ATO Interpretative Decision

ATO ID 2003/1024

Income Tax

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Issue

Does CGT event E1 in section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997) happen if the owner of a share in a company in administration creates a trust over the share by declaration or settlement?

Decision

Yes. CGT event E1 in section 104-55 of the ITAA 1997 happens in these circumstances as the creation of the trust is not rendered illegal by the scheme of the Corporations Act 2001 (Corporations Act).

Facts

The taxpayer agreed to sell shares in a company in administration to an unrelated party (the intending purchaser).

In accordance with that agreement, a share transfer form was completed.

At the time the transfer form was signed, court approval for the transfer had not been obtained. Accordingly, section 437F of the Corporations Act prevented the recording of the transfer in the company's share register.

The taxpayer intended that, on the completion of the transfer form, the taxpayer would hold the shares on trust for the intending purchaser until the transfer could be registered.

The market value of the shares, at the time of completion of the transfer form, was less than their reduced cost base.

Reasons for Decision

CGT event E1 in section 104-55 of the ITAA 1997 happens if a trust is created over a CGT asset by declaration or settlement.

The elements for the creation of an express trust over the shares appear to be satisfied. The taxpayer intended to create a trust over the shares and there is also certainty of the terms of the trust, the trust property (the shares) and the object of the trust (the intending purchaser).

However it is not certain that a trust can be created in respect of an asset if there exists a legal impediment to the transfer of the asset's legal title. There are cases where equity will not recognise interests created over an asset that is not freely transferable at law. However, McHugh J said in Nelson v. Nelson (1995) 184 CLR 538 at 613

[Courts] should not refuse to enforce legal or equitable rights simply because they arose out of or were associated with an unlawful purpose unless:

(a)

the statute discloses an intention that those rights should be unenforceable in all circumstances; or

(b)

(i)

the sanction of refusing to enforce those rights is not disproportionate to the seriousness of the unlawful conduct

(ii)

the imposition of the sanction is necessary, having regard to the terms of the statute, to protect its objects and policies; and

(iii)

the statute does not disclose an intention that the sanctions and remedies contained in the statute are to be the only legal consequences of a breach of the statute or the frustration of its policies.

The declaration of trust by the legal owner of shares in a company in administration does not fit within any of the exceptions outlined by McHugh J. Section 437F of the Corporations Act provides that:

a transfer of shares in a company, or an alteration in the status of members of a company, that is made during the administration of the company is void except so far as the Court otherwise orders.

It is considered that this provision does not absolutely prohibit dealings in, or the creation of rights in respect of, shares in a company in administration.

In McPherson's Law of Company Liquidation (Keay, A 1999, 4th ed, 239-40) it is pointed out that the object of comparable liquidation provisions (subsections 468(1) and 493(2) of the Corporations Act) is:

...to prevent the transfer of a share to an impecunious entity to avoid liabilities that may arise in respect of that share...[is] sufficiently served by avoiding only the transfer itself. A mere contract to transfer shares is not rendered illegal or void by the statute so that, as between the parties themselves, the purchaser would be entitled to any dividends declared, and bound to pay calls made upon those shares after the contract was entered into.

It is considered that the object of the provisions is also not frustrated by a declaration of trust, as the legal owner of the shares (as the trustee) remains principally liable in respect of the liabilities that attach to the shares.

Therefore, CGT event E1 happens to the taxpayer when the trust is created: subsection 104-55(2) of the ITAA 1997. In this case, as the market value of the shares at that time is less than their reduced cost bases at that time, the taxpayer will make a capital loss: subsection 104-55(3) of the ITAA 1997.

Year of income:  year ended 30 June 2004

Legislative References:
Income Tax Assessment Act 1997
   section 104-55
   subsection 104-55(2)
   subsection 104-55(3)

Case References:
Nelson v. Nelson
   (1995) 184 CLR 538

Related ATO Interpretative Decisions
ATO ID 2003/865

Other References:
Keay, A 1999, McPherson's Law of Company Liquidation, 4th ed, 239-40

Keywords
Capital gains tax
CGT events E1 - E9 - trusts
Shares
Voluntary administration

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  14 November 2003
Date reviewed:  3 April 2014

ISSN: 1445-2782