Capital Gains Tax


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A capital gains tax (CGT) is a tax on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a cost amount that was lower than the amount realized on the sale.

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Capital Gains Tax

  1. 1. Topic 4 – Capital Gains Tax CGT events, CGT assets, Calculation of capital gain, cost base elements, and CGT exemptions Chapter 9
  2. 2. Overview • Capital gains taxed as assessable income on assets or events from 20 September 1985 – statutory income – s 6-10 • Assets acquired prior to that date exempt when later disposed of with a capital gain • Division 100, ITAA 97 provides the legislative provisions covering CGT
  3. 3. CGT Flow Chart • The following diagram is found in s 100-15, ITAA 97 • Two step process: – 1. Have you made a capital gain or a capital loss – 2. Work out the amount of capital gain or loss Step 3. Work out your net capital gain or loss for the income year
  4. 4. Did a CGT event happen in the income year? You do not have a Capital gain Does an exemption apply ? Disregard (or reduce) a capital gain or loss from the event Do the capital proceeds exceed the cost base? The excess is your capital gain from the event The excess is your capital loss from the event Does the reduced cost base exceed the capital proceeds? No No Yes Yes Yes Yes No
  5. 5. IMPORTANCE OF CGT EVENTS • You can only make a capital gain or loss if a CGT event happens - s 100-20 • Most CGT events involve a CGT asset – s 100-25 • HOWEVER, THE CONCEPT OF A CGT EVENT IS WIDER THAN THE CONCEPT OF A CGT ASSET • Many CGT events are concerned with capital receipts and do not involve a CGT asset e.g you sell a business, but agree with the purchaser not to operate a similar business in the area for a payment of $25,000 – CGT event but no asset involved
  6. 6. CGT Events - Division 104 • A Capital Gain or Loss can only arise if a CGT event occurs • SUMMARY OF EVENTS - S.104-5 • EVENTS A1- through to - L8 (total 52) • Example: Event A1 – Disposal of a CGT asset – Time of event is: when disposal contract is entered into or, if none, when entity stops being asset’s owner – see case of FCT v Sara Lee Household – Capital Gain: capital proceeds from disposal less asset’s cost base – Capital loss: asset’s reduced cost base less capital proceeds
  7. 7. FCT v Sara Lee Household • What is the date of the sale of a business, the date of the contract or the date of settlement? • Date of the contract, s 104-10(3), not settlement. This is the case even if the terms of the contract are altered. • Note: what happens if the proceeds are not paid until settlement and settlement is in the next financial year?
  8. 8. CGT Events (cont) • SOME CGT EVENTS DO NOT INVOLVE A CGT ASSET - • Relate only to an event which gives rise to a capital receipt - • E.g. – Event - H1- Forfeiture of a deposit or when an individual or a company stops being a resident. See the case of Brooks v FCT
  9. 9. Brooks v FCT • Deposit on the sale of real property was forfeited. Was the deposit a capital gain. • Federal Court held that it was where the seller keeps the deposit and looks for a new buyer. If they sue for specific performance then no deposit paid, no capital gain. In this case an actual contract for the sale of land and not a ‘prospective purchaser’.
  10. 10. CGT Events (cont) • CGT EVENT C1 - END OF A CGT ASSET - S.104-20 • CGT event C1 happens when a CGT asset owned by a taxpayer is lost or destroyed and receives compensation - if no compensation received happens at time of loss or destruction
  11. 11. CGT Events (cont) • CGT EVENT D1 - BRINGING AN ASSET INTO EXISTENCE • CGT event D1 happens when a taxpayer creates a contractual right or other legal or equitable right in another entity such as a restrictive covenant, eg, • (1) a person agrees not to compete with another person for a specified period for a specified time • (2) a person agrees to play sport only with a particular club • (3) a person agrees to enter into an exclusive trade tie agreement with another person.
