Taxation Law

ACC 304 Taxation Law Workshop 5 Capital Gains Tax

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Capital Gains Tax

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Learning Objective 1

Explain the basic CGT concepts

Overview  A gain characterised as capital is not subject to income tax under

ordinary concepts.  Capital Gains Tax (‘CGT’) commenced on 20 September 1985 and

brings capital receipts into the tax base. It is not a separate tax. It is a set of residual provisions designed to determine an amount of Statutory Income to be included in a taxpayer’s assessable income if the amount cannot be assessed as ordinary income, or under other provisions.

 A taxpayer’s income tax liability includes a net capital gain

(being total capital gains less certain capital losses)

Assessable Income

Ordinary Income

Statutory Income

Net Capital Gain

PoTL 2017 paragraph [11.10]

Overview • CGT on applies to assets that have been acquired on or

after September 20,1985.

• Residents are subject to CGT on CGT assets located anywhere in the world whereas non-residents are subject to CGT only on taxable Australian property (direct or indirect interests in land, buildings or business assets).

CGT - 5 Step Process

 To determine whether the taxpayer has made a capital gain or capital loss, the following issues are considered:

1 • Has a CGT event happened?

2 • Is the asset a CGT asset?

3 • Is the CGT event/ CGT asset exempt?

4 • Do the special CGT rules apply?

5 • Does a capital gain or capital loss arise from the

CGT event?

PoTL 2017 paragraph [11.30]

Learning Objective 2

Explain the key role of the CGT event

Step 1: Has a CGT event happened?

 A taxpayer only makes a capital gain or loss if a CGT event occurs: s 102-20 ITAA97.

 Sometimes, more than one CGT event will happen. Generally, the most specific to the situation is used: s 102-25(1).

 More than 50 CGT events exist. For summary of CGT events, see s 104-5.

 The following key CGT events are covered in these slides:

CGT event A1 – Disposals (most common event)

PoTL 2017 paragraph [11.40]

Has a CGT event happened?

CGT Event A1 – Disposal of a CGT asset (s 104-10) • Occurs when the taxpayer disposes of a CGT asset. • Time of the CGT event:

• When the taxpayer enters into the contract, or • If no contract, when ownership change occurs. See, FCT v

Sara Lee Household.  Illustration: Timing of CGT event (and hence capital gain or loss)

will be in the income year ended 30 June X1

Contract signed

30 June X1

Settlement ($)

1 June X1 1 July X1

PoTL 2017 paragraph [11.50]

Other CGT events CGT Event C1 – loss or destruction of a CGT asset (s 104- 20) • The time of the event is when you first receive compensation for the

loss or destruction or, if there is no compensation, when the loss is discovered or destruction occurred.

CGT Event D1 – creating contractual or other rights (s 104-35) • The time of the event is when you enter the contract or create the

other right.

CGT Event K4 – CGT asset starts being trading stock (s104-220) • The time of the event is when you start to hold the asset as trading

stock

Class activity 1

Discuss the following comment:

“The disposal of any form of asset will always result in an assessable amount under the capital gains tax rules”

Learning Objective 3

Identify the different categories of CGT assets

Step 2: Is the asset a CGT asset ? Broad definition of a CGT asset. Defined in s 108-5(1) as:

 Any kind or property; or  Legal or equitable right that is not property. Examples include: • Land and buildings • Shares in a company • Bonds or debentures in a company • Units in a unit trust • Collectables costing over $500 (eg stamp collection) • Personal use assets costing over $10,000 (eg boat) • Contractual rights (eg restraint of trade) • Business goodwill. • Foreign currency • Cryptocurrency… see next page

PoTL 2017 paragraph [11.170]

Cryptocurrency • From ATO web-site One example of cryptocurrency is Bitcoin. Our view is that Bitcoin is neither money nor Australian or foreign currency. Rather, it is property and is an asset for CGT purposes. Other cryptocurrencies that have the same characteristics as Bitcoin will also be assets for CGT purposes and will be treated similarly for tax purposes

Is the asset a CGT asset ?

 Important to classify CGT assets into their relevant categories (special rules apply to each):

Categories of CGT assets

CGT assets (if not a collectable

or personal use asset)

Collectables Personal use assets

PoTL 2017 paragraph [11.170]

Collectable

Collectables Defined in s 108-10(2) as:

• Artwork, jewellery, an antique or a coin or medallion; or • A rare folio, manuscript or book; or • A postage stamp or first day cover; that is used or kept mainly for personal use or

enjoyment.

