorp is a statement referring to $900,000 paid to it under a short-term loan arrangement. Ms Burke does not mention repayment of the $6,500,000 loan. She does refer to the ETP payments totalling $2,750,000 and provides documents relating to Mr and Mrs Scanlon's resignation as directors of L & R Health but in the context that they had resigned or retired in a bona fide manner as an employee or as a director. Ms Burke also incorrectly states that the ETP payment was paid directly from L & R Health to the TGS Scanlon Superannuation Fund. That statement was corrected in later correspondence, indicating the payment was made directly by Lifehealthcare (PKF letter to ATO dated 13 January 2010). To add to the confusion, Ms Burke, in her letter of 28 October 2009 referred to the loan of $6,500,000 between Brencorp and the purchaser, Lifehealthcare. The loan was of course made to L & R Health. In her letter of 22 January 2010 Ms Burke, in response to a request for documentation from the entity showing the withdrawal of transfer funds used to make the ETP payments said that the drawdown notice provided by Lifehealthcare was the only document available to evidence that payment. Again, had PKF been involved in advising Mr and Mrs Scanlon regarding the proposed ETPs, I would have expected something further from PKF.

128. In any event, given the fact that the total consideration for the transaction in question was $14,000,000, and that to be eligible for small business relief from CGT, the maximum net assets which are the subject of the CGT event could not exceed $5,000,000, it must have been apparent to Mr and Mrs Scanlon that there would be considerable difficulty in meeting this limit. While the Brencorp loan of $6,500,000 was unquestionably a liability of L & R Health which needed to be discharged and that would reduce the asset value to $7,500,000, there remained a substantial problem. To then reduce that figure to below $5,000,000 by the payment of an ETP to Mr and Mrs Scanlon may well have seemed like a good idea at the time as it

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clearly made a significant difference to their taxation liability. However, the real risk attached to that course must have been apparent at least to Mr Scanlon who had been in business for many years. Given that Mrs Scanlon was present when discussions took place regarding the possibility of paying ETPs between her husband and Mr Peter Scanlon, it is difficult not to conclude that she also became aware of that risk.

129. In addition, both Mr and Mrs Scanlon must have been aware that L & R Health did not have sufficient cash to make that payment to them. The money had to come from the intending purchaser, Lifehealthcare. Quite clearly, both Mr and Mrs Scanlon must have been aware that the consequences of error or misjudgement regarding the ETPs would have had significant consequences on their tax liability. Accordingly, to proceed with those payments and to then lodge income tax returns, albeit through their tax agent, without clearly stating to their tax agent the basis upon which they concluded that the moneys from Lifehealthcare paid to them ostensibly for their ETPs was a liability of L & R Health just before the CGT event, does not demonstrate that they exercised reasonable care. I did not have in evidence any instructions given to their tax agent. If in fact the tax agent had been given a complete history and account of these transactions, and he or she nevertheless proceeded to lodge the 2007 income tax returns in the form in which they were lodged, that would have been unreasonable.

130. In my opinion, Mr and Mrs Scanlon have not discharged the burden of proving, on the balance of probabilities, that the Commissioner's decision to impose an administrative penalty should not have been made or should have been made differently. The proposed ETP payments should have been properly investigated and, if any doubt remained, a private ruling from the Commissioner sought. Mr and Mrs Scanlon elected not to do any of those things. I find that they accepted the risk that they did not meet the maximum net asset value test for small business CGT relief and arranged the lodgement of their income tax returns in the form in which they did. That discloses they did not take reasonable care in providing the information contained in those returns to the Commissioner. They are liable to an administrative penalty in the amount of 25% of the shortfall amount.

Reasonably arguable position

131. While it is not strictly necessary for me to determine whether the position adopted by Mr and Mrs Scanlon regarding the ETPs was reasonably arguable, in the event that I am wrong about my findings regarding reasonable care, I will proceed with this analysis.

132. The Commissioner argued, in the alternative, that the positions adopted by Mr and Mrs Scanlon in their 2007 income tax returns were not reasonably arguable and therefore they were liable to an administrative penalty pursuant to s. 284-75(2) of Schedule 1 of the Administration Act. Mr and Mrs Scanlon contended that the positions they adopted in their 2007 income tax returns were reasonably arguable and hence they should not be liable to an administrative penalty of 25% of the shortfall amount.