  12. 12. CGT Events (cont) • CGT EVENT D1 - BRINGING AN ASSET INTO EXISTENCE (cont) • knowledge is neither a right nor property and therefore not a CGT asset. However, a right to require the supply of knowledge is a CGT asset. • a taxpayer makes a capital gain from CGT event D1 if the capital proceeds from creating the right are more than the incidental costs incurred in creating it (losses - vice versa)
  13. 13. CGT Events (cont) • CGT EVENT D2 - GRANTING AN OPTION - S.104-40 • CGT event D2 happens when a taxpayer grants an option to an entity, or renews or extends a previously granted option. • A taxpayer makes a capital gain from CGT event D2 if the capital proceeds from granting, renewing or extending the option are more than the expenditure incurred in making the grant, renewal or extension (losses - vice versa)
  14. 14. CGT ASSETS: s 100-25(2) • Land AND Buildings, e.g a weekend holiday home • Shares in a Company • Units in a Unit Trust • collectables which cost over $500 • Personal use assets which cost over $10,000, e.g boat • Other assets not so well known: • Family Home-main residence (Usually exempt from CGT) • Contractual Rights e.g restraint of trade • Goodwill associated with a business • Foreign Currency
  15. 15. DOES AN EXCEPTION OR EXEMPTION APPLY? - s100-30 • EXEMPT ASSETS, e.g, Motor Cars • EXEMPT TRANSACTIONS, e.g, Personal injury compensation • ANTI-OVERLAP PROVISIONS – ( same income could be taxed twice) s. 118-20, • SMALL BUSINESS PROVISIONS – CGT concessions. See case of FCT v Murry – ‘goodwill’ • ROLL-OVER RELIEF, s 100-33 (takeover of company and shares given as consideration) • LIMITED EXEMPTIONS – Family Home (main residence), TRADING STOCK, S. 118-25
  16. 16. FCT v Murry • Case concerns the sale of a taxi licence. Was part of the proceeds ‘goodwill’ and subject to ‘small business CGT concessions’? • Answer, no goodwill in the case of the sale of a taxi licence. Case gives a good analysis of what constitutes goodwill. Goodwill a CGT asset – customer attraction, reputation.
  17. 17. Collectables – Subdivision 108-B • Read definition s 108-10(2) – artwork, jewellery, antique, coin collection, rare folio or manuscript, stamps • Note: s 118-10 exemption if acquired for $500 or less • Sets of collectables - treat as a single collectable s.108-15 • Treatment of capital losses from collectables – s 108-10(1) & s 108-10(4) - Capital losses from collectables used only to reduce capital gains from collectables s 108-10(1) • Cost base of collectables - Disregard 3rd cost element - non- capital costs of ownership –s 108-17
  18. 18. Personal Use Assets – Subdivision 108-C • Read definition s108-20(2) – “kept for your personal use and enjoyment • Note: s118-10 exemption if acquired for $10,000 or less • Note: s 108-20(3) a personal use asset does not include land, a stratum unit or a building or structure that is considered a separate CGT asset because of subdivision 108-d.
  19. 19. Personal Use Assets – Subdivision 108-C • Sets of personal use assets - treat as a single personal use asset- s.108-25 • Cost base of personal use assets - disregard 3rd cost element - non-capital costs of ownership - s 108-30 • Capital losses from personal use assets - disregard s.108-20(1)
  20. 20. SEPARATE CGT ASSETS- SUBDIVISION 108-D • Building separate asset from land s108-55(1) & (2) • A building or structure on land acquired post 19 September 1985 is treated as a separate CGT asset from the land if balancing adjustment provisions apply to the building or structure under the uniform capital allowances system • Pre 20 September 1985 land, post CGT construction contract or post CGT construction if no contract - s 108.55(2)
  21. 21. SEPARATE CGT ASSETS- SUBDIVISION 108-D • Plant that is part of a building is a separate asset from the building - s 108-60 • Post-CGT land adjacent to pre-CGT land treated as separate CGT asset from the pre-CGT land if amalgamated into one title – s 108-65 • Capital improvements s 108-70 - A capital improvement to a pre-CGT asset is treated as a separate asset from the pre- CGT asset if its indexed cost base, when a CGT event happens to the pre-CGT asset, is: – (1) More than the improvement threshold for the income year in which the event happens; and – (2) More than 5% of the capital proceeds for the event.
