Contributed by Andrew Henshaw, Director, Velocity Legal
A recent case before the Full Federal Court has tested the limits of the CGT marriage breakdown roll-over. In Ellison & Anor v Sandini Pty Ltd & Ors; FC of T v Sandini Pty Ltd & Ors 2018 ATC ¶20-651, the court held that the CGT marriage breakdown roll-over (“CGT roll-over”) cannot apply where CGT assets are transferred to a discretionary trust. For CGT roll-over to apply, the CGT assets must go to the spouse or former spouse personally.
The court, which overturned the decision of the single judge in the lower court (Sandini Pty Ltd & Ors v FC of T & Ors 2017 ATC ¶20-610;  FCA 287), also made a number of interesting observations regarding the application of CGT event A1.
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Mr and Ms Ellison were separating. The Family Court made orders pursuant to s 79 of the Family Law Act 1975 (Family Law Act) directing that Sandini Pty Ltd (controlled by Mr Ellison) transfer 2,115,000 shares in Mineral Resources Limited (MIN) to Ms Ellison. The Family Court orders had numerous defects, which are briefly explained further below.
After the Family Court orders (but before the transfer of the shares), Ms Ellison requested that Mr Ellison arrange instead for Sandini Pty Ltd to transfer the MIN shares to Wavefront Asset Pty Ltd (Wavefront) as trustee for the Felstead Family Trust (ie Ms Ellison’s family trust), and not to Ms Ellison personally. Mr Ellison agreed to do so, and Sandini Pty Ltd and Wavefront signed share transfer forms to that effect.
The ATO later audited Sandini Pty Ltd (and Mr Ellison). The ATO determined that CGT marriage breakdown roll-over relief did not apply. This was because Sandini Pty Ltd transferred the shares to Wavefront as trustee for the Felstead Family Trust (and not to Ms Ellison personally).
Federal Court decision
At first instance (Sandini Pty Ltd & Ors v FC of T & Ors 2017 ATC ¶20-610), McKerracher J held that CGT event A1 happened when the Family Court orders were made, and that CGT roll-over could apply to that CGT event, because Ms Ellison was sufficiently “involved” in the ultimate share transfer to Wavefront as trustee for the Felstead Family Trust.
- Which CGT event occurred, and when did it happen?
- Could the CGT marriage breakdown roll-over apply?
Which CGT event and when did it happen?
CGT event A1 applies when you “dispose” of a CGT asset. Section 104-10(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that 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”.
Firstly, the Full Federal Court held that a change in beneficial ownership (but not legal ownership) is sufficient to trigger CGT event A1. The key issue was determining whether the Family Court orders effected a change in beneficial ownership, or some later event. The majority (consisting of Jagot and Siopis JJ) spent significant time considering the following:
- What did the term “change in (beneficial) ownership” require?
- Did the Family Court orders effect a change in beneficial ownership?
Meaning of beneficial ownership
The majority held that the term “change in (beneficial) ownership” required that a person (other than the legal owner of the asset) be entitled in equity to receive a transfer of that property. In particular, that to be a beneficial owner, a person must have rights which a court of equity would enforce involving “full dominion” over the asset.
Did the Family Court orders effect a change in beneficial ownership?
Ultimately, the majority held that the Family Court orders did not effect a change in beneficial ownership. While the reasoning behind this is complex, the reasoning of the majority can be distilled into the following key issues:
- The “fungibility” of shares. This issue centred around the fact that Sandini Pty Ltd owned more than 2,115,000 MIN shares, and that it appeared that the Family Court orders did not refer to any particular parcel of MIN shares.
- The parties to the orders. This issue centred around the fact that the Family Court orders incorrectly specified the capacity in which Sandini Pty Ltd held its MIN shares. In particular, the Family Court orders required that Sandini Pty Ltd do certain acts in its capacity as trustee for the Ellison Family Trust (whereas Sandini Pty Ltd held its MIN shares as trustee for the Karratha Rigging Unit Trust).
- Whether an order made pursuant to s 79 of the Family Law Act could itself effect a change in beneficial ownership, or whether an order made pursuant to s 79 gave a party some other right that did not equate to immediate beneficial ownership.
- The specific terms of the Family Court orders that were inconsistent with an immediate change in beneficial ownership. This issue centred around the fact that Sandini Pty Ltd had seven days to comply with the order. During that time, Sandini Pty Ltd could do as it pleased with its MIN shares and was not restrained from dealing with its MIN shares. For example, Sandini Pty Ltd could sell all of its MIN shares on day two, and then buy some other parcel of MIN shares on the ASX on day six.
For a combination of the above reasons, the majority held that the Family Court orders themselves did not effect a change in beneficial ownership of any MIN shares.
