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Focus: Tax – May 2008

Federal Court decision places greater uncertainty over capital gains tax

In brief: The recent decision in Metlife Insurance Ltd v FCT suggests that the provision that permits the Federal Commissioner of Taxation to amend assessments at any time in respect of certain CGT events is considerably broader than was the case under the former capital gains tax regime. Partner Sarah Bernhardt (view CV) and Senior Associate Melanie Baker discuss Metlife and its implications for taxpayers.

• Introduction
• Facts
• Extension of time limits for CGT
• Interpreting rewritten provisions enacted in the 1936 Act
• Conclusion

Introduction

By consent between the parties, Metlife Insurance Ltd v FCT [2008] FCA 568 (Justice Emmett, 29 April 2008) dealt with one issue only: namely, whether or not the Federal Commissioner of Taxation (the Commissioner) was authorised to amend the taxpayer's original assessment outside of the usual four-year time limit that applied at that time. In dealing with this question, the case dealt with a number of statutory interpretation issues, including the relevance of the former provision, which was rewritten as part of the Tax Law Improvement Project.

Facts

The taxpayer, Metlife Insurance, had entered into a transfer of business agreement on 19 July 2000, which occurred during the substituted accounting period adopted by the taxpayer in lieu of the year ended 30 June 2001 (the 2001 year). Settlement of the sale of the business occurred in January 2001, during the taxpayer's subsequent substituted accounting period (the 2002 year).

The taxpayer's capital proceeds for the sale amounted to $43,359,741, which was allocated to net tangible assets ($1,998,656), policy rights ($12,491,602) and goodwill ($28,869,482). On the basis that the disposal of the business gave rise to CGT event A1, and that the date of the transfer of business agreement was the date on which the event occurred by reason of subsection 104-10(3) of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act), the taxpayer dealt with the capital gain arising from CGT event A1 in its income tax return for the 2001 year. The taxpayer disclosed the allocation of the purchase price in its income tax return for the 2001 year but included in assessable income only $28,869,482 as its capital gain in respect of the disposal.

As the taxpayer's income tax return for the 2001 year was lodged on 16 July 2001, the Commissioner was deemed to have made an assessment of the taxpayer on that date. Notwithstanding that the taxpayer fully disclosed the circumstances concerning its disposal in its return, the Commissioner waited until 15 July 2005 to issue a notice of amended assessment to the taxpayer, increasing the taxpayer's assessable income for the 2001 year by $12,491,602 (being an amount in respect of the taxpayer's disposal of the policy rights).

Although the notice of amended assessment issued on 15 July 2005 looks suspiciously like the Commissioner incorrectly assumed that the usual four-year time limit for amending assessments ran from the date of the original assessment, it was common ground between the parties that the time limit was four years from the date on which tax became due and payable under the assessment. As the tax had originally become due and payable on 1 June 2001 under section 204 of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act), the parties agreed that the usual four-year time limit had expired on 1 June 2005.

Extension of time limits for CGT

Subsection 170(10AA) of the 1936 Act provides that nothing in s170 prevents the 'amendment, at any time, of an assessment for the purpose of giving effect to the provisions of the 1997 Act set out in the table'. That table provides at item 30:

On the basis that this item was enacted as part of the Taxation Law Improvement Project in 1998, it was (not unreasonably) thought that it operated in a similar manner to former subsection 160U(10) of the 1936 Act, which was the provision that item 30 apparently rewrote. Former subsection 160U(10) of the 1936 Act stated:

Section 170 does not prevent the amendment of an assessment at any time to give effect to subsection (3) or (8) where the time of an acquisition or disposal is taken to have been before the making of the assessment. [Emphasis added.]

Not only did former subsection 160U(10) operate only where the time of the acquisition or disposal was 'taken to have been before the making of the assessment', the former provision was also interpreted with regard to certain policy statements made at the time it was introduced. For instance, Senator Cook, the then Minister for Industry, Science and Technology, was asked a question on notice about the scope of subsection 160U(10) and whether it was intended that the provision give the Commissioner 'unrestricted time limits for issuing amended assessments' in all cases or whether this apparent result was merely the result of 'poor drafting' (Senate Hansard, Wednesday, 8 June 1994, at 1522). In asking the question, Senator Watson noted that the proposed provision was so broad it appeared to extend well beyond the situation it sought to remedy, which he described in the following terms:

... An example would be the disposal of land under a terms contract in 1987 but the title to the land would not pass until 1993. By the time there had been an actual disposal the Commissioner would be too late to tax the capital gain.

