Contingencies – when are they taken into account?

Contingencies – when are they taken into account?

Pfenning & Snow [2016] FamCA 29 (27 January 2016)

The following is annotated. For full case: http://www.austlii.edu.au/au/cases/cth/FamCA/2016/29.html

Contingencies

89. It can be seen from a number of authorities that CGT and issues similar to those raised by the husband in this case concerning tax on dividends have historically been considered, sometimes as an asset valuation issue (that is, to be determined in arriving at the proper value of an asset) or as a liability or cost issue to be accounted for, not necessarily in identifying the value of assets but as a s 75(2) factor; or disregarded. It can be seen that some authorities are not readily reconcilable with others. The following provides examples.
90. In Kelly & Kelly (No 2),^[18] a case concerning, inter alia, potential income/company tax liabilities, the Full Court said (at page 76,801):

As regards the argument that liability for income tax should have been deducted, this argument is very hard to sustain. In the first place there was no evidence what, if anything, the husband’s liability to income tax would have been. Secondly, the High Court has on several occasions declined to take liability to income tax or company tax into account in valuing a business since such liability is dependent on too many hypothetical factors: [citations omitted]
…
…where it is anticipated that specific items of property be sold and the proceeds divided amongst the parties, it is appropriate to make deductions for costs of sale. However, where as here the amount payable is quantified as a lump sum which the husband may raise through a variety of methods in whole or in part, including the apportioning of liquid assets, the sale of assets or by mortgage, costs of sale and realization are not relevant.

91. In Shaw & Shaw^[19] the Full Court considered a case involving, inter alia, the valuation of a party’s art collection. That case is authority for the proposition that where it is apparent that realisation of the assets will incur costs, then it will be reasonable to take those costs into account when fixing a value for the item.
92. In Rothwell & Rothwell^[20] (“Rothwell”) Holden J adopted a different course. His Honour considered the issue of notional CGT liability in the valuation of shares even though a sale of those shares was not contemplated. His Honour undertook a detailed discussion of authorities and differing approaches and concluded that notional CGT should be deducted even though sale of the asset was not contemplated.
93. In principle there is no apparent reason to distinguish between a liability for CGT as distinct from a liability from any other tax including taxation on dividends actually incurred or likely to be incurred as an economic consequence of an order made. The question has fallen for some consideration by the Full Court in In The Marriage of Bland^[21] and in Harrison & Harrison.^[22] In Carruthers & Carruthers^[23] Nicholson CJ in referring to these authorities held that there is no authority for the view that CGT can only be calculated if an immediate sale is contemplated. The Chief Justice held that it was “…of real relevance to consider the issue of when or if the relevant property is likely to be sold…” His Honour referred to the changing nature of the tax, market fluctuations, and the possibility of reducing its incidence through tax minimisation schemes.
94. Nicholson CJ adopted the test propounded by Finlayson JA in McPherson v McPherson^[24] as contained in the following statement in the judgment from Finlayson JA:

The cases appear to turn on their own facts and if I might hazard a broad distinction, an allowance should be made in the case where there is evidence that the disposition will involve a sale or transfer of property that attracts tax consequences, and it should not be made in the case where it is not clear when, if ever, a sale or transfer of property will be made and thus the tax consequences of such an occurrence are so speculative that they can be safely ignored.

95. In Rosati v Rosati^[25] (“Rosati”) the Full Court (at page 85,043) stated the following general principles as emerging from the authorities:

(1) Whether the incidence of capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset.
(2) If the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
(3) If none of the circumstances referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid term,then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s 75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur.
(4) There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs. (original emphasis)

96. In this case the husband’s shareholding in Pfenning-Snow Pty Ltd has not been valued. Rather, in circumstances where the husband is not simply the majority shareholder, but the sole shareholder, the assets of the company have been valued. Further, there is no evidence as to any CGT or other tax consequences if the husband were to cause the further issue of shares in the company or to sell all or part of his shareholding in the company.
97. It is readily apparent from Rosati that taking CGT into account in valuing an asset depends upon a number of circumstances including, importantly, consideration of the likelihood of sale in the “near future” or “immediate future”; or consideration whether an asset was acquired solely as an investment and with a view to its ultimate resale for a profit.
98. As point (3) in Rosati refers, the Court has a discretion as to whether or not CGT ought be taken into account as a relevant s 75(2) factor if the Court is satisfied that there is a significant risk that the asset will have to be sold “…in the short to mid term…” In that event the weight to be attributed to that factor varies according to the degree of the risk (of sale) and the length of the period within which the sale may occur.
99. It may also be noted that in Rosati, in discussing the obligation of a trial judge to have regard to the economic consequences of any proposed orders, reference was made (by Queen’s Counsel and the Court) to the New Zealand case ofHatrick v Commissioner of Inland Revenue.^[26]
100. At page 85,042 the Full Court observed of that case:

…That was a revenue case involving the valuation of shares in a company. Its only relevance, for present purposes, is that it was held by the New Zealand Court of Appeal, that if, in a given case, the value of the shares in a company is properly to be arrived at by the “assets-value method” (i.e. on a notional liquidation of assets basis), then allowance should be made for any dividend tax upon undistributed profits which would be payable upon such a liquidation.