PoTL 2017 paragraph [11.180]

Collectable

Collectables  Special rules apply to collectables, as follows:

1 • Capital gains and capital losses are disregarded when the

first element of a collectable’s cost base is less than $500

2 • Cost base of a collectable: disregard 3rd element (non-

capital costs of ownership)

3 • Quarantining rule: capital losses from collectables can only

be used to reduce capital gains from collectables

4 • Set of collectables are treated as a single collectable

PoTL 2017 paragraph [11.180]

Personal Use Assets Personal use assets  Defined as an asset (other than a collectable) that is used or kept

mainly for personal use or enjoyment, excluding land or buildings (s 108-20(2)).

 Examples include: • television at home • mobile telephone for private use • a bicycle • a yacht owned for personal use and enjoyment.

 Personal use asset do not include land and buildings, personal motor vehicles or motor bikes.

 If the asset is considered a collectable it will not be treated as a personal use asset.

PoTL 2017 paragraph [11.190]

Personal Use Assets Personal use assets  Special rules apply to personal use assets, as follows:

1 • Capital gains and capital losses are disregarded when the first

element of a personal use asset’s cost base is less than $10k

2 • Cost base of a personal use asset: disregard 3rd element

(non-capital costs of ownership)

3 • Capital losses from personal use assets are disregarded

4 • Set of personal use asset are treated as a single personal use

asset

PoTL 2017 paragraph [11.190]

Pre-workshop question 1

Are the following CGT assets, collectables, or personal use assets? (a) an engagement ring which cost $5,000? (b) a second-hand car purchased for $2,000? (c)shares in BHP? (d) your home? (e) a painting hung in the foyer of your

accountant’s office? (f) a holiday home at Byron Bay?

Learning Objective 4

Identify exceptions and exemptions from the CGT rules

Step 3: Is the CGT event / asset exempt ?

 An exception or exemption allows a taxpayer to reduce a capital gain or disregard the gain altogether.

Categories of

exemptions

Exempt gains and losses on

certain assets

Exempt or loss

denying transactions

Anti-overlap provisions

Small business

relief

PoTL 2017 paragraph [11.220]

Is the CGT event / asset exempt ?

Disregarded capital gains and losses on certain assets

1 • Cars, motorcycles and valour decorations (s118-5)

2 • Collectables < $500; personal use assets < $10,000 (s118-

10)

3 • Assets used to produce exempt income (s118-12(1))

4 • Shares in a pooled development fund (s118-13)

5 • Depreciating assets (s118-24(1))

6 • Trading stock (s 118-25)

PoTL 2017 paragraphs [11.230] – [11.275]

Main residence Exemption

Basic exemption allows a capital gain or loss arising from a CGT event where the CGT asset is a dwelling and the:

 Basic case can be extended, limited, or a partial exemption may apply.

1 • Taxpayer is an individual; and

2 • The dwelling was the taxpayer’s main residence

throughout the whole of ownership period: s 118-110 (1).

PoTL 2017 paragraphs [11.380] – [11.390]

Step 4: Do the special CGT rules apply?

• ITAA 1997 Part 3-3 contains special CGT rules for certain CGT events, including rollover relief, which permits a capital gain to be deferred to a future income period.

• The rollover applies to a range of capital gains tax (CGT) events involving the transfer of ownership of assets, where those events occur as a result of a court order, formal agreement or award.

• The rollover applies to CGT events where the transferor disposes of an asset to the transferee spouse (CGT event A1)

https://legalvision.com.au/when-does-cgt-rollover-relief-apply/

Step 5: Does a capital gain or capital loss arise from the CGT event?

To calculate whether there has been a capital gain or loss must determine:

1. Determine the capital proceeds from the CGT event

2. Determine the cost base of the CGT event

3. Subtract the cost base from the capital proceeds.

Capital gain or Capital Loss

 For most CGT events, a capital gain occurs when the “capital proceeds” exceeds the “cost base” of the CGT asset.

 Taxpayer makes a capital gain if: Capital Proceeds > Cost Base

 Taxpayer makes a capital loss if: Reduced Cost Base > Capital Proceeds

 Taxpayer makes neither a capital gain nor capital loss if the capital proceeds are less than the cost base but more than the reduced cost base.

