24 Aug 09 Capital contribution part of shares' cost base - National Mutual
The Full Federal Court has, by majority (Finn and Sundberg JJ, Perram J dissenting) upheld the taxpayer's appeal from the decision of Middleton J, who held that a capital contribution of pounds sterling 42.912 million, made by the taxpayer to its wholly owned UK subsidiary NM (UK) Limited (NM UK), did not form part of the reduced cost base of the taxpayer's shares in NM UK under the former s 160ZH(3)(c) of ITAA 1936.
Former s 160ZH(3)(c) referred to expenditure "of a capital nature incurred by the taxpayer to the extent to which it was incurred for the purpose of enhancing the value of the asset and is reflected in the state or nature of the asset at the time of disposal of the asset". Middleton J held that although the expenditure enhanced the value of the shares, it was not reflected in the "state or nature" of the shares. His Honour was of the view that "it cannot be said in relation to a share as an item of property, which may be bought and sold, that 'value' forms any part of the nature or state of that form of asset".
In upholding the taxpayer's appeal, Finn and Sundberg JJ said at para 38:
"What must be reflected in the state or nature of the asset on disposal is the expenditure incurred for the purpose of enhancing its value. While the provision does not require the expenditure to have been successful in enhancing the asset’s value, in many cases that will be its effect. It would be curious in that situation for the expenditure not to be taken into account on the ground that it is not reflected in the state or nature of the asset on disposal."
In the alternative, the taxpayer relied on a fact that was agreed by the Commissioner, namely, that the expenditure was reflected in the shareholder’s equity in NMUK. Their Honours also upheld the appeal on this basis, saying at para 51:
"Having regard to the legal nature of a share as described in the authorities, the inevitable consequence of the finding that at the time of the sale the expenditure was reflected in the shareholder’s equity in NMUK is that it was reflected in the state or nature of the shares in NMUK. We accept the taxpayer’s submission that if the expenditure was reflected in the shareholder’s equity, it must also be reflected in the state or nature of the very rights which are the source of that equity. The shares themselves and the rights inhering in them (including the shareholder’s equity) were not separate rights or interests. The authorities show that the rights derived from a share are embodied within the share. A share is incapable of legal description save by reference to what it represents: the rights and interests its holder derives from it. If, as the primary judge found, the expenditure was reflected in the shareholder’s equity, it is reflected in the state or nature of the rights which are the source of the equity."
National Mutual Life Association of Australia Ltd v FCT  FCAFC 96 (Full Federal Court; Finn and Sundberg JJ, Perram J dissenting; 21 August 2009).
For a copy of the decision, go here
TAXVINE COMMENT: Note that for CGT events happening on or after 1 July 2005, s 110-25(5) ITAA 1997 (which replaced the former s 160ZH(3)(c)) was amended to remove the "state or nature" requirement found in the second limb of s 160ZH(3)(c).