133. The Commissioner has issued a Miscellaneous Taxation Ruling MT 2008/2 which deals with an administrative penalty for taking a position that is not reasonably arguable. By way of contrast with the reasonable care test, the Commissioner states in paragraph 29 - 30:

In contrast there is no personal aspect to the reasonably arguable position test as it applies an objective standard involving an analysis of the law and application of the law to the relevant facts. It is not a question of whether an entity thinks or believes that its position is reasonably arguable, but simply whether it is reasonably arguable.…

In this sense, a higher standard is imposed than that required to demonstrate reasonable care. Because of these differences, an entity may not have a reasonably arguable position despite having satisfied the reasonable care test.

134. Section 284-15 provides:

(1) A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.
(2) To the extent that a matter involves an assumption about the way in which the Commissioner will exercise a discretion, the matter is only reasonably arguable if, had the Commissioner exercised the discretion in the way assumed, a court would be about as likely as not to decide that the exercise of the discretion was in accordance with law.
(3) Without limiting subsection (1), these authorities are relevant:
- (a) a *taxation Law;…

135. The base penalty amount set out in s. 284-90 of the Administration Act at item 4 provides:

Your *shortfall amount or part of it resulted from you or your agent treating an *income tax law as applying to a matter or identical matters in a particular way that was not *reasonably arguable, and that the amount is more than the greater of $10,000 or 1% of the income tax payable by you for the income year, worked out on the basis of your *income tax return.

136. There was no issue in this matter that the shortfall amount involved was greater than $10,000 and, for that matter, 1% of the income tax payable by Mr and Mrs Scanlon based on their 2007 income tax returns. The reason for limiting the application of the reasonably arguable test to matters involving more significant dollar amounts was explained by Middleton J in
Federal Commissioner of Taxation v Traviati (2012) 205 FCR 136 where his Honour cited a passage from the Minister's Second Reading Speech at page 2777, where the Minister said:

However, following experience in the United States, the Government considers it appropriate that a more rigorous standard apply with the item at issue is very large, for example, generally more than $10,000 in tax. Where the interpretation of the law for such large items is in issue, we expect taxpayers to exercise more care, that is, the taxpayer must have a reasonably arguable position on the matter.

137. Middleton J also referred to Hill J's decision in
Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 which is accepted as the authority and correct approach to the interpretation of the reasonably arguable position provisions which were then set out in s. 226K of the Income Tax Assessment Act 1936. They are not dissimilar to the current provisions. Hill J set out seven propositions generally accepted to be the correct approach to the application and interpretation of s. 226K at pages 26 - 27, those being:

1 The test to be applied is objective, not subjective. This is clear from the use of the words "it would be concluded" in para (1)(b) of the section;
2 The decision-maker considering the penalty must first determine what the argument is which supports the taxpayer's claim;
3 That person will already have formed the view that the claim is wrong, otherwise the issue of penalty could not have arisen. Hence the decision-maker at this point will need to compare the taxpayer's argument with the argument which is considered to be the correct argument;
4 The decision-maker must then determine whether the taxpayer's argument, although considered wrong, is about as likely as not correct, when regard is had to "the authorities";
5 It is not necessary that the decision-maker form the view that the taxpayer's argument in an objective sense is more likely to be right than wrong. That this is so follows from the fact that tax has already been short paid, that is to say the premise against which the question is raised for decision is that the taxpayer's argument has already been found to be wrong. Nor can it be necessary that the decision-maker form the view that it is just as likely that the taxpayer's argument is correct as the argument which the decision-maker considers to be the correct argument for the decision-maker has already formed the view that the taxpayer's argument is wrong. The standard is not as high as that. The word "about" indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued

ATC 6539
which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right;
6 An argument could not be as likely as not correct if there is a failure on the part of the taxpayer to take reasonable care. Hence the argument must clearly be one where, in making it, the taxpayer has exercised reasonable care. However, mere reasonable care will not be enough for the argument of the taxpayer must be such as, objectively, to be "about as likely as not correct" when regard is to be had to the material constituting "the authorities"; and
7 Subject to what has been said that view advanced by the taxpayer must be one where objectively it would be concluded that having regard to the material included within the definition of "authority" a reasoned argument can be made which argument when contrasted with the argument which is accepted as correct is about as likely as not correct. That is to say the two arguments, namely, that which is advanced by the taxpayer and that which reflects the correct view will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen to be wrong it is nevertheless "about" as likely to be correct as the correct view. A question of judgement is involved.

