A gain "in kind" offsets the loss incurred
2010 case note – deduction claim under FIF rules disallowed by CIR - comparative value method, 'in kind and not in money', paid, payment.
Dr Saha was a partner in a large accounting firm. When part of that business was sold, he was allocated a number of shares in the purchaser company. However, if Dr Saha left the employment within five years he would forfeit the right to some of those shares. Dr Saha subsequently left the partnership but was only required to forfeit 50% of those shares, by way of settlement of an employment dispute. Dr Saha claimed a deduction under the FIF rules for the value of the shares he forfeited. The Commissioner disallowed that deduction. Dr Saha appealed to the High Court and the Court of Appeal. Both Courts upheld the decision of the Commissioner. Dr Saha appealed to the Supreme Court, which also dismissed his appeal. The Court held that under the FIF rules, Dr Saha derived a gain "in kind", which offset the loss he incurred through the forfeiture of the other shares.
Impact of decision
The decision confirms the High Court and the Court of Appeal decisions, but on different reasoning. Although there is discussion of the operations of the FIF rules, some of the provisions discussed have been amended or repealed.
Dr Saha was a partner in Ernst & Young (E&Y). In 2000, E&Y sold a portion of its business to an overseas French company, Cap Gemini SA. The partners were paid by means of an allocation of shares in Cap Gemini. Part of the sale arrangements was that some of the E&Y partners, including Dr Saha, would work for Cap Gemini for five years. If a partner stopped working for Cap Gemini before the five years were up, share forfeiture would occur. This is what happened with Dr Saha and he was later required to return some of the shares he had received.
The share allocation and disposals were subject to the Foreign Investment Fund (FIF) taxation regime. Dr Saha chose to return his FIF income/losses under the comparative value method (section CG 18 of the Income Tax Act 1994) whereby if the value of a person's holding had increased during the course of a tax year, that increase would be treated as income, and if it had decreased it would be treated as a deductible loss.
Dr Saha forfeited 2095 of the 7566 shares he was allocated when he left the employment of Cap Gemini. Dr Saha claimed a deduction of $602,938 being the market value of the 2095 shares he forfeited to Cap Gemini. The Commissioner disallowed that deduction.
Dr Saha chose the "comparative value" method under section CG 18. In applying the analysis to the formula, the Court noted at paragraph  that:
- because Dr Saha no longer owned the shares at the end of the income year during which they were forfeited their value at the time was nil;
- Dr Saha derived no gains during the year "with respect to" those shares (his "interest" in a FIF) because their forfeiture resulted in loss to him;
- the market value of the shares at the end of the preceding income year was $602,938; and
- no expenditure was incurred during the income year in acquiring the shares.
The formula in section CG 18 is (a + b) - (c + d). The calculation therefore is (nil plus nil) less ($602,938 plus nil). As a result, the Court said that if section CG 18 was the only relevant section, the deduction would have been correctly claimed. But section CG 18 is subject to sections CG 23(5) and CG 14(2).
Under section CG 23(5), if a person disposes of any interest for no consideration the person shall be deemed to have derived from the disposition consideration equal to the market value of the property. The Court concluded that it could not be said that Dr Saha disposed of his interest for no or inadequate consideration, as there was a benefit to him in the value of the shares he was permitted to retain.
For the Commissioner to rely on section CG 14(2), the Court said that the Commissioner must establish that as a consequence of the forfeiture Dr Saha derived a gain "in kind and not in money". If so, the amount of the gain was deemed to be the market value of the gain. The Court held at paragraph  that the gain was deemed by section CG 14(2) to be the market value of the shares which were retained.
The result was (at paragraph ):
- The effect of section CG 14(2) was that Dr Saha was deemed to have derived a gain of $602,938 from the forfeiture of the shares. That sum therefore became input (b) into the section CG 18 formula. The resultant calculation was (nil plus $602,938) less ($602,938 plus nil), namely nil. It followed that the Commissioner's assessment that Dr Saha was not entitled to claim a deduction of $602,938 was correct, and his appeal must therefore be dismissed.
Income Tax Act 1994, FIF rules