  22. 22. Unrelated Improvements • See for examples: s108-70(2) Pre CGT assets – you own a boat that was purchased in 1983. In 1999 you install a new mast (capital improvement) for $30,000. You sell the boat for $150,000 on 30 January 2008. The cost base for the improvement is $41,000 and the threshold is $109,447. The mast will not be treated as a separate asset. • The improvement threshold is indexed annually. The Commissioner publishes the threshold before the beginning of each financial year. • Capital improvement may include a non-tangible improvement - council approval to rezone, subdivide
  23. 23. COST BASE RULES -DIVISION 110 • General rules on cost base – s 110-25 - Cost base includes five elements – s 110-25(1)-(6) – (1) acquisition costs – s 110-25(2) – (2) incidental costs incurred in acquiring a CGT asset or in relation to a CGT event – s 110-25(3), s 110-35 – includes - costs of surveyor, valuer, auctioneer, legal adviser, etc, transfer costs, stamp duty, advertising costs. – (3) non-capital costs in respect of ownership of asset acquired after 20 august 1991 – s 110-25(4) – includes interest, repairs, insurance, rates - this element does not apply to collectables or personal use assets.
  24. 24. COST BASE RULES -DIVISION 110 • (4) Capital enhancement costs incurred to increase the value of the CGT asset – must be reflected in the state of the asset at the time of the CGT event. Includes non- deductible initial repairs. • (5) title costs – capital expenditure incurred to establish, preserve, defend taxpayer’s title to the asset. • Expenditure not included as part of cost base of an asset to the extent that; – (1) the expenditure is deductible , eg interest; – (2) the expenditure is an input tax credit for GST purposes; – (3) a non-assessable recoupment is received in respect of it.
  25. 25. REDUCED COST BASE RULES - SUBDIVISION 110-B • General rule –s 110-55 • Read s 110-55(1) to (6) • Reduced cost base is relevant to determining if a capital loss has been made. • All of the elements (except the 3rd) of the reduced cost base are the same as the cost base. • The 3rd element is instead any amount that is assessable because of a balancing adjustment for the asset.
  26. 26. REDUCED COST BASE RULES • Amounts not included in the reduced cost base: • Expense is not included in any element of the reduced cost base if: – (1) it is deductible; or – (2) if it a non-assessable recoupment is receivable in respect of the asset. • Deductible amounts excluded from the reduced cost base include amounts that are deductible because of available balancing adjustments
  27. 27. MODIFICATION OF COST BASE RULES & REDUCED COST BASE RULES DIVISION 112 • S112-20 - use market value for 1st element of cost base & reduced cost base if you did not incur any expenditure to acquire it - eg. a gift, or it was a non- arm's length transaction. See the case of Granby v FCT for ‘arms length’. • S112-30 - apportionment rule – if only part of the expenditure incurred in relation to a CGT asset relates to the asset, the relevant element of the cost base and reduced cost base of the asset only includes that part of the expenditure reasonably attributable to the acquisition of the asset.
  28. 28. Granby v FCT • The case concerned the sale of an interest in a partnership and equipment such as vehicles and plant. Those items had been bought from the finance company for their residual value under a finance lease. The price paid as the residual value was well below the market value. The Commissioner assessed the capital gain at a higher figure because the price paid was below the market value. • Federal Court held that if the parties are at ‘arm’s length, then it does not matter that the price was not ‘market value’. For CGT purposes the price paid can be less than market value provided the parties are at arm’s length.
  29. 29. AMOUNT OF CAPITAL GAIN OR LOSS - s102 • A net capital gain is included in taxpayer’s assessable income. • A net capital loss cannot be deducted from taxpayer’s assessable income. • For most capital gain events, the amount of a capital gain or capital loss is the difference between the two amounts referred to in the section dealing with the relevant capital gain event.
  31. 31. STEPS IN CALCULATING NET CAPITAL GAIN - s102-5 • Step 1: reduce the capital gains made during the income year by the capital losses made during the income year. • Taxpayer can choose the order in which any capital gains are reduced. • Step 2: if the capital gains are more than the capital loss apply any previously deducted net capital losses from earlier income years to reduce any remaining capital gains under step 1. – Taxpayer can choose the order in which any capital gains are reduced. – Net capital losses from previous income years applied in order in which they were made – s102-15.
