For income tax purposes, the seller of a CGT asset (such as real estate) will likely consider that CGT event A1 is the most specific CGT event which happens to them.

However, if the seller has sold a CGT asset to a trust, is CGT event E2 the most specific CGT event that happens to them?

CGT event A1 happens when you dispose of a CGT asset, whereas CGT event E2 happens when you transfer a CGT asset to an existing trust.

Given the prevalence of trusts as entities to hold capital appreciating assets, CGT event E2 may happen more often than we appreciate, leading to unexpected income tax outcomes.

Why do we care which CGT event happens?

Sometimes a transaction may trigger more than one CGT event. In such circumstances (and with limited exceptions) taxpayers need to identify and apply the “most specific” CGT event to their situation (subsection 102-25(1) of the Income Tax Assessment Act 1997).

As not all CGT events happen at the same time, correctly identifying the most specific CGT event can have significant consequences to a taxpayer’s capital gains tax exposure.

For example:

CGT events generally inform the period that a taxpayer has owned an asset, and so may impact on whether a taxpayer qualifies for the 50% CGT discount (generally only applies if a CGT asset has been owned for at least 12 months).
The maximum net asset value test (one of the potential gateways to qualifying for the small business CGT concessions) is based on a taxpayer’s status just before the CGT event.
The market value of a CGT asset under the market value substitution rule (which can apply if parties are not dealing at arm’s length) is determined at the time of the CGT event.
Taxpayers must record their capital gain (or loss) in their tax return for the income year when the CGT event occurs, which may in turn affect a taxpayer’s period of review and / or ability to request an amendment.
The capital gains tax outcomes to beneficiaries of trusts generally depend on how the trustee resolves to distribute the trust’s capital gains in the income year of the CGT event.

Distinguishing CGT events A1 and E2

The time of CGT event A1, if there is no contract, is when there is a change of ownership.

Conversely, if there is a contract (as is often the case for CGT assets of significant value) the time of CGT event A1 is when the taxpayer enters into the contract for the disposal of the CGT asset.

Pinpointing the precise moment of contractual formation can be complex because:

contracts are not always in writing (and even when they are in writing, they may not be properly executed or dated);
the parties may have entered into multiple contracts (including a heads of agreement), but there can only be one contract of disposal for the purposes of CGT event A1 (as highlighted by the High Court in Commissioner of Taxation v Sara Lee Household & Body Care(Australia) Pty Ltd [2000] HCA 35);
the test for the formation of a contract is not legislatively codified and requires satisfying the elements outlined in the case law, including offer, acceptance, consideration, and intention;
even when the elements of contractual formation cannot be easily identified, Australian courts have accepted the formation of a contract based on objective manifestations of mutual assent (Branir Pty Ltd v Owston Nominees (No 2) Pty Ltd [2001] FCA 1833); and
it may be unclear whether a contractual term is a condition precedent to formation as opposed to a condition precedent to performance.

Unlike CGT event A1, CGT event E2 does not require taxpayers to assess whether and when a contract has been formed. CGT event E2 happens when a taxpayer transfers a CGT asset to an existing trust, and the time of CGT event E2 is when the CGT asset is transferred.

CGT event E2 therefore requires an assessment of the transfer time, which would typically be on settlement (in the context of real property) or when a company’s share registry is updated (in the context of shares, but this may also depend on the company’s constitution).

What have the courts said about the distinction between CGT event A1 and E2?

In the Federal Court case of Healey v Federal Commissioner of Taxation [2012] FCA 269 (Healey), two companies executed a “Standard Transfer Form” to transfer shares in a company (JAH) to another company (Newcode) as trustee for a discretionary trust (Esteem Trust).

Although the "Standard Transfer Form” was signed on 1 May 2004, it was not until 9 December 2005 that another shareholder of JAH had waived its pre-emptive rights to acquire the shares and the share transfer was recorded in JAH’s shareholder register.

Was CGT event A1 the most specific CGT event (in which case, the capital gain occurred on 1 May 2004 when the “Standard Transfer Form” was signed) or CGT event E2 (in which case, the capital gain occurred when the transfer was recorded on 9 December 2005)?

Justice McKerracher of the Federal Court concluded that CGT event E2 was the more specific event as it was (unlike CGT event A1) specifically directed to trusts. His Honour also considered that the legislative provisions supported the view that “transfer” under CGT event E2 encompassed a conveyance by way of sale.