PoTL 2017 paragraphs [11.440] – [11.460]

Learning Objective 5

Determine the capital proceeds and the relevant cost base for a CGT asset

Capital Proceeds  Capital proceeds are the amount the taxpayer receives or

is entitled to receive in relation to the CGT event: s 116-20.  GST on the supply is disregarded: s 116-20(5).  Six modifications to capital proceeds:

1 • Market value substitution rule

2 • Apportionment rule

3 • Non-receipt rule

4 • Repaid rule

5 • Assumption of liability rule

6 • Misappropriation rule

PoTL 2017 paragraph [11.470]

Capital Proceeds

Modification 1: Market value substitution rule (s 116-30)  Applies when the taxpayer:

• receives no capital proceeds; • some or all capital proceeds cannot be valued; or • did not deal at arm’s length with the another entity.

 Capital proceeds are deemed to be the market value.

Wife Husband Wife transfers a CGT asset to her husband

Husband pays less than the market value MV sub. rule applies

PoTL 2017 paragraph [11.470]

Capital proceeds Modification 2: Apportionment rule (s 116-405)

- If a payment covers several CGT events then the payment needs to be split amongst the relevant assets. Also, if payment includes consideration for an asset (or assets) subject to a CGT event (or events) as well as other things, apportionment needs to happen so that the asset(s) subject to the CGT events are apportioned with reasonable amounts.

Modification 3: Non-receipt rule (s 116-45) • Capital proceeds are reduced if the taxpayer does not receive, or is not likely to receive, some

or all of the capital proceeds. Modification 4: Repaid rule (s 116-50)

• Capital proceeds are reduced to the extent the taxpayer has to repay capital proceeds already received.

Modification 5: Assumption of liability rule (s 116-55) • Capital proceeds are increased if another entity assumes liability in connection with the CGT

event. For example the party disposing of the asset may receive part of the compensation in case and the balance will constitute an interest-bearing loan. The initial value of the loan will need to be included in capital proceeds.

Modification 6: Misappropriation rule (s 116-55) • Capital proceeds are reduced by the amount misappropriated by an employee of agent in

connection with the CGT event.

PoTL 2017 paragraph [11.470]

Class activity 2

• On 2 June 2018, David transfers a rental property to his wife Tanya for no consideration.

• David acquired the property in May 2013 for $250,000 including stamp duty, legal fees and all other incidental costs connected with the procurement of the land.

• The market value on the day of disposal was $500,000.

Is there a capital gain and how much?

Cost Base

 Cost base is the total of the costs associated with the CGT asset. There are 5 elements:

Element Cost base item (s 110-25(1)-(6)) 1 Cost of acquisition 2 Incidental costs in relation to the acquisition or event, eg

stamp duty, lawyer fees, transfer fees, commission 3 Non-capital costs of ownership for assets acquired after

20 August 1991, e.g. interest, rates, repairs, land tax 4 Capital enhancement costs to increase the value of the

CGT asset, e.g. cost of a new kitchen in a rental property 5 Capital expenditure incurred to establish, preserve or

defend the taxpayer’s title to the asset

PoTL 2017 paragraph [11.480]

Indexed cost base

The indexed cost base corrects for inflation and is available if the asset is acquired on or after 20th September 1985 and before 20th September 1999. Essentially the cost base is multiplied by a factor: Indexed cost base = Cost base x CPI (Disposal)/CPI (Acquisition)

PoTL 2017 paragraph [11.500]

Reduced cost base

‘Reduced cost base’ for capital losses (s 110-55)  Reduced cost base is used for the purpose of working out a

capital loss.  Largely the same as cost base, except for 2 differences:

• Reduced cost base cannot be indexed. • 3rd element is any amount that is included in the taxpayer’s

assessable income because of balancing adjustments. All other elements are the same.

PoTL 2017 paragraph [11.500]

Pre-workshop question 2

Which of the following can form part of the cost base of a rental property used for income producing purposes?

• Repairs to broken window • Rates and land tax • Interest expense on loan • Legal fees on purchase • Legal fees on mortgage(loan) • Stamp duty of purchase (a State Govt Tax). Sometimes called a

Land Transfer Fee • Purchase price of rental property • Extensions to build extra room • Concrete driveway replacing existing gravel driveway • Removal of old chimney • Clearing old vegetation away

Pre-workshop question 3 Consider the following 2 transactions: • You acquire a large block of land with a single

title. You subdivide the land into 6 smaller blocks and sell 5 of them.

• On the remaining block you construct a house with an associated granny flat. As you do not have a granny, you sell the granny flat.

Are there any CGT implications associated with these transactions?

