In 2013, your farming clients Thomas and Olivia entered into a conditional contract to sell their farming property just outside of Queanbeyan to a development company for $5.5m (“Contract”).
They acquired the property in 1999 for $1m and were very happy with the purchase price but were concerned about the CGT and GST implications.
The Contract contained a special condition stating that the property would be sold subject to the satisfaction of the Condition Precedent that the company obtain the appropriate approvals and licences to develop the land for a residential subdivision. The company had two years from the date of the Contract to satisfy the Condition Precedent and if it was not satisfied the company had the right to either waive the Condition Precedent or rescind the Contract.
The company did not waive or satisfy the Condition Precedent by the due date so, by a separate deed, your clients agreed to vary the Contract to extend the due date by another 12 months.
The Condition Precedent was satisfied prior to the new due date and the sale was completed.
Because the Contract was conditional on satisfaction of the Condition Precedent and a further deed was entered into to extend the due date, you advise your client that you believe the date of disposal for CGT purposes was the date the Condition Precedent was satisfied in 2015, not the date of the Contract.
Thomas and Olivia are very happy with this advice. They acquired the property in 1999 so with a disposal in 2015, they will have owned the property for 16 years and therefore, because they also comply with the other requirements of the exemption, they qualify for the small business 15 year exemption so won’t have an assessable capital gain.
Thomas and Olivia are registered for GST and, without looking at the relevant legislation, you’ve also told your clients the sale is GST free because it is farmland.
Thomas and Olivia go away singing your praises, not only did you save them a bucket in CGT and GST you did it all within your fee estimate.
Thomas and Olivia come to see you some months later about advice they received from their accountant who had spoken to a taxation lawyer.
Their advice basically says everything you have told them about CGT and GST is wrong. Given you have been their lawyer for 30 years and they have a great deal of trust in you, they ask you to look into things further and advise whether you agree with the different advice.
Because you have no experience in CGT and GST you call Charlotte, another lawyer you know that specialises in tax and ask her advice. She later confirms, after looking at the legislation and some ATO ID’s, you were wrong.
Under section 104-10 (3) of the Income Tax Assessment Act 1997 (ITAA 1997) the time of CGT event A1 is:
- when you enter into the contract for the disposal; or
- if there is no contract – when the change of ownership occurs.
In ATO ID 2003/1190 the ATO demonstrates the need to draw a distinction between a condition precedent to the performance of the contract and a condition precedent to the formation of the contract in determining when the disposal occurs for CGT purposes.
In reaching its decision the ATO said (in part):
“ …Where it is evident from the terms of the agreement that the parties intend the arrangement to come into effect only at the time of the death or disablement of one of the shareholders, this will be a condition precedent to the formation of the option contract.”
The decision in ATO ID 2004/668 was a buy-sell agreement with a condition precedent to its formation that one of the shareholders die, was not entered into for the purposes of paragraph 104-10 (3) (a) of the ITAA 1997 until the condition precedent to its formation was met:
“If a contract is subject to a condition, an issue arises whether the condition is a condition precedent to its formation or whether it is a condition precedent to performance of the contract. In the first case, the contract does not come into existence until the condition is met. In the second case, the condition does not prevent the creation of the contract – non-fulfilment of the condition merely entitles a party to terminate the contract: see Perri v. Coolangatta Investments Pty Ltd (1982) 149 CLR 537.”
Charlotte advises that, in her view:
- the clause is a condition precedent to the performance of the contract because it does not prevent its creation;
- the fact that a clause was needed to require the company to either waive the Condition Precedent or rescind the Contract further supports this because if the Condition Precedent prevented the creation of the contract, the clause would not be required.
and, therefore, the time of CGT event A1 is when Thomas and Olivia entered into the Contract in 2013, therefore they had only held the property for 14 years so did not qualify for the 15 year exemption.
She also confirms that under section 38.480 of the A New Tax System (Good and Services Tax) Act 1999 the supply of farmland is only GST free if you qualify for BOTH (a) and (b) of the section. Whilst a farming business was carried out on the property for 5 years preceding the supply, the company was developing the property for a residential subdivision and had no intention to continue to run a farming business.
Feeling sick to the stomach, you phone your favourite clients to deliver the bad news.
This article is general information only and should not be relied on without obtaining further specific information.
By Amanda Tully