Key takeaways
- Restructuring and Sale: The JG Moloney Family Trust sold shares in a freight company for approximately $3.5 million to a related company, applying the 50% CGT discount and small business CGT concessions, resulting in no assessable capital gain.
- Tax Audit Adjustment: The Commissioner substituted a market value consideration of approximately $7 million for the sale, disqualifying the beneficiaries from small business CGT concessions and resulting in an assessable net capital gain of approximately $3.5 million.
- Market Value Substitution Rule: Section 116-30 of ITAA 1997 replaces capital proceeds with the market value if the parties did not deal at arm's length, impacting the calculation of capital gains.
- MNAV Test: The small business CGT concessions require the maximum net value of all CGT assets to be less than $6 million. The valuation differences between the Commissioner and taxpayers affected the eligibility for these concessions.
- Valuation Dispute: The Deputy President preferred the taxpayers' valuation, which considered the cyclical nature of the agricultural sector and the challenges of selling an interest in an unlisted entity, ultimately allowing access to the small business CGT concessions.
Table of contents
- Background
- The facts
- The Legislation
- The arm’s length issue
- Maximum Net Asset Value issue
- The result
- Comment
Background
Just as in Act 4, scene 1 of Macbeth we receive some insight into what goes into a Witches’ brew, the recent decision in Moloney & Ors v FC of T 2024 ATC ¶10-726; [2024] AATA 1483 (7 June 2024) delves deep into the brew concocted by valuers. And much as the Witches magically conjure apparitions from their brew, it would appear that a valuer just as magically conjures a valuation. So, where valuations differ, how are lay people to decide which is correct? This is the dilemma that faced Deputy President Molloy.
The valuations at issue differed by an astonishing $4 million. That relied upon by the taxpayers (prepared by PKF) was a mere $3 million. On the other hand, that relied upon by the Commissioner (prepared by Korda Mentha (KM)) was $7 million. The difference mattered, not only in terms of the taxpayers’ quantum of capital gain, but also as to the availability of the small business CGT concessions. In the result, the Deputy President ruled in favour of the taxpayers’ valuation, in a ruling that should be read by all valuers and understood by those relying on the “magic”.
The facts
The JG Moloney Family Trust owned shares in a freight company operating in the agricultural sector in Victoria. As part of a restructuring, these shares were sold for (approx.) $3.5 million to a related company. In calculating the net capital gain assessable to the beneficiaries, the 50% CGT discount in Div 115 of ITAA 1997 was applied as well as various small business CGT concessions contained in Div 152, with the result that no amount of the capital gain was included in assessable income.
Following a tax audit, the Commissioner substituted a market value consideration for the sale of the shares resulting in deemed capital proceeds of (approx.) $7 million. This also had the result of dis-entitling the beneficiaries to access to the small business CGT concessions leaving them with an assessable net capital gain of (approx.) $3.5 million between them.
The Legislation
The market value substitution rule is contained in s 116-30 of ITAA 1997. Section 116-30(2) provides (relevantly) that the capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if those capital proceeds are more or less than the market value of the asset and the parties did not deal with each other at arm’s length in connection with the event. The definition of “arm’s length” in s 995-1(1) provides that in determining whether the parties deal at arm’s length consideration is to be given to any connection between them.
The small business CGT concessions are contained in Div 152 of ITAA 1997. Relevantly, for a business to qualify, the maximum net value of all CGT assets of the business and its related persons and entities must be less than $6 million (the MNAV test).
The main elements of the MNAV test are contained in ss 152-15 and 152-20. Section 152-15 identifies an entity’s net CGT assets value as including those of connected entities (s 328-125) and affiliates (s 328-130). Section 152-20(1) provides that the net value of the CGT assets is the amount obtained by subtracting from the sum of the market values of those assets the sum of the liabilities related to the assets and certain provisions.
(For a consideration of the strategies to navigate the MNAV see the author’s article “Managing the $6m MNAV test to access CGT concessions” in Australian Tax Week Issue 8/2023 (3 March 2023).)
The arm’s length issue
There was no contention that the parties to the transaction were not at arm’s length but the taxpayers argued that they were nevertheless dealing at arm’s length in that they had relied on an independent valuation to arrive at a price for the shares. However, the Deputy President took the view that simply relying on an independent valuation, no matter how objectively and competently arrived at, did not amount to real independent bargaining as envisaged by the concept of dealing at arm’s length. There was no challenging or querying of the valuation by either party and simply none of the normal indicia of parties negotiating in their own best interests.
Thus, the market value substitution rule applied to substitute whatever the market value was for the capital proceeds specified in the share sale contract.
Maximum Net Asset Value issue
The determination of the market value of the shares relied on by the Commissioner also jeopardised the availability of the small business CGT concessions by virtue of the $6 million threshold of the MNAV being breached.
The competing valuers for the Commissioner (KM) and the taxpayers (PKF) both adopted the capitalisation of maintainable earnings valuation methodology (the Deputy President agreed that the alternative notional realisation of assets methodology was more appropriate for an unprofitable or insolvent business).
The final positions of the valuers are comparable as follows:
