In structuring 30 June transactions it is often desirable to sign a contract before 30 June, but defer payment of capital gains tax (CGT) or the CGT event until a subsequent income year; particularly where settlement is deferred to a subsequent income year so there are no sale proceeds for the vendor to pay the tax or it is desired to set-off losses in the subsequent income year.
Deferring payment of CGT by the ATO’s deferred settlements administrative practice or by options may be appropriate. Drafting the agreements to achieve the deferral requires care.
Legislative references are to the Income Tax Assessment Act 1997 (Cth) (ITAA 1997)
A capital gain or loss may arise upon the occurrence of a CGT event (e.g. a transfer) in respect of a CGT asset (e.g. land, shares or a business), unless an exemption applies, rollover relief defers the capital gain or a provision denies the loss.
For example, the time of the CGT event on transfer of a CGT asset is when the taxpayer enters into the contract for the transfer or, if there is no contract, when the change of ownership occurs on settlement (sec. 104-10(3) ITAA 1997 (CGT event A1)).
When determining the time of the CGT event (FCT v Sara Lee Household & Body Care P/L  HCA 35 at , ,  & ):
- the relevant contract is that which is the source of the obligation to perform the transfer of assets which constitutes the relevant disposal;
- if two or more contracts are the source of the obligation to perform the transfer, a judgment is required as to which of the contracts is property to be seen as the source of the obligation to effect the disposal;
- if it is impossible to identify a single contract under which the disposal occurs, then the time is the change of ownership;
- the date of disposal and the date of acquisition of the same CGT asset may be different and need not be contemporaneous;
- the relevant time is that of making the contract not when it became unconditional or specifically enforceable; and
- the disposal may occur under a contract even though the transferee is not a party to the contract.
Where a heads of agreement, interdependent contracts or subsequent variation agreements are signed, determining the relevant contract can be difficult.
Where the relevant contract is signed before 30 June, the CGT event and liability for CGT will be payable in respect of the year ended 30 June.
ATO’s deferred settlements administrative practice
The ATO’s deferred settlements administrative practice permits the taxpayer to defer payment of CGT until receipt of the capital proceeds, so the capital proceeds can be used to pay the tax.
The ATO considers that the obligation to declare the capital gain does not arise until settlement of the land sale contract, however, the capital gain is included in the earlier year in which the land sale contract was signed. Provided the income tax return for the year the land sale contract was signed is amended and tax is paid within 30 days of settlement, the ATO will not impose any penalties or interest (Ruling TR 94/29).
Although the administrative concession applies to land, the administrative concession should also apply to the transfer of other CGT assets such as shares and businesses.
The ATO’s deferred settlements administrative practice may avoid cash flow problems associates with deferred settlements without the need to use options.
An option may defer the CGT event time (rather than only deferring payment) until a subsequent year so, for example, capital losses in the subsequent year can be set-off.
A put option (or option to sell), call option (or option to purchase) or put and call option (which includes both types of options), if drafted correctly, may defer the CGT event time.
'Option' has two legal meanings or forms (Laybutt v Amoco Australia P/L  HCA 49):
- a ‘conditional contract’ to sell pursuant to the conditional contract upon exercise of the option; or
- an ‘irrevocable offer’ to enter into a separate contract to sell upon exercise of the option.
Under a conditional contract, there is one contract that comes into existence on the grant of the option with one or more conditions to completion (such as exercise notice and entry into a formal contract). Under an irrevocable offer there are two contracts, a preliminary contract to keep the offer open for a certain time and a main contract of sale that comes into existence on exercise of the option (Cheshire & Fifoot, Law of Contract, Butterworths (8th ed) at [3.56]).
An option is not strictly speaking either exclusively a conditional contract or an irrevocable offer because an option includes aspects of each of these concepts and each analogy may be a valid way of characterising a particular form of option (Sydney Futures Exchange Ltd v Australian Stock Exchange Ltd (1995) 128 ALR 417 at 451).
It is possible to make a contract to execute a formal contract (Masters v Cameron (1954) 91 CLR 353). To be an irrevocable offer, the option should include a clause that requires the parties to enter into a separate sale contract.
Either form of option may have a sale contract attached, it is the classification of option as a conditional contract or an irrevocable offer that determines the time of the contract.
Correctly incorporating the distinction when drafting agreements is often difficult.
Option Effective Time
Depending on the drafting of the agreements, the time of the CGT event under an option can be:
the date of signing the option, if no separate sale contract is to be signed (being in effect a conditional contract);
the date of signing the option, if a separate sale contract is to be signed and the vendor can complete the terms of the separate sale contract (being in effect a conditional contract) (Laybutt v Amoco Australia P/L  HCA 49);
the date the option is exercised, if a separate sale contract is to be signed and the vendor cannot complete the terms of the separate sale contract (being an irrevocable offer) (Van v FCT  AATA 1313); or
the date the separate sales contract is signed, if when the option is exercised a separate sale contract is to be signed, the vendor cannot complete the terms of the separate sale contract and the sales contact is to be signed subsequent to the option exercise time (being the source of the transfer obligation) (FCT v Sara Lee Household & Body Care P/L  HCA 35 at ).
The ATO considers that the time of the CGT event arising from exercise of a call option is the date of exercise of the call option and signing the separate sale contract (Determination TD 16). The ATO provides the following example:
Example: On 1 April 1990, a landowner grants a taxpayer an option to buy his or her property before 30 June 1991 for $100,000.The option fee is $10,000.The taxpayer exercises the option. The contract for the sale of the land pursuant to the exercise of the option is executed on 1 June 1991.The date of the taxpayer's acquisition of the land is 1 June 1991, the date the contract for sale of the land was made (subsection 160U(3)). Correspondingly, this will also be the date of disposal for the vendor landowner.
The example does not address the consequences where the exercise of the option and the signing of the subsequent sale contract occur at different times. The relevant contract and CGT event time is likely to be the executed subsequent sale contract.
Where the option merely requires the parties to enter into a separate sale contract and does not create obligations itself to transfer the asset, it is the date of signing the sale contract that is the time of the CGT event (FCT v Sara Lee Household & Body Care P/L  HCA 35 at ).
The ATO considers that an irrevocable offer put and call option with no real exercise conditions may be treated as the sale document even if a separate sale contract is to be signed (CSR (Qld) v Camphin (1937) 57 CLR 127; CGT Subcommittee meeting 7 June 2000 item 8).
Drafting a put and call option may be ineffective if in reality it merely disguises an actual sale.