National Mutual Life Association of Australia Ltd v Commissioner of Taxation
Document type: Decision Impact Statement
Venue: Federal Court of Australia (VID 1082 of 2008)
Judgment date: 21 August 2009
Date published: 11 March 2010
Decision outcome: Adverse

Summary of decision:
Outlines the ATO's response to this case which concerned whether capital expenditure incurred to enhance the value of shares formed part of the reduced cost base under former paragraph 160ZH(3)(c) of the ITAA 1936.

Overview of facts:
1. The applicant carries on a business of life insurance which until 1993 included the selling of life insurance policies in the UK. The UK business was established in the late 19th century and was carried on through the applicant's No.6 statutory fund which operated as a self contained entity subject to UK regulation. | 2. The applicant conceived of a plan whereby it would grow its UK business by buying another UK life insurance company. It decided that it should acquire three subsidiaries of Schroder plc, namely Schroder Financial Management Ltd, Schroder Life Assurance Ltd (later called National Mutual Schroder Life Assurance Limited or "NMSLAL") and Schroder Unit Trust Management Ltd. NMSLAL wrote unit linked policies, which at the time were popular in the UK. NMSLAL had, for that reason, expanded greatly in the 1980s, but needed further capital to keep growing. The applicant's plan was to use the surplus in its No.6 fund to provide that capital. It would do so by merging the assets and liabilities of that fund with NMSLAL. | 3. NMSLAL was ultimately acquired on 19 December 1986 by the applicant's UK resident subsidiary, NMUK. | 4. Between December 1986 and March 1988 the applicant took steps to merge the business of its No.6 fund with that of NMSLAL. | 5. Under the arrangement agreed with the Department of Trade, that part of the surplus which could be used to grow NMSLAL's business would be paid as contributed capital by the applicant to the shareholders' funds of NMSLAL, and thereafter be transferred to NMSLAL's Long Term Business Fund ("LTBF"). | 6. The LTBF comprised: 34.1.1. a " Closed Fund " into which the liabilities of the former No.6 fund would be transferred together with assets sufficient to make good those liabilities (including part of the No.6 fund surplus as agreed with the DTI); 34.1.2. an " Other Business Fund " or "OBF" which contained all of the former unit linked business of NMSLAL. It was intended that most of the capital contribution would be used to fund new business for this fund; and 34.1.3. a smaller " With-Profits Business Fund ". | 34.1.1. a " Closed Fund " into which the liabilities of the former No.6 fund would be transferred together with assets sufficient to make good those liabilities (including part of the No.6 fund surplus as agreed with the DTI); 34.1.2. an " Other Business Fund " or "OBF" which contained all of the former unit linked business of NMSLAL. It was intended that most of the capital contribution would be used to fund new business for this fund; and 34.1.3. a smaller " With-Profits Business Fund ". | 7. Pursuant to the arrangement the applicant transferred an amount to the shareholders' funds of NMSLAL and subsequently that amount was transferred to NMSLAL's Long Term Business Fund | 8. The amount allocated to the LTBF was allocated partly to the Closed Business Fund and the balance to the OBF. It was accepted that of the amount allocated to the OBF, £42.912 million increased the surplus in the fund and was used to grow the business by NMSLAL. | 9. The £42.912 million was not credited to NMSLAL's share capital account, no issue of scrip accompanied the expenditure and the expenditure did not effect any change to the memorandum or the articles of association of NMSLAL or NMUK | 10. The £42.912 million remained in NMSLAL's OBF and was not dissipated or transferred prior to the sale in 1993 of NMUK to Friends. Neither NMUK nor NMSLAL paid dividends or returned capital from 1988 until the sale to Friends. | 11. In early December 1993 the applicant sold its shares in NMUK to Friends for £113 million. | 12. It is accepted by the parties that the amount equal to the Capital Contribution Amount paid by the applicant to NMSLAL, to the extent of £42.912 million, was incurred by the applicant for the purpose of enhancing the value of the shares in NMUK, the parent of NMSLAL. Moreover, at the time of the sale of the NMUK shares to Friends the £42.912 million was: 34.1.1. reflected in the "embedded value" of NMSLAL; 34.1.2. reflected in the "embedded value" of NMUK; and 34.1.3. reflected in the value of the shares and the shareholders' equity in NMUK. | 34.1.1. reflected in the "embedded value" of NMSLAL; 34.1.2. reflected in the "embedded value" of NMUK; and 34.1.3. reflected in the value of the shares and the shareholders' equity in NMUK. | Issues decided by the court | The issue before the Court was whether capital expenditure in the amount of £42.912 million that was incurred by the Applicant and added value to the shares that it held in its subsidiary, NMUK, was reflected in the state or nature of those shares upon disposal.

