The AAT has confirmed that a taxpayer was not entitled to a discount capital gain in relation to the cancellation of 150,000 shares that were held by her in a company pursuant to an employee share scheme (ESS). At issue was the required 12 months, since ‘acquisition’, for CGT purposes, had gone by, when the shares were acquired under an ESS.
In the end the Taxpayer failed because her submissions about the facts were not accepted. This case could be reported at only that level. But this would miss the interesting and complex interaction between he ESS provisions (Div 83A of the ITAA97) and the CGT provisions (in Parts 3-1 & 3-3 of the ITAA97), which I want to cover here.
I will start with the key facts are these.
- The taxpayer is a Dr Manveen Mangat.
- In mid to late 2011 she was in serious discussions about working at IVF Australia Pty Ltd (IVF Aust).
- These discussions included the offer of 150,000 shares in Virtus Health Pty Ltd (Virtus) pursuant to an employee share scheme. She was shown a copy of the Virtus Health Share Offer Information Statement dated 16 December 2011.
- On 30 December 2011, on 30 December 2011, she contracted with IVF Aust to be an independent contractor on a 5-year term.
- Dr Mangat claimed that the offer made to her included, as part of her remuneration, and for undertaking not to compete, 150,000 shares in Virtus at $4.71 per share.
- On 23 January 2012, Dr Mangat commenced work with IVF Aust, as a Certification in Reproductive Endocrinology & Infertility Fellow, for a 1 year period until January 2013.
- Virtus planned a ‘trade sale’ of its shares and throughout 2012, it dealt with the Taxpayer, as if she were an option holder, or a person who was entitled to options.
- In August 2012, the trade sale was delayed and the Taxpayer formally applied for, and was issued, the same number of Options mentioned, on terms that gave them the same economic effect as the initial number of shares discussed, at the time she started working at the company. At this time, Virtus observed that the terms on which the Options were issued was “excellent” as the strike price of $4.71 was the 2010 share price and the 30 June 2102 market value of the shares was $6.88 per share, making an aggregate discount of $325,000.
- The proposed trade sale did not eventuate, and by December 2012, Virtus decided to make an ‘Initial Public Offering’.
- On 13 June 2013, Virtus was listed on the Australian Stock Exchange.
- On the same date the Taxpayer’s options were cancelled and she took half the proceeds as cash ($271,500) and the other half as 39,206 shares in the, then, publicly listed Virtus.
- The Taxpayer argued that she acquired the right to the options as part of her remuneration when she signed the Engagement Letter on 30 December 2011 – 17 months before her Options were cancelled and she received the agreed consideration.
The tax return and assessment history was as follows.
- The Taxpayer had not lodged her 2013 Income Tax Return (the year in which she was issued the Options and they were cancelled, in return for cash and shares).
- So, the Commissioner ultimately issued her with a default assessment, based on (amongst other things) information Virtus had given the ATO, about the 150,000 Options. It said these Options had been issued to her, and cancelled, in the same 2013 Financial Year. [para 55]
- The Taxpayer objected, saying, amongst other things, that she acquired the right, to these Options, in the 2012 financial year and the discount should have been assessed in that (earlier) 2102 year. It’s not entirely clear what happened to the assessment of the discount, but it appears that it was not in contention.
- Rather, the focus was on the remaining capital gain, after treating the Options as purchased for the Div 83A ‘market value’ (on which the assessable ESS ‘discount’ is based). This is the effect of s83A-30(1). The cost base was, presumably, the $325,000 amount mentioned above.
- The Options had been cancelled, triggering a CGT event C2 (for cancellation of assets).
- The ‘capital proceeds’ from this C2 event were the $271,500 in cash and the 39,206 Virtus shares, at market value of $222,690 ($271,500 + $222,690 = $494,190).
- This would leave a capital gain of, presumably, $169,190 ($494,190 – $325,000 = $169,190).
- The Taxpayer objected, saying that only half this amount was assessable, as the 50% CGT discount applied.
- The Commissioner disallowed that objection and the Taxpayer brought this matter to the AAT.
The Law worked (and the Taxpayer contended the law worked) in this way.
- There was no dispute that Virtus had issued the 150,000 Options under an Employee Share Scheme (ESS). Likewise, there was no dispute that the ‘discount’ (at which the Options were issued) was assessable, under the ESS provisions, in Div 83A. Further, there were no restrictions, on the Taxpayer exercising the options, so there was no dispute that the discount was assessable (upfront) in the year the Options were issued (subdiv 83A-B). Neither was there argument that the ESS provisions had precedence over the CGT provisions (s130-80(1))
- As the ESS provisions assess the ‘discount’ (to market), at the time the Options were issued, the CGT ‘cost base’, for the Options, is their ‘market value’s that time (s83A-30(1)).