The Minister responded by stating that the new provision did not give the Commissioner unrestricted time limits for amending even where there was no delay between the contract date and disposal date. In this context, the Minister stated (Senate Hansard, Monday, 20 June 1994, at 1707):

The scope of the new subsection is limited by the important words 'to give effect to'. This means that the Commissioner may only amend an assessment for the purpose of making subsections 160U(3) and (8) effective.

The explanatory memorandum to the Taxation Laws Amendment Bill (No 2) 1994 (Cth) also reinforced this message.

Based on these policy statements, it was commonly accepted that former subsection 160U(10) of the 1936 Act applied only where there was a delay between the contract date and the disposal date. In particular, the provision was believed to apply only where the disposal occurred after the original assessment had been made and the delay was sufficiently significant that, in the absence of former subsection 160U(10) of the 1936 Act, the Commissioner would have been prevented by s170 of the 1936 Act from issuing an amended assessment to give effect to the provisions that state that the disposal occurred at the date of the contract. Further, by virtue of s1-3 of the 1997 Act and the policy statements surrounding the Tax Law Improvement Project, it was thought that item 30 of subsection 170(10AA) of the 1936 Act would be interpreted in the same manner as former subsection 160U(10) of the 1936 Act.

Despite the history of the provision, and the fact that its legislative context arguably suggests that subsection 170(10AA) of the 1936 Act is directed at events that occur after an original assessment has been made, Justice Emmett in the Federal Court focused on construing 'the meaning of the words used by the Parliament' [41]. His Honour considered that a plain reading of the relevant item supported the view that the Commissioner's power to amend was unlimited. Although Justice Emmett acknowledged that this result may be because of deficient drafting, his Honour concluded that item 30 of subsection 170(10AA) of the 1936 Act could be invoked by the Commissioner to justify an amended assessment at any time, including where the relevant disposal occurred before the original assessment was made (and, in this case, where all the information pertaining to that CGT event was disclosed to the Commissioner at the time the original assessment was made, but the Commissioner had been tardy in issuing a notice of amended assessment).

Interpreting rewritten provisions enacted in the 1936 Act

Finally, his Honour swiftly rejected the contention that item 30 of subsection 170(10AA) of the 1936 Act should be interpreted by reference to former subsection 160U(10) of the 1936 Act by reason of s1-3 of the 1997 Act, which was introduced to facilitate the Tax Law Improvement Project.

Justice Emmett stated that the use of the words 'this Act' and 'that Act' in s1-3 made it clear that the section was only intended to deal with provisions in the 1936 Act that were rewritten and enacted in the 1997 Act. As the rewritten provision in this case was enacted in the 1936 Act, s1-3 of the 1997 Act did not apply and therefore subsection 160U(10) of the 1936 Act had no bearing on the interpretation of item 30 of subsection 170(10AA).

Conclusion

Metlife is authority for the proposition that the Commissioner may amend assessments at any time for the purpose of assessing capital gains arising out of certain CGT events under the 1997 Act where the time of the relevant CGT event is determined based on when a contract was entered into.

At a practical level, Metlife means that taxpayers will be exposed to greater uncertainty in their CGT treatment of many common transactions, irrespective of whether the basis for their taxation treatment was fully disclosed to the Commissioner at the time the original assessment was made. As a consequence, taxpayers will need to consider retaining records relating to affected CGT events indefinitely and not just for the time periods prescribed by Division 121 of the 1997 Act. Taxpayers may also need to reconsider their exposure under expired tax warranties. At a broader level, taxpayers will also need to revisit the common assumption that the taxation law rewrite and simplification projects of the late 1990s did not have a substantive effect on the interpretation of tax laws – particularly where the rewritten law has been enacted in the 1936 Act rather than the 1997 Act.

At the date of publication, the taxpayer had not yet lodged an appeal to the Full Federal Court. If Metlife is upheld on appeal, or no appeal is lodged, legislative amendment will be required to ensure that the Commissioner's power to amend is restricted.

For further information, please contact:

• Sarah BernhardtPartner, Melbourne
  Ph: +61 3 9613 8937
  Sarah.Bernhardt@aar.com.au
• Toby KnightPartner, Melbourne
  Ph: +61 3 9613 8590
  Toby.Knight@aar.com.au
• Grant CathroPartner, Melbourne
  Ph: +61 3 9613 8644
  Grant.Cathro@aar.com.au
• Ross StittPartner, Sydney
  Ph: +61 2 9230 4643
  Ross.Stitt@aar.com.au
• Peter AllenPartner, Brisbane
  Ph: +61 7 3334 3350
  Peter.Allen@aar.com.au

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