This is not to say that the Family Court orders did not give rights to Ms Ellison, or that Mr Ellison (or Sandini Pty Ltd) would not be in contempt of the Family Court for failure to follow those orders. Merely, that the rights provided to Ms Ellison by Family Court orders could not be characterised as “beneficial ownership”, as required by CGT event A1.
Accordingly, the majority held that CGT event A1 did not occur when the Family Court orders were made. Instead, it occurred when Sandini Pty Ltd executed the share transfer form, or on registration of Wavefront as the shareholder. This meant that the parties to CGT event A1 were Sandini Pty Ltd and Wavefront as trustee for the Felstead Family Trust (not Ms Ellison).
CGT event E2
Interestingly, the Court of Appeal did not address CGT event E2. Section 104-60(1) of ITAA 1997 provides that CGT event E2 happens “if you transfer a CGT asset to an existing trust”. Based on the facts as disclosed, it would appear that CGT event E2 also happened (as a CGT asset was transferred to an existing trust). However, the application of CGT event E2 was not addressed in the case.
Application of the CGT marriage breakdown roll-over
Having formed the view that CGT event A1 happened when Sandini Pty Ltd executed the share transfer form (or on registration of Wavefront as the shareholder), the majority then considered whether or not the CGT marriage breakdown roll-over could apply.
(1) There is a roll-over if a *CGT event (the trigger event) happens involving an individual (the transferor) and his or her *spouse (the transferee), or a former *spouse (also the transferee), because of:
- (a) a court order under the Family Law Act 1975 or under a *State law, *Territory law or *foreign law relating to breakdowns of relationships between spouses; or
(2) Only these *CGT events are relevant:
- (a) CGT events A1 and B1 (a disposal case); and
- (b) CGT events D1, D2, D3 and F1 (a creation case).
(4) A *capital gain or a *capital loss the transferor makes from the *CGT event is disregarded.
(1) There are the roll-over consequences in section 126-15 if the trigger event involves a company (the transferor) or a trustee (also the transferor) and a *spouse or former spouse (the transferee) of another individual because of:
- (a) a court order under the Family Law Act 1975 or under a *State law, *Territory law or *foreign law relating to breakdowns of relationships between spouses;
Requirements for the CGT roll-over
- whether Ms Ellison was involved in the trigger event (ie the CGT event), and
- whether the transfer was “because of” the Family Court order.
First requirement: involved in the trigger event?
The majority held that the correct interpretation of s 126-15 is that a spouse or former spouse can be involved in a trigger event in one capacity only, as transferee from a company or a trustee. In other words, a spouse or former spouse must be the transferee in order to be “involved” and hence for the CGT marriage breakdown roll-over to apply.
The majority’s reasoning for this is based on the fact that s 126-15(1) internally defines “transferor” and “transferee”. By using those definitions, the majority held that the internal definition specifies the type of involvement required (ie as transferee or transferor).
With respect, I agree with the majority’s approach. To take a different view would largely render the internal definitions of “transferor” and “transferee” redundant.
In addition to the above, the majority noted that this interpretation was consistent with former s 160ZZMA of the Income Tax Assessment Act 1936. Former s 160ZZMA contained the CGT marriage breakdown roll-over prior to Tax Law Improvement Act (No 1) 1998.
Second requirement: “because of” the Family Court order
The majority held that the “because of” requirement should be interpreted as involving a trigger event (ie CGT event) required by an order of the Family Court. In the majority’s view, a trigger event involving the transferor and transferee as identified in s 126-15 occurs because of an order of the Family Court, if the order requires that event to occur and the event occurs.
The “trigger event” was CGT event A1, occurring between Sandini Pty Ltd and Wavefront. The Family Court orders specified that Sandini Pty Ltd transfer MIN shares to Ms Ellison. The parties chose to transfer the MIN shares not in strict conformity with the Family Court orders. Thus, the trigger event (ie the transfer to Wavefront) did not occur because the Family Court orders required it, and hence did not occur “because of” the Family Court order within the meaning of s 126-15.
Key takeaway points
The takeaways from the Full Federal Court decision are as follows:
- The majority’s decision makes it very clear that the CGT marriage breakdown roll-over cannot apply to a transfer to a trust (or company). For the CGT marriage breakdown roll-over to apply, the CGT assets must go to the spouse or former spouse, personally.
- Specialist tax and duty advice should be obtained well before entering into any family law settlement. Prevention is better than tax litigation.
- Spouses or former spouses who are transferring assets should strictly follow the terms of consent orders. Failure to do could mean that the CGT marriage breakdown roll-over will not apply.
It remains to be seen whether Sandini Pty Ltd will seek special leave to appeal the decision to the High Court.