ATO ID 2002/744: Capital gains tax - creation of contractual rights where a club acquires the assets and liabilities of another club (in liquidation)
Date of decision: 15 May 2002
Year of income: Year ending 30 June 2002
Business line: Centres of Expertise Capital Gains Tax

Issue
Is there a contractual right created under CGT event D1 in section 104-35 of the Income Tax Assessment Act 1997 (ITAA 1997) in Club A (in liquidation) when Club B acquires the assets of Club A and agrees to pay, or guarantees to pay, all of the creditors and honour all obligations under contracts of Club A (in liquidation)?

Decision
No. Club A (in liquidation) does not acquire a CGT asset under CGT event D1 pursuant to section 104-35 of the ITAA 1997 resulting from Club B agreeing to pay the liabilities of Club A (in liquidation).

Facts
Club A and Club B are companies limited by guarantee. Both clubs are registered under the Registered Clubs Act 1976 (NSW). Club A is to amalgamate with Club B pursuant to subsection 17A(1) of the Registered Clubs Act 1976 (NSW) which states, at paragraph (b), that a reference to the amalgamation of 2 or more registered clubs is a reference to an amalgamation effected by the continuation of one of those clubs and the dissolution of the other club or clubs. A Memorandum of Understanding (MOU) to amalgamate the clubs pursuant to the provisions of the Registered Clubs Act 1976 (NSW) was entered into by the clubs. The MOU at clause 2 provides that Club B will acquire all the assets of Club A and will pay (or guarantee to pay) all creditors of the club A and will honour all obligations under contracts made by the Club A. Club B accepts liabilities of Club A that may crystallise after the amalgamation eg employment and OH&S liabilities. The members of both clubs voted at a general meeting to amalgamate. Club A was placed in voluntary liquidation. The liquidator is to transfer the club A's assets to Club B.

Reasons for decision
Summary: Federal Commissioner of Taxation v. Orica Ltd (1998) 194 CLR 500; (1998) 98 ATC 4494; (1998) 39 ATR 66 (Orica) concerned a debt defeasance arrangement where Orica paid the Melbourne and Metropolitan Board of Works (MMBW) $62.3m for MMBW to pay a total of $98.7m to holders of debentures issued by Orica. The High Court decided that a chose in action consisting of MMBW's promise to Orica in the Orica Assumption Agreement was an 'asset' of Orica's and that the payment made by MMBW from time to time in performance of that promise constituted pro tanto 'disposal' of that asset, in each case for the purposes of Pt IIIA of the Income Tax Assessment Act 1936. In terms of the ITAA 1997 Orica acquired a CGT asset under CGT event D1, being the contractual rights created in it by MMBW. A CGT event C2 pursuant to section 104-25 of the ITAA 1997 would happen to Orica upon payment of the liability by MMBW in performance of that contract. The arrangement reflected in the MOU is analogous to a legal defeasance whereby Club B is to take-over the obligation to repay the debt of Club A. In Orica the creditors (debenture holders) had recourse against Orica in the event of default by the assumption party's (MMBW) performance of its promise (ie payment of the liabilities). The principles in Orica only apply where a taxpayer has rights created in it which enable it to compel performance (eg payment of its liabilities) by another party. Under the terms of the current arrangement Club A will not be in existence when the liabilities are ultimately paid by Club B. The arrangement anticipates and requires that Club A be liquidated and therefore there is no intention that rights be created in Club A on which it can compel performance. This means that the arrangement does not constitute the sort of debt defeasance addressed in Orica and therefore contractual rights under CGT event D1 have not been created in Club A.

Legislative references: Income Tax Assessment Act 1997 section 104-35
Case references: Federal Commissioner of Taxation v. Orica Ltd (1998) 194 CLR 500 (1998) 98 ATC 4494 (1998) 39 ATR 66
Subject references: Association income Capital gains Capital gains tax CGT events D1-D3 - bringing into existence a CGT asset Non profit companies Debt defeasance Liquidation Voluntary liquidation