101. It is instructive that in Jarrott & Jarrott^[27] the Full Court found that an “all or nothing” approach of either including CGT or not including it but trying to take it into account under s 75(2), had the potential to visit an injustice upon one of the parties. There the Full Court found that in the circumstances of that case, the appropriate course would have been for the trial judge to make a contingent order which would operate if and when a CGT liability actually arose. The Full Court observed at [62] and [63]:
     62. Her Honour was correct in finding…that in complying with the orders she would make there “could” give rise to a CGT liability of the husband. As such, an “all or nothing” approach of either including CGT or not including it but trying to take it into account under s 75(2) had the potential to visit an injustice upon one of the parties. If allowance were made for CGT, either in the balance sheet, or pursuant to s 75(2), and no CGT liability materialised, the wife would be disadvantaged. Although the risk was less, the husband could be disadvantaged if CGT of $80,000 – $90,000 materialised, and the trial Judge had discounted that figure significantly in her conclusion with respect to s 75(2) because its incidence was only a possibility.
     63. The appropriate course would have been, although no one seems to have urged this upon her Honour, and we have not been referred to any submission in which it was, to have made a contingent order, which would operate if and when, a CGT liability arose, because it was not inevitable (see Rosati & Rosati [1998] FamCA 38; (1998) FLC 92-804 and Brett-Hall & Brett-Hall [2006] FamCA 712; (2006) FLC 93-276) that it would, and as the wife asserted, there were some unsatisfactory aspects of the company’s financial disclosures.
102. In that case, in re-exercising the discretion the Full Court made an order for the parties to indemnify each other, in accordance with the percentage determinations, in the event that the husband incurred a CGT or other taxation liability as a consequence of his compliance with an order to pay the wife a cash sum.
103. It is to be noted in this context that in Rosati the Full Court observed (at [6.42]):

6.42 In the course of argument of the appeal, it was put to counsel by a member of the bench that an appropriate way of dealing with this problem might be to make an allowance for capital gains tax in a specific amount in calculating the value of the property for the purpose of the proceedings, but with a provision in the orders that if the tax were not assessed as payable within a specified period (suggested as being two years), the husband should pay an appropriate adjustment to the wife…

104. In Noetel & Quealey^[28] the trial judge had considered the potential tax on dividends which may be paid to the husband at some point in the future from his company. It was contended by the husband that estimated tax on dividends ought be deducted from the value of the asset. The wife disputed that to be so and agitated as to different ways in which money might be extracted from the company with differing tax consequences. The trial judge referred to a submission on behalf of the wife “…it is quite possible that the husband will retain the relevant real estate and public company shares until his death, whereupon the capital gains tax liability would be “rolled over” [to] the beneficiaries and would not be realised until their ultimate disposal of the shares…” It was also pointed out on behalf of the wife, as recorded by the trial judge, of the prospect of tax rates changing and generally as to the uncertainties associated with the tax. The trial judge accepted those submissions in not deducting the estimated potential tax on dividends.
105. The discussion of this topic on the appeal appears at [119] to [121] in the judgment of the Full Court and the Full Court concluded at [122]:
     122. We are satisfied that the course adopted by the trial Judge of disregarding the potential future tax liability of the husband was open to his Honour in the circumstances of this case particularly as there was no certainty such tax would be incurred by the husband withdrawing funds by way of dividend… (emphasis added)
106. In this case, Queen’s Counsel for the husband addresses the contingencies advanced at, inter alia, paragraph 2.2 of the husband’s written submissions with reference to authority as follows:

2.2 …
In IABH & HRBH (2006) FamCA 379 the Full Court (@ para 79) in referring to the Wife’s submissions with apparent agreement said, in respect of the treatment of properties that were not intended to be sold:
“…the appropriate course would have been for the Trial Judge to have had regard to the possibility of those liabilities within the context of S75(2) or S79(2).”
Indeed that is what Watts J did in the second retrial IABH & HRBH (2010) FamCA 110 (in paras 358-366) where he allowed a 7.5 per cent [sic] for this under S75(2).
(original emphasis)

Application of these principles in this case

107. In my judgment applying these principles to the evidence here, the husband’s contention that notional CGT and sale costs on the Store F Town asset held in the PS Trust as a deduction from the value of the asset, is readily dismissed. Contrary to any suggestion of a sale of the asset in even the foreseeable future or the short to mid-term, even in circumstances of the need for property settlement to be effected, the husband’s evidence was of an intention to retain that asset at least until the current lease expires which will not occur until 2023. In my judgment there is no basis for deducting notional CGT and costs of sale with respect to this asset from its value nor indeed would it be appropriate to make allowance for that as a relevant s 75(2) factor.