- When the Options were cancelled, CGT event C2 happened (which applies to cancellations). I’ve calculated the capital gain, above, at $169,190.
- However, only half of this $169,190 amount is assessable, if the Taxpayer ‘acquired’ these Options, no less than 12 months before their 13 June 2013 cancellation. If that were so, the 50% CGT discount could then apply (s115-25(1)).
- The time of CGT ‘acquisition’ is, the time that Taxpayer entered into the contract for the issue of these Options (or if there is no such contract, then the date on which the Options issued). This is the rule in s109-10, item 2, for ‘equity interests’, which include options to acquire other ‘equity interests’ (under s974-75(1), item 4(a)).
- The Options were actually allotted, to the Taxpayer, in August 2012 (viz: the 2013 financial year, and less than 12 months from their 13 June 2013 cancellation).
- However, the Taxpayer submitted that she had an enforceable contract, to be allotted these Options much earlier than this. She alleged that she had an enforceable right to be issued 150,000 shares at $4.71 per share on 30 December 2011, when she signed the Engagement Letter. This was because she said she also signed ‘Schedule A’ on this date, which set out her right to be issued these shares.
- She acknowledged that this right, to be issued shares, became a right to be allotted Options, on terms that had the same economic effect, but she said that she acquired this different ESS Interest, in or about March 2012, because it was at this time that she found out that she was not a ‘sophisticated investor’ and Virtus then changed the agreement, to the same number of Options (priced to have the same economic effect).
- If she was right about this March 2012 contract, then she would have won the CGT discount point.
In the end, the Taxpayer failed.
- The Taxpayer ultimately failed, however, was on the facts, based on the evidence. [paras 60 – 69]
- The AAT found that the Taxpayer did not have a right to be allotted shares on 30 December 2011, as ‘Schedule A’ wasn’t signed then (and may not have existed then).
- The AAT considered the arguments about the Taxpayer having an enforceable right, in March 2012, to get these Options, in lieu of shares, when she found out that she was not a ‘sophisticated investor’. However, it concluded that the correspondence fell short of any binding offer to issue the Options. [para 64]
- There was ultimately no correspondence, that the AAT could rely on, providing the Taxpayer any right to the Options, earlier than the August 2013 Application Form, which she signed.
- Accordingly, it found that the Options were issued in the 2013 financial year, meaning that the ESS ‘discount’ was assessable in that year, and that the whole of the remaining capital gain was assessable, in that year (because the 50% CGT discount was not available).
- Finally, the Commissioner initially assessed the Taxpayer to the full administrative penalty, equal to 75% of the primary tax, under s284-75(3), because she had not lodged a document necessary for the (default) assessment. At objection stage, the Commissioner remitted the penalty, so that it was 50% of the tax. And, the AAT further remitted the penalty, so it was 40% of the tax assessed.
(Mangat v CofT  AATA 3012, AAT, File No: 2016/5665, Lazanas SM, 21 August 2018.)
[LTN 162, 23/8/18; Tax Month – August 2018]
Comprehension questions (answers available)
- Was this a case about whether the remaining capital gain (after the ESS provisions assessed the discount at which the Options were issued) was only half assessable, under the 50% CGT discount provisions?
- Did this depend on whether the 150,000 Options had been relevantly ‘acquired’, at least 12 months before the CGT C2 cancellation event?
- Is the relevant acquisition date, the date on which contract, under which the Options were issued, was made (assuming there was such a contract)?
- Did the AAT find that there was such a contract, prior to the August 2012 Application for the Options?
- Did this mean that the Taxpayer was entitled to the 50% CGT discount?
- Did this mean that the ESS ‘discount’ was assessed in the 2013 financial year, as well?
- Was the Taxpayer stuck with the 50% penalty (that applied after the Commissioner allowed the Taxpayer’s objection to the initial 75% penalty)?
More detailed summary of the facts
- The taxpayer is a Dr Manveen Mangat.
- In mid to late 2011 she was in serious discussions about going IVF Australia Pty Ltd (IVF Aust).
- These discussions included the offer of 150,000 shares in Virtus Health Pty Ltd (Virtus) pursuant to an employee share scheme (Virtus ESS). She was shown a copy of the Virtus Health Share Offer Information Statement dated 16 December 2011 (the Share Offer).
- On 30 December 2011, on 30 December 2011, she contracted with IVF to be an independent contractor on a 5-year term.
