CGT rollover for marriage breakdowns – Sandini Pty Ltd v Commissioner of Taxation  FCA 287
WHO SHOULD READ THIS
- People drafting Family Court orders dealing with assets with potentially large capital gains tax implications.
- Individuals looking to place assets the subject of Family Court orders into a more protected environment.
THINGS YOU NEED TO KNOW
- The recent Federal Court decision of Sandini Pty Ltd v Commissioner of Taxation  FCA 287 has broadened the application of the CGT rollover for marriage breakdowns. The decision also marks a potentially wider application of CGT Event A1.
WHAT YOU NEED TO DO
- Where Family Court proceedings will deal with assets with potentially significant capital gains tax consequences, seek tax advice on the best approach to structuring orders.
On 22 March 2017, McKerracher J of the Federal Court of Australia handed down his decision in the case of Sandini Pty Ltd v Commissioner of Taxation  FCA 287 (Sandini Case). The case marks an important change to how the marriage breakdown rollover in Subdivision 126-A of the Income Tax Assessment Act 1997 (Cth) (ITAA97) can be utilised to allow spouses to receive marital property in an asset-protected environment.
On 23 September 2009 the Family Court ordered as part of divorce proceedings between Mr and Mrs Ellison that Sandini Pty Ltd as trustee for Karratha Rigging Unit Trust, which was wholly controlled by Mr Ellison, ‘do all acts and things and sign all documents necessary to transfer’ 2,115,000 shares in Mineral Resources Limited (Shares) to Ms Ellison. Following those orders, Ms Ellison provided a written direction to Mr Ellison requiring the Shares to be transferred to her family trust. Transfer forms were signed to that effect and Mr Ellison relied upon the rollover for marriage breakdowns contained in Subdivision 126-A ITAA97. The Commissioner later audited Mr Ellison and assessed him on the capital gain made on transferring the shares, on the basis that the rollover did not apply.
Marriage breakdown rollover
Section 126-5 ITAA97 provides relief for CGT events A1, B1, D1, D2, D3 and F1 where that CGT event happens involving an individual and his or her spouse or former spouse because of, (amongst other listed events) a court order to the breakdown of marriages. Section 126-15 ITAA97 extends the application of s 126-5 where the transferring entity is a trust or company. The rollover allows a capital gain or loss to be disregarded and provides the first element of the transferee’s cost base will be transferor’s cost base at the time of acquisition.
The rollover is only permitted in respect of a transfer to the spouse in their individual capacity and is not available where assets are transferred from the disposing party directly to a family trust. The main rationale for disallowing the rollover in circumstances where assets are transferred to a trust is because this invokes CGT event E2 (transferring a CGT asset to a trust), which is not covered by the rollover.
The Federal Court held that Mr Ellison could rely on the marriage breakdown rollover in respect of the transfer of the Shares to Ms Ellison’s trust. In doing so, McKerracher J made a number of important findings about the Family Court orders and the wording of sections 126-5 and 126-15 ITAA97 which mark a significant change in how the marriage breakdown rollover can be utilised.
Effect of the Family Court orders
The first issue in the case was the effect of the Family Court orders on ownership of the Shares. Sandini argued that the Family Court orders gave Ms Ellison a beneficial interest in the Shares; while the Commissioner argued the Family Court orders did not vest a beneficial interest in the Shares in Ms Ellison.
The Federal Court held that the effect of the Family Court orders were to vest beneficial ownership of the Shares in Ms Ellison. This was so notwithstanding that:
- the orders were couched in terms of doing ‘all acts and things’ and signing documents to effect the transfer, as opposed to ordering the transfer
- there were some defects and misdescription in the Family Court orders, and
- further steps were required to transfer legal ownership of the Shares.
When does CGT event A1 occur?
The Commissioner argued that even if the Family Court orders vested a beneficial interest in the Shares, CGT event A1 could only occur if a change in legal ownership occurred. In contrast, Sandini argued that CGT event A1 contemplated changes in beneficial ownership and therefore the Family Court orders caused CGT event A1 to occur.
In finding that the Family Court orders did result in CGT event A1 occurring, McKerracher J made a number of important observations:
- a person can be the owner of a CGT asset with equitable title only
- the consequence of the submission of the Commissioner that CGT event A1 required a change in legal and beneficial ownership to occur would be that dispositions of equitable ownership without legal ownership changing would not cause CGT to be assessable
- the context of CGT event A1 is in fact focused on beneficial and not legal ownership
- Brooks v FCT (2000) 44 ATR 352 (in relation to the predecessor of the current CGT event A1 provision) is authority for the point that changes in beneficial ownership cause a disposal of a CGT asset regardless of how that change was brought about, and
- the errors in the Family Court orders did not change the effect of the orders.
In light of these reasons, the Court found that the Family Court orders caused CGT event A1 to happen in respect of the Shares. Sandini could therefore rely on the marriage breakdown rollover to disregard the capital gain on its disposal of the Shares.
It is curious that in coming to its view on CGT event A1, the Court did not invoke the definition of a CGT asset under section 108-5 as including equitable rights that are not property (i.e. beneficial ownership). Instead, the Court looked more generally to the predecessor to CGT event A1 (the former section 160M(1) ITAA1936) which ‘deemed’ a disposal of an asset to have occurred, where there has been a change in ownership of an asset. By the Family Court order vesting beneficial ownership in Mrs Ellison, the Court considered this to be a change in ownership to which CGT event A1 can apply.