138. Mr and Mrs Scanlon's claim that the position they adopted was reasonably arguable essentially on the grounds that the provisions dealing with the CGT small business concessions, and particularly the application of the maximum net asset value test, involved contentious issues. They pointed to the length of the objection decisions issued by the Commissioner; the length of time taken to issue the objection decisions (approximately 2 ½ years from lodgement of the applicants' joint notice of objection); and the number and complexity of issues involved in the current proceeding. They claimed those proceedings have involved PKF Melbourne, Price & Co and Rigby Cooke Lawyers to provide assistance in determining the correct legal position.

139. With respect to Mr and Mrs Scanlon, the bases advanced for their claim that the position they adopted was reasonably arguable cannot be sustained. In determining this issue, it is not the length of time taken to deal with objection decisions or the complexity of the issues involved which establishes the claim. It is about putting forward an argument which is about as likely to be correct as incorrect or is more likely to be correct than incorrect.

140. Effectively, what Mr and Mrs Scanlon did in this case was to first determine what they considered to be the correct valuation for the sale of the business of L & R Health. They arrived at a figure of $14,000,000. They found a purchaser who was prepared to pay $14,000,000 for that business. That purchaser valued the business based on its NTA and a multiple of the 2007 income year earnings. It also based its valuation on receiving a company which had cleared all of its financial liabilities at the time of completion of the sale agreement. That involved clearing all of L & R Health's loan accounts including loans made to Mr Scanlon (provided they were less than $20,000) and to Brencorp. It was also required to clear any outstanding liabilities to its employees. In order to facilitate the clearing of those debts, the purchaser agreed to make direct payments to Brencorp on account of its loan and interest owed on that loan and Mr and Mrs Scanlon's claimed ETP payments. L & R Health plainly did not have sufficient cash to pay out those liabilities. Its financial statements for the year ended 30 June 2007 disclose the sum of $1,160,063 in its bank accounts. That was well short of the amount required to discharge its debts and to make the proposed ETP payments to Mr and Mrs Scanlon.

141. Nevertheless, having found a buyer willing to pay $14,000,000 for the business of L & R Health, Mr and Mrs Scanlon decided that they would make allocations from the consideration provided from the sale of the business which, in effect, resulted in payments being made directly to Brencorp to discharge its

ATC 6540

loan and accrued interest and also to themselves for their claimed ETPs. While there may be some legal issues about the valid discharge of L & R Health's liability for the Brencorp loan and accrued interest, they do not of course arise in this proceeding. However, the purported discharge of the liability of L & R Health to pay an ETP to each of Mr and Mrs Scanlon is a different matter.

142. In my opinion, it was apparent to Mr and Mrs Scanlon, even prior to committing to the sale of the business of L & R Health, that upon completion of the sale, they would both become liable for a substantial CGT sum. In fact, they could not take advantage of the small business CGT concessions unless they reduced their combined net CGT asset value to below $5,000,000. Were they able to do so, there were substantial tax savings to be had. The problem is that whichever way they decided to allocate the consideration paid by Lifehealthcare for the business of L & R Health, the proceeds nevertheless formed part of the consideration for the sale of the CGT assets. While Brencorp's loan and accrued interest was properly set off against that total consideration to arrive at a net value, the same cannot be said for the ETPs. Even if, contrary to my findings, L & R Health had incurred a liability to pay those ETPs before CGT event A1 occurred, Lifehealthcare nevertheless made payments to them directly in discharge of their claimed respective rights to receive an ETP from L & R Health. It must have been apparent to Mr and Mrs Scanlon and their financial and legal advisers that there was a serious risk that in claiming the ETPs were liabilities of L & R Health which were required to be discharged prior to completion of the sale, that the correct position was in fact that the total consideration was simply being paid for its CGT assets.

143. Of course there was also the obvious problem that the maximum net asset value test was to be applied just before the CGT event, in this case, A1. The acceptance by Mr and Mrs Scanlon of the offer in Lifehealthcare's letter of 22 November 2006 was plainly the acceptance of that offer in accordance with its terms. It is inconceivable that any legal adviser would have informed Mr and Mrs Scanlon that the acceptance of that offer did not constitute a binding agreement in accordance with its terms. Any such advice could not possibly be regarded as being reasonably arguable or as likely to be correct as incorrect given the clear authorities dealing with the formation of contracts, in particular, the
Masters v Cameron; Baulkham Hills Private Hospital and Anaconda Nickel cases. The circumstances of this case do not indicate that the correct assessment of the position following the acceptance of Lifehealthcare's offer was finely balanced. In fact it is weighted heavily against the position argued on behalf of Mr and Mrs Scanlon.