- Dr Mangat claimed that the offer made to her included as part of her remuneration, in exchange for the restraint clause, 150,000 shares in VH at $4.71 per share.
- On 23 January 2012, Dr Mangat commenced work with IVFA, as a Certification in Reproductive Endocrinology & Infertility Fellow (CREI Fellow), for a 1 year period until January 2013 (2012 Employment Agreement).
- On 27 January 2012, a Mr Moller (Managing Director of IVF Aust) emailed the Taxpayer to raise the subject of the Virtus ESS. In it he attached a summary of the scheme and drew certain key issues to her attention.
- On 2 February 2012, the Managing Director emailed the Taxpayer again, attaching the latest set of documents and noting that they were already past the draft ‘closing date’ (for share applications), which was 31 January 2012. These documents an ‘Offer Information Statement’ which had, with it, a ‘Share Purchase Application Form’. This, in turn made reference to special arrangements for ‘Sophisticated Purchasers’ (to be certified by the Taxpayer’s accountant – if applicable).
- On 27 March 2012, the Taxpayer’s accountant advised that she was NOT a sophisticated purchaser.
- On 30 March 2012, the Managing Director emailed the Taxpayer, to advise that there would be new ‘non-sophisticated’ investor arrangements, that would work the same way.
- On 1 May 2012, an IVFA Board Member emailed about 10 doctors (including the Taxpayer) to advise that Quadrant (the main shareholder in Virtus) was intending to sell its holding in a ‘trade sale’, which could ‘impact [their] working future’ of, amongst others ‘option holders’ (though, the Taxpayer did not formally hold any ‘options’ to acquire shares in Vitrus).
- On 17 May 2012, a Ms Channon send a letter to the Taxpayer, assuming she was an ‘option holder’ asking for an indicative (non-binding) election as to what she’d do with her proceeds from the trade sale (with 26th May 2012 as the required response date).
- ON 17 May 2012, also, PwC wrote to another of the investors in Virtus, dealing with (amongst other things) the tax consequences of the trade sale, for the “New Doctors contracted to Virtus” (who they understood were engaged subsequent to the last issue of options to doctors). In other words, this acknowledged that doctors, without formal options, would still participate in the trade sale.
- PwC gave this tax advice on the assumption that the plan was as follows. There were 26 ‘New Doctors’. 14 were ‘sophisticated investors’ and they would be provided with 150,000 shares in Virtus at a cost of $4.71. 8 were ‘non-sophisticated investors, and they would be issued a cash bonus equal to the half the discount on Virtus shares (which the sophisticated investors would be allowed to keep) and options, to subscribe for shares in the purchaser (which matched the obligation of the sophisticated investor New Doctors, to invest their net proceeds in the purchaser). It was also assumed that there would be no ‘vesting conditions or performance hurdles’ on the new shares (or the bonus). In earlier ESS offers, a condition was 100 ‘cycles’ (being 100 pregnancy attempts for patient mothers).
- On 13 July 2012, the Chief Financial Officer of Virtus emailed the Taxpayer saying that the exact nature of the “incentive arrangements for new Doctors” would be finalised after they had determined the “nature of the liquidity event” which was to be the end of July 2012.
- On 8 July 2012, the same Financial Officer sent a letter to about the “Virtus Health – Incentives for New Doctors and Liquidity Event”. It advised that the trade sale had been delayed and they were proceeding with the plan to issue shares and options, without vesting or performance hurdles. Non-sophisticated New Doctors were invited to sign an attached ‘Share Purchase Application Form, under which they would be issued options (to acquire shares in Virtus), for zero consideration, but on a ‘liquidity event’, $4.71 would be deducted from the valuation of the shares (so it was economically the same as being issued shares).
- On 17 August 2012, the Taxpayer signed the Application Form, which constituted an offer to subscribe for 150,000 options in Virtus (one share per option). This Application Form was not put into evidence and the Taxpayer only put the 18 December 2011 Share Offer into evidence at the Hearing (so, whilst apparently different, the terms could not be compared).
- On 30 August 2012 the CEO emailed the Taxpayer observing that the Options applied for were “excellent” as the strike price of $4.71 was the 2010 share price and the 30 June 2102 market value of the shares was $6.88 per share, making an aggregate discount of $325k.
- The proposed trade sale did not eventuate, and by December 2012, Virtus decided to make an ‘Initial Public Offering’ (IPO).
- On 13 June 2013, Virtus was listed on the Australian Stock Exchange.
- On the same date the Taxpayer’s options were cancelled and she took half the proceeds as cash ($271,500) as cash and the other half as 39,206 shares in the, then, publicly listed Virtus.