Although it is clear that legal ownership of the shares existed in Sandini at that time of the Family Court order, it was not the legal ownership but the equitable ownership that was considered in light of CGT event A1. However, what does not seem to have been addressed is that the wording of the former Section 160M(1) and the currently worded provisions of CGT event A1, both require the asset to have been “owned” by the taxpayer immediately before the change.1 In the case of the former 160M, circumstances in which assets were created or cancelled as a result of the transaction were ‘deemed’ to fall within the concept of a change of ownership by later subsections,2 however it is noted that those extensions have now been enshrined in their own CGT events (i.e. C2 in the case of cancellations and D1 in the case of creation) rather than being explicitly provided for under CGT event A1.
On the view that the relevant asset was in terms of Section 108-5, the ‘equitable right’ to the Shares, the Court’s analysis does not sit well with assets that are created in another person, that is, that were never owned by the taxpayer before their creation in some other person. It is submitted that Sandini never owned the equitable rights created in Mrs Ellison by virtue of the Court order,3 making it difficult to see how they could be disposed of for the purposes of CGT event A1 by Sandini.
The decision would seem to cast CGT event A1 as a ‘catchall’ provision, capable of application in all of the circumstances previously contemplated by section 160M, including those that are now described in other CGT events such as C2 and D1. If correct, this would have the effect that CGT event A1 has significantly broader application than it has been given to date.
Despite these concerns, one sympathises with the anomaly that otherwise occurs, that is, if CGT event A1 does not happen where a Family Court order vests beneficial ownership of a CGT asset in a spouse by ordering its disposal, it is arguable that CGT event A1 would likely not have application on the subsequent transfer to the spouse. This is because of the effect of absolute entitlement that the spouse would then have to the asset.4 As alluded to in the decision, the further result would likely be that no CGT event applies.5 This could have dire consequences for the transferee, who may well be left without even the benefit of a rollover cost base for the asset.6
Meaning of ‘transferee’
In considering the operation of the rollover, the Court also interpreted the wording of the rollover which requires the receiving spouse to be involved in the trigger event, and which also describes the spouse as the ‘transferee’. The Court applied section 103-10 ITAA1997 in treating Mrs Ellison as the recipient of the Shares, on the basis that they had been applied for her benefit and as she directed, when they were transferred to her trust. On that basis, section 103-10 deemed Mrs Ellison to be the ‘transferee’ of the Shares.
We find this reasoning problematic on the basis that section 103-10 ITAA97 would only seem to apply to treat Mrs Ellison as the transferee, insofar as the CGT provisions of the ITAA apply to Mrs Ellison. On its own terms, it does not extend to apply that treatment for either the transferor or Mrs Ellison’s trust as taxpayers.
In addition to expanding the range of circumstances in which CGT event A1 might apply, Sandini’s case marks an important change in how parties the subject of family law proceedings will be able to use the CGT rollover for marriage breakdowns to move assets into a protected environment. Although the rollover may not be used where the Family Court orders assets to be transferred directly into a discretionary trust, it does provide an opportunity, where the Family Court orders an asset to be transferred to a spouse directly, for that spouse to direct the transfer of the asset to a family trust without upsetting the application of the rollover.
However, Sandini’s Case does not open up more generally the possibility of Family Court orders requiring transfers directly into family trusts as the conditions of the rollover do not extend to CGT Event E2. Given the decision is authority for a more expansive application of CGT event A1 (which has potentially much broader consequences than the current family law context), it will be interesting to see if the case is appealed.
1 Note in respect of former section 160M(1), this was expressly modified in the asset creation case under former section 160M(6) which provided for its application “whether or not the person creating the asset owned or disposed of anything at the moment of creation“ (former section 160M(6C)). The equivalent to the former section 160M(6) is now CGT event D1.
2 See the above note 1 by way of example.
3 DKLR Holding Company (No 2) Pty Ltd v Commissioner of Stamp Duties (NSW)  1 NSWLR 510 is long standing authority that a legal owner of property absolute does not hold two estates in that property, the legal and the equitable, nor is the equitable estate carved out of the legal estate when it arises in some other person. It is annexed to or grafted onto the legal estate.
4 This decision drew significant support from the Full Federal Court decision of Official Trustee in Bankruptcy v Mateo  FCAFC 26 which held that a Family Court order altering interests in property to the parties to a marriage creates a trust relationship between those parties until the transfer is effected (at pars. 62-63 and 137). Section 106-50 of ITAA1997 deems an absolute beneficiary of trust property to be the owner of that property for the purposes of the CGT provisions.
5 Sandini Pty Ltd v Commissioner of Taxation  FCA 287at par. 144. Note CGT Event E5 has application where you ‘become’ absolutely entitled to an asset as against a trustee, but the wording and context of this provision indicates that it would not apply where the entitlement arises on creation of the trust.
6 Section 112-20(1)(a)(ii) ITAA1997: the market value substitution rule does not apply to a cost base where the ownership arose because of something some other entity has done, which did not result in a CGT event happening.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.