In what seems a surprising result, the courts have held that the date of disposal of a capital gains tax asset was the date the Heads of Agreement was signed and not when the contract was signed some four (4) months later.
The taxpayer had an interest in a business in Melbourne which he decided to sell in 2008.
In August 2008, the taxpayer and the purchaser executed a Heads of Agreement. The Heads of Agreement stated that a deposit of $20,000 was payable on the signing of the Heads of Agreement and a further $20,000 (described as the balance of the deposit) was to be paid on the signing of the formal contract.
The contract on the sale of business was provided to the purchaser’s lawyer in early December 2008. It was a standard type of document although the conditions were spelt out and dealt with in significantly more detail.
It appears to have been executed by the purchaser later in December 2008.
In the taxpayers 2009 tax return, he claimed the small business active asset exemption and the small business retirement exemption to reduce his capital gain of $704,129 to Nil. In November 2010, the Tax Office issued a notice of assessment for the 2009 income year which included the capital gain in his taxable income and, of course, a penalty.
The court was asked to decide when the taxpayer disposed of the capital gains tax asset, comprising his interest in the business.
The date was crucial to the taxpayer because if the earlier date applied, he would not be entitled to access the capital gains tax small business concessions.
However, the Tax Office submitted that the disposal took place from when the Heads of Agreement was signed in August 2008.
The agent handling the sale testified that it was a long-standing practice in the industry for an intending purchaser and vendor to enter into an in-confidence period of exclusivity during which time the intending purchaser used professional advisors to carry out due diligence.
He said the practice had evolved over the years to protect both the vendor and purchaser by having a prospective purchaser sign a document confirming the right to exclusive dealing and also an obligation to maintain confidentiality.
He also testified that it was industry practice that a party which had signed a Heads of Agreement could walk away at any time if unsatisfied with the result of the due diligence.
The solicitor for the taxpayer submitted that, in essence, the Heads of Agreement was an agreement to agree.
He also submitted to the court that the court should consider the circumstances leading to the execution of the agreement which included the fact that the agent was not a lawyer and provided the Heads of Agreement in response to the taxpayer’s request and the agreement was executed at the start of negotiations before the parties had seen their lawyers.
The court stated that the question is whether the Heads of Agreement is a legally binding document between the vendor and the purchaser which binds the parties to the disposal and acquisition of the business in question.
The court stated that the Heads of Agreement document in this matter leaves little room for doubt that the parties to that document had agreed to the sale and purchase of the business in question.
Furthermore, the court said it was worthwhile noting that the Heads of Agreement document makes it very clear that the vendors and purchasers had agreed to the sale of the business and the document expressively states that to be the case.
The court went on to say that they had agreed to the sale on the terms and conditions set out in the first schedule.
The document also states the parties agreed to be bound by the terms of the Heads of Agreement.
Finally, the court found that the Heads of Agreement is legally binding of the parties upon its execution. Furthermore, by that agreement, the parties agreed to the sale and purchase of the business. In other words, the court found the disposal of the taxpayer’s capital gains tax asset comprising his interest in the business occurred in August 2008.
Clearly this is a very important issue and the timing for capital gains tax can have major ramifications as this case shows. Heads of Agreements are also commonly used in real estate transactions and so the decision in this case has wider reaching implications to just the sale of businesses.
Before signing any agreement/contract, please contact Ellingsen Partners so that we can work through the deal with you and ensure there are no unwanted tax surprises.