144. If that were not sufficient, a serious question nevertheless arose regarding whether L & R Health ever had a legal obligation to make the ETP payments claimed by Mr and Mrs Scanlon. While both parties appeared to accept that the letters from L & R Health to Mr and Mrs Scanlon on 15 December 2006 and their respective acceptance or agreement to the ETP payments constituted a binding contract between the company and the executive directors as employees, it seems that a significant detail was overlooked. The purported consideration for that agreement was the past services rendered by Mr and Mrs Scanlon. It is a fundamental principle of contract law that past consideration is no consideration at all. Without consideration moving from the promisee, there could be no legally binding agreement.

145. I would have expected competent lawyers advising Mr and Mrs Scanlon to have informed them of that problem assuming of course that they understood the context in which those purported agreements would be used. Again, in my opinion, I do not see this issue as being finely balanced. L & R Health never incurred a legal liability to make ETP payments to Mr and Mrs Scanlon and therefore it was not reasonably arguable, even if it was L & R Health that made the payment to Mr and Mrs Scanlon via an arrangement with Lifehealthcare, that the payment or obligation to make that payment necessarily reduced the CGT assets net value.

146. For the reasons I have set out above, I find that the position taken by Mr and Mrs Scanlon in respect of the ETP payments was not reasonably arguable and therefore, even if I am

ATC 6541

wrong about whether they took reasonable care in the lodgement of their 2007 income year tax returns, their liability to 25% of the shortfall remains.

CONCLUSIONS

147. I have found that for the purposes of s. 104-10(3), Mr and Mrs Scanlon disposed of their interests in the business of L & R Health, a CGT asset, on the day on which they executed the letter of offer dated 22 November 2006 from Lifehealthcare. According to their evidence, that occurred on or about 24 November 2006. That was the date on which CGT event A1 occurred.

148. Although Mr and Mrs Scanlon submitted that they were entitled to the small business entity capital gains tax concessions because they satisfied the maximum net asset value test in s. 152-15 of ITAA 1997, respectfully, I disagree. That is because I have found that just before the CGT event A1, the ETP liability which Mr and Mrs Scanlon claimed they were owed by L & R Health had not arisen. Even if, contrary to my findings, L & R Health incurred an enforceable liability to pay Mr and Mrs Scanlon an ETP, that could not have risen until 15 December 2006.

149. Although I have found that L & R Health never incurred an enforceable liability to pay Mr and Mrs Scanlon an ETP because there was no enforceable agreement between L & R Health and Mr and Mrs Scanlon to that effect, assuming that I am wrong about that, I have nevertheless found that if such a liability existed, it was not related to the CGT assets.

150. An alternative argument raised by the Commissioner was that if L & R Health had a liability to pay ETPs just before CGT event A1, the right to enforce a contractual obligation was itself a CGT asset. Mr and Mrs Scanlon submitted that their rights to receive an ETP were assets used solely for the personal use and enjoyment. I have found that if the rights to an ETP held by Mr and Mrs Scanlon were enforceable, they were not being used let alone being used solely for their personal use and enjoyment.

151. The Commissioner argued that in any event, an amount equal to the ETPs received by Mr and Mrs Scanlon should be included in their capital proceeds from the CGT event A1. In other words, those moneys are properly described as capital proceeds from a CGT event in accordance with s. 116-20(1) of ITAA 1997. I have found that the Commissioner's submission must be correct. I have also accepted the Commissioner's alternative submission that if it be understood that Lifehealthcare promised to ensure that L & R Health fulfilled its obligation to pay the ETPs to Mr and Mrs Scanlon, that promise formed part of the consideration or capital proceeds for the purposes of s. 116-20(1)(b).

152. Finally, I have found that Mr and Mrs Scanlon and/or their tax agent failed to take reasonable care when they lodged their 2007 income tax returns. Accordingly, they are both liable to an administrative penalty in the amount of 25% of the shortfall amount. I have also found that the position Mr and Mrs Scanlon adopted in their 2007 income returns was not reasonably arguable. Accordingly, I have found that if Mr and Mrs Scanlon did take reasonable care in the lodgement of their 2007 income tax returns, they are nevertheless liable to a 25% administrative penalty on the reasonably arguable ground.

153. In my opinion, the objection decisions made by the Commissioner on 30 April 2013 in respect of Mr and Mrs Scanlon's income tax assessments and penalty assessments for the income year ended 30 June 2007 were correct. I affirm those decisions.

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