The consequence of the decision was that:

the two companies were required to account for and assess their capital gains tax exposure from the transfer of the shares in the 2006 income year, not the 2004 income year; and
Newcode (in its trustee capacity) acquired the shares in the 2006 income year, not the 2004 income year (and could not therefore avail of the CGT discount as the subsequent share disposal occurred within 12 months of acquisition).

Other Federal Court cases in certain circumstances have decided that the CGT “E” events (in particular, CGT event E1) are more specific to trusts and therefore apply in preference to CGT event A1 (see Taras Nominees Pty Ltd as Trustee for Burnley Street Trust v Commissioner of Taxation [2015] FCAFC 4, Kafataris v Deputy Commissioner of Taxation [2015] FCA 874, and Oswal v Federal Commissioner of Taxation [2013] FCA 745.

What does the ATO think?

In ATO Interpretative Decision ATO ID 2003/559, the ATO consider that CGT event A1 (not CGT event E2) is the more specific event when a CGT asset is disposed of to an existing trust and the parties are “completely unconnected and are dealing with each other at arm’s length.”

However, the Federal Court in Healey did not have regard to the relationship between the parties in reaching its conclusion that CGT event E2 (rather than CGT event A1) was the most specific CGT event. The identification of the most specific CGT event was based principally on an analysis of the statutory construction of the word “transfer.”

Furthermore, even though it was held that the parties dealt with each other at arm’s length, one of the directors and shareholders of the transferor companies (Ms de Hollander) was also a specified beneficiary of the transferee trust (Esteem Trust). That is, the transferors and transferee were not completely unconnected.

Accordingly, and despite the ATO continuing to rely on ATO ID 2003/559 in recent private rulings (see for example PBR 1052129282146), it is difficult to reconcile the ATO’s views with the pronouncements in Healey. Is the fact that Healey concerned a “Standard Transfer Form” rather than a typical share sale contract significant?

What does this mean?

The decision in Healey arguably suggests that CGT event E2 (as opposed to CGT event A1) is the most specific CGT event when the purchaser/transferee of a CGT asset is an existing trust. The relationship between the parties would not appear to be relevant consideration.

Accordingly, even in the most basic of commercial transactions involving the sale of a CGT asset to a trust, sellers may need to carefully assess whether CGT event E2 is the most specific CGT event which happens to them. This raises further questions:

Just as Healey considered that the time of CGT event A1 was when the “Standard Transfer Form” to effect the transfer of the shares was signed, does the same principle apply to a standard contract for the sale of real estate? Is CGT event E2 (rather than CGT event A1) the most specific CGT event when a trust purchases land under a standard contract for the sale of real estate?
Would Healey have been decided differently if the parties had entered into a share sale agreement to effect the disposal of the shares (rather than executing a “Standard Transfer From” to effect the disposal of the shares)?
Many commercial contracts contain purchaser nomination clauses. Is CGT event E2 the most specific CGT event in the circumstance where the purchaser trust does not exist at the time of contract execution, but is subsequently nominated as the purchaser at the time of settlement? Is the answer different if the trust exists at the time of contractual formation? What if land is purchased at auction?
If there is a written contract that is the source of the obligation to effect the disposal of a CGT asset, why should CGT event E2 apply if the purchaser is a trust but CGT event A1 apply if the purchaser is an individual or a company?
Would a purchaser trust under a contract prefer that CGT event A1 is the most specific CGT event because the date of contractual formation, not settlement, informs their eligibility for the CGT discount?

Lastly, an ATO interpretative decision is not a public ruling which offers taxpayers the same protection as a taxation ruling or determination. Accordingly, even if taxpayers rely on ATOID 2003/559 to assert that CGT event A1 is the most specific CGT event, they have no protection from tax shortfalls should a court find otherwise (which has perhaps already occurred per Healey!)

Please contact a member of our federal tax team if you have any questions.

Edward Hennebry
Senior Associate
T +61 3 9611 0113 | M +61 428 439 730
E ehennebry@sladen.com.au

Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au

Kaitilin Lowdon
Special Counsel
M +61 402 859 214 | T+61 3 9611 0120
E: klowdon@sladen.com.au

Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327 | T +61 3 9611 0105
E: dsmedley@sladen.com.au

Rob Warnock
Principal Lawyer
T +61 3 9611 0155 | M +61 419 892 115
E rwarnock@sladen.com.au