CGT Discount A CGT discount can be applied to reduce the amount of a capital gain if :

• the gain is made by a tax resident individual, trust or complying super fund (including self-managed super funds);

• it results from a CGT event happening after 21 September 1999;

• no indexation applies to the cost base; and • the asset must be owned for at least 12 months

The discount percentage for individuals and trusts is 50%. It is one-third for a complying super fund. Companies are not entitled to the 50% discount.

Applying Capital Losses

Five-step process to calculate the net capital gain (gains and losses for all events in the income year)

1 • Current year capital gains less current year capital losses (in the

order the taxpayer chooses)

2 • Remaining capital gains are reduced by any unapplied net capital

losses from previous years (in the order the taxpayer chooses, however applied in the order they were made)

3 • Reducing any remaining discount capital gains by the discount

percentage

4 • Apply small business concessions (if available)

5 • Add up: any remaining capital gains that are not discount capital gains

+ any remaining discount capital gains

PoTL 2017 paragraphs [11.510] – [11.570]

Capital losses • A net capital loss is worked out by

subtracting capital gains for the income year from capital losses for the income year. If the resulting amount is more than nil, it is the taxpayer’s net capital loss for the income year (s 102-10).

• A net capital loss is not deductible from assessable income – it must be offset against capital gains made by the taxpayer in the current or later income years.

• The capital loss must be applied before any discount

Learning Objective 6

Calculate the net capital gain/loss on disposal of CGT assets.

Capital gain calculation

On an individual asset, the taxpayer: makes a capital gain under the indexation method if Capital Proceeds > Indexed Cost Base makes a capital loss under the indexation method if Capital Proceeds < Indexed Cost Base

makes a capital gain under the discount method if Capital Proceeds > Cost Base makes a capital loss under the discount method if Capital Proceeds < Cost Base

PoTL 2017 paragraphs [11.440] – [11.460]

Net Capital Gain calculation

Taxpayer makes a net capital gain under the indexation method if Indexed Capital Gains > Capital Losses (whether indexed or not) - The Net Capital Gain will be Indexed Capital Gains – Capital Losses (whether indexed or not)

Taxpayer makes a net capital gain under the discount method if Capital Gains > Capital Losses – The Net Capital Gain will be Capital Gains - Capital Losses

if the taxpayer is ineligible for a discount. – Eligible taxpayers will have their Net Capital Gain

reduced by half or one-third depending on the nature of the entity (see slide 44).

PoTL 2017 paragraphs [11.440] – [11.460]

Pre-workshop question 4 Jan is an Australian resident adult individual non-business taxpayer entity. She has carried forward capital losses of $2,000 from the 2017 income year. During the 2018 income year, the following occurred:

• In January 2018, Jan sold ANZ shares which she purchased in March 2014. This resulted in a capital gain of $50,000.

• In May 2018, Jan sold 500 Rio Tinto shares she purchased in May 2012. This resulted in a capital loss of $10,000.

Calculate Jan’s net capital gain to be included in her assessable income for the year ended 30 June 2018.

Class activity 3 Aramis is an Australian resident adult individual non-business taxpayer entity who sold the following items during the income year ended 30 June 2018:

(1) Vacant land sold in June 2018 for $300,000 that had been bought by him on 21/3/2006 for $25,000. This is being paid in 12 monthly instalments of $25 000, however the purchaser has declared bankruptcy and the last two instalments due next financial year will not be paid. Aramis also has interest deductions of $60 000 which he has not claimed as a tax deduction. (2) A collectible car sold in March 2018 for $150,000. Aramis bought the car in October

2000 for $50,000 as he loves collectible cars, (3) A high-performance racing bicycle sold in January 2018 for $12,000. Aramis bought

the bicycle in January 2009 for $9,000 for recreational purposes. (4) 10,000 shares in XYZ Ltd sold in February 2018 for a total sale price of $180,000.

Aramis bought all the shares for long term investment purposes during November and December 1997 at a total cost of $95,000. (5) An antique sold on 1 May 2018 for $11,000. Aramis bought the antique on 31

December 1988 at a cost of $6000 for personal reasons. The CPI rate of quarter ending 30 September 1999 is 68.7 (there was no evolution in the rate after that point) whilst the CPI rate of quarter ending 31 Dec 1988 was 51.2 (6) Jewelry sold in July 2017 for $12,000. The jewelry was purchased for 29/09/09 for

$20,000.

Calculate Aramis’s net capital gain/loss for the year

Closing summary

CGT is a distinct statutory regime within ITAA1997. It affects an individual’s income tax liability because of the inclusion of net capital gains in assessable income.