Disposal deemed at market value
2009 case note - plaintiff claimed as deduction the purchase price of shares; CIR disallowed deduction and deemed disposal of shares to be at market value.
The plaintiff acquired 100% of the shares in a company and amalgamated that company with three others into one unit. As a result of the amalgamation the newly acquired shares were cancelled.
The plaintiff claimed as a deduction the purchase price of the shares. The Commissioner disallowed the deduction and deemed the disposal of the shares to be at market value.
Impact of decision
This decision is of limited application as the wording of the Income Tax Act 2007 requires both a transferee and a transferor.
The plaintiff acquired 100% of the shares in North Island Dairy Company Holdings Limited for $2.3 million. It did so intending to amalgamate that company with three others into one unit. As a result of the amalgamation, Kapiti Fine Foods Limited emerged as the new entity and the newly acquired shares were cancelled.
The plaintiff took the position that its purchase of the shares fell within section CD 4 of the Income Tax Act 1994 (the "ITA 1994") as it had bought the shares in order to dispose of them by way of the amalgamation process. This position had the effect of making the shares "trading stock" and "revenue account property".
In its tax return for the year ended March 2004, the plaintiff claimed as a deduction the purchase price of this trading stock, being $2.3 million. It did not have an equivalent income entry attaching to the disposal of the shares by amalgamation.
The Commissioner considered section GD(1) of the ITA 1994 applied to the disposal of the shares so as to deem the plaintiff to have received as income the value of the shares. The Commissioner assessed the market value of the shares to be $2.3 million. The Commissioner also imposed a 20% penalty for an unreasonable tax position.
The plaintiff argued section GD1 did not apply as the section required both a transferor and transferee. The Commissioner argued that this was not a requirement of the ITA 1994.
Section GD 1(1) states:
- Subject to subsection (2), where any trading stock is sold or otherwise disposed of without consideration in money or money's worth or for a consideration that is less than the market price ... of the trading stock at the date of the sale or other disposition,-
- the trading stock is, for the purpose of this Act, treated as having been sold at and realised at its market price on the date of the sale or other disposition:
- The price which under this section the trading stock is deemed to have realised shall be treated as gross income of the person selling or otherwise disposing of the trading stock;
- The person acquiring the trading stock shall be deemed to have purchased the trading stock at the price which under this section the trading stock is deemed to have realised.
The Court held that it did not matter that the shares were not disposed of to a purchaser or transferee. The Court acknowledged that in many of these situations the transaction is analysed in terms of creating a transferor and transferee. The Court found that not every situation must be capable of such analysis to properly come within section GD1 of the ITA 1994.
The Court found that a purchaser is irrelevant to the need to adjust the accounts of the owner of the trading stock who has disposed of his property. The plaintiff bought the shares, chose to treat them as trading stock, chose to bring them within its "revenue account property" and claimed the deduction for the purchase price. When the plaintiff then chooses to dispose of the trading stock, there must be an adjustment to its tax position regardless of whether the method of disposal has further implications for a different plaintiff.
The plaintiff argued that at the time of disposition, the shares had nil value, because the amalgamation decision and process required them to be cancelled without consideration being given. The Court rejected this argument and reiterated the Commissioner's analysis that the correct method at which the market value should be assessed is prior to the change in value effected by the disposition. Once cancelled, the shares of course had no value, but prior to the cancellation they were worth $2.3 million and could have been sold.
In relation to the imposition of a shortfall penalty, the Court noted that the scope of section GD1 of the ITA 1994 is far from settled and that the plaintiff advanced a tenable argument.
The Court also took account of the fact that the Income Tax Act 2007 is consistent with the plaintiff's position. Accordingly it considered that a shortfall penalty should not be imposed.
- I cannot ignore that the wording of the 2007 Act either means I am wrong in my conclusions, or the drafters made the same mistake that the taxpayer has. In such circumstances I consider it incorrect to impose a penalty and accordingly I quash the penalty.
Tax Administration Act 1994, Income Tax Act 1994