Issues decided:
The issue before the Court was whether capital expenditure in the amount of £42.912 million that was incurred by the Applicant and added value to the shares that it held in its subsidiary, NMUK, was reflected in the state or nature of those shares upon disposal.

ATO view of decision:
The Commissioner accepts the Full Federal Court's interpretation of paragraph 160ZH(3)(c) of the ITAA 1936, as it applied to the non-scrip share capital contribution made by the taxpayer in this case. | The majority of the Full Federal Court concluded that the added 'value' of a share, in this case reflected by way of an increase in shareholders' equity, could not be separated from the rights that made up that share, and the 'state' of those rights reflected the enhanced value at the time of disposal of the share. | Therefore, for the purposes of paragraph 160ZH(3)(c) of the ITAA 1936, the non-scrip capital contribution by the Applicant was reflected in the 'state or nature' of the shares at the time of disposal and consequentially included in the reduced cost base. | The decision will also apply to the calculation of cost base under former paragraphs 160ZH(1)(c) and 160ZH(2)(c) of the ITAA 1936. | However, the decision will have limited application as, for CGT events occurring on or after 1 July 2005, the equivalent provisions in the ITAA 1997 have been amended (subsections 110-25(5) and 110-55(2)). There is no longer a requirement that the expenditure be reflected in the 'state or nature' of the asset at the time of the CGT event in order for the expenditure to be included in the cost base or reduced cost base. | Taxation Determination TD 2004/2 expressed the Commissioner's view as to what extent a non-scrip share capital contribution to a company could be included in the cost base or reduced cost base of a share in that company for the purposes of subsections 110-25(5) and 110-55(2) of the ITAA 1997 and former paragraphs 160ZH(1)(c), 160ZH(2)(c), an 160ZH(3)(c) of the ITAA 1936. | As the view expressed in TD 2004/2 is contrary to the view of the Full Federal Court, TD 2004/2 has been withdrawn. | As stated above, for CGT events occurring on or after 1 July 2005, the amendments made to subsections 110-25(5) (cost base) and 110-55(2) (reduced cost base) of the ITAA 1997 no longer require that expenditure be reflected in the 'state or nature' of the asset at the time of the CGT event in order for the expenditure to be included in the cost base or reduced cost base. Therefore, a replacement for TD 2004/2 is not required.

Administrative treatment:
Implications on current Public Rulings & Determinations and Law Administration Practice Statements | None

Legislative references: Income Tax Assessment Act 1936 Former paragraph 160ZH(1)(c) Former paragraph 160ZH(2)(c) Former paragraph 160ZH(3)(c) Income Tax Assessment Act 1997 110-25(5) 110-55(5)
Case references: Aberdeen Construction Group Ltd v Commissioners of Inland Revenue 52 TC 281 [1978] AC 885 Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) 77 CLR 143 [1948] HCA 28 Re Taxpayer and Federal Commissioner of Taxation 58 ATR 1172 2005 ATC 101 The Trustees of the FD Fenston Will Trusts v The Commissioners of Her Majesty's Revenue and Customs (unreported, Special Commissioners, 7 February 2007) [2007] SWTI 556
Subject references: Capital Loss reduced cost base state or nature shares