Value of gain in kind when calculating FIF income or loss was market value of shares disposed of

Summary

The Commissioner treated the forfeiture of shares as a disposal at market value. Dr Saha maintained that the shares were not disposed of for gain; rather there was an adjustment to the original purchase price. The Court held that Dr Saha obtained a gain from the transfer of the shares to Cap Gemini, but it was a gain in kind and not in money. There was no evidence of the market value of the gain in kind but as it could not be less than the market value of the shares at the time of disposition, the market value of the shares was to be used.

Impact of decision

Where there is no valuation evidence of the market value of the gain derived in kind but if it is less than the market value of the shares at the time of disposition, this market value must be adopted in accordance with section CG 23(5) of the Income Tax Act 1994 (ITA).

Facts

This was an appeal against the decision of Simon France J delivered on 23 September 2008.

Dr Saha was a partner in Ernst & Young (EYNZ). In 2000, EYNZ sold a portion of its business to an overseas company, Cap Gemini. The then partners in EYNZ were paid by means of an allocation of shares in Cap Gemini. Part of the sale arrangements was that some EYNZ partners, including Dr Saha, would work for Cap Gemini for five years; and agreements were entered into to give effect to this commitment. The agreements included a share forfeiture regime, which was to apply if the partner stopped working for Cap Gemini before the five years was up. This is what happened with Dr Saha, and he was later required to return some of the shares he had received.

The share allocations and disposals were caught by the Foreign Investment Fund (FIF) Rules. Dr Saha chose to return his FIF income/losses under the comparative value method (section CG18 of the ITA) whereby if the value of a person's holding has increased during the course of a tax year, that increase will be treated as income, and if it has decreased it will be treated as a deductible loss. In the 2001 tax year Dr Saha applied the formula in section CG 18 of the ITA to the acquisition of his parcel of shares, sales he had made, and the market value of the shares at the time of acquisition and at year's end. Because the value of Cap Gemini shares had dropped over the year, he was able to claim a loss of $1,210,651.

During the 2002 year, Dr Saha forfeited 2095 shares as he had left the employment of Cap Gemini. The Commissioner and Dr Saha disagreed as to the treatment of these shares in the formula in section CG 18 of the ITA. The Commissioner treated the disposal of the forfeited shares as a gain at market value to Dr Saha. Dr Saha maintained that the forfeiture operated as a purchase price adjustment.

In the High Court, Simon France J treated the forfeiture of shares as an adjustment to the original purchase price. However, he concluded that because the shares were disposed of for nil consideration, section CG 23(5) of the ITA deemed that disposal to be at market value.

Decision

The Court of Appeal focused on the settlement deed agreed to between Dr Saha and Cap Gemini upon termination of his employment, rather than the deed of covenant; the settlement deed effected a new contractual arrangement between the parties.

Clause 4 of the settlement deed provided:

• CGE&EYNZ and Cap Gemini agree that 50% of Unreleased Transaction Shares (being 2095 shares) will not be forfeited. The remaining Unreleased Transaction Shares will be transferred to Cap Gemini or as it directs. The Deed of Covenant will remain in full force and effect.

In respect of the matters it covered, the settlement deed was expressed to supersede all previous agreements and understandings between the parties and recorded various agreements to end the employment dispute between them.

The Court stated that Dr Saha agreed to relinquish half of his unreleased transaction shares as part of his side of the bargain. The shares were not forfeited but transferred as part of an overall settlement of his employment dispute, and in return Dr Saha received certain benefits such as the freedom to undertake other employment.

In reaching its decision, the Court took a different line of reasoning from the High Court and considered the position was covered by section CG 14(2) of the ITA:

• CG 14(2) [Non-monetary gain] For the purposes of the FIF rules, where any gain is derived in kind and not in money, the amount of gain shall be equal to the market value of the gain derived in kind, measured at the time derived.

The Court held that Dr Saha did obtain a gain from the transfer of the shares to Cap Gemini, but it was a gain in kind and not in money. There was no valuation evidence of the market value of the gain but if it was less than the market value of the shares at the time of disposition, section CG 23(5) of the ITA deemed that consideration received was the market value of the shares. Accordingly, the Court held that it was the market value of the shares that was to be applied in the formula in section CG 18 of the ITA.