  32. 32. STEPS IN CALCULATING NET CAPITAL GAIN • Step 3: to calculate the net capital gain - each amount of a discount capital gain remaining after step 2 is reduced by the discount percentage provided taxpayer held the asset for 12 months - – 50% - if capital gain is made by an individual or a individual beneficiary in a trust; – 33.3/3% by a complying superannuation fund • Step 4: if the capital gain (including discount capital gains) qualify, the small business concessions to the capital gain • Step 5: add up the amounts of capital gains remaining after step 4. The sum is the net capital gain for the income year.
  33. 33. STEPS IN CALCULATING NET CAPITAL LOSS - S.102-10 • Step 1: add up the capital losses made during the income year. Also add up the capital gains made. • Step 2: subtract capital gains from capital losses. • Step 3. If capital losses exceed capital gains - it is the net capital loss for the income year. • Net capital losses can be carried forward indefinitely – S 102-15(3) • S102-5 -current year losses are applied in any order and then apply prior year. Net capital losses in order they were made - see s102-15
  34. 34. Calculation of Capital Gain • Choice of indexation or discount - read s.110-25 • CGT asset acquired before - 11.45 am EST 21 September 1999 and disposed of after - 11.45am EST 21 September 1999 – choice: – (1) index up to September 1999 quarter (except 3rd element); or – (2) apply CGT discount to the capital gain instead of indexation
  35. 35. Discount Method • Acquisition and disposal after 11.45am EST 21 • September 1999 – - discount method only provided taxpayer acquired the asset at least 12 months before a CGT event in relation to the asset. • Discount method is not available to companies - only indexing up to 30 September 1999 • Individual – 50%, Superannuation fund – 33%, Companies – nil (Trust beneficiary ?)
  36. 36. INDEXATION OF COST BASE ELEMENTS – Division 114 • General rule s114-1 and s 960-260 • CGT asset acquired and disposed of before - 11.45am Eastern standard time 21 September 1999 – Index factor frozen • generally index for inflation (except 3rd element) if taxpayer acquired the asset at least 12 months before a CGT event in relation to the asset - s.114-10
  37. 37. EXCEPTIONS AND MODIFICATIONS S.102-30 • You can only subtract collectable capital losses from collectable capital gains • Net capital gains from collectables are added to any other net capital gain. • Disregard capital losses you make from personal use assets. • Net capital gains from personal use assets are added to any other net capital gains • Companies can only offset a net capital loss against a capital gain if they pass either the continuity of ownership test or the same business test in relation to capital loss year, capital gain year and any intervening years.
  38. 38. EXEMPTIONS - DIVISION 118 • Cars, motor cycles, valour decorations & cultural bequests - s118-5 • gains or losses from collectables you acquired for less than $500 provided the market value of the collectable is $500 or less at the time you acquired it - s118-10 • Capital gain from a personal use asset is disregarded if you acquired it for $10000 or less- s118-10 • Note : a capital loss from a personal use asset is disregarded - see s.108-20 – certain compensation receipts, prizes and gambling winnings and losses - s118-15 – trading stock - s118-25
  39. 39. MAIN RESIDENCE - BASIC EXEMPTION S.118-110 • Meaning of dwelling -s.118-115 • Extends to adjacent land up to 2 hectares – s118-20 • Rules extending exemption - • Moving in s.118-135 – if a dwelling became a taxpayer’s main residence by the time it was first practicable for the taxpayer to move in after it was acquired, the dwelling is treated as the taxpayer’s main residence from when it was acquired until it was actually became the taxpayer’s main residence.
  40. 40. MAIN RESIDENCE - BASIC EXEMPTION • Changing residence -both exempt for 6 months -s118-140 • If a taxpayer acquires a dwelling that is to become the taxpayer’s main residence and the taxpayer still owns an existing main residence, both dwellings are treated as the taxpayer’s main residence for up to 6 months – s118-140. • This rule only applies if the taxpayer’s main existing residence was the taxpayer’s main residence for a continuous period of at least 3 months in the 12 months before it was disposed of and was not used for income- producing purposes in the 12 months it was not the taxpayer’s main residence.
  41. 41. ABSENCE -TREAT IT AS MAIN RESIDENCE FOR 6 YEARS - S.118-145 • If a dwelling that was a taxpayer’s main residence stops being his/her main residence the taxpayer may choose to continue to treat it as a main residence – s118-145 • If the dwelling is used for income-producing purposes while the taxpayer is absent the maximum period that the dwelling can be treated as a main residence is 6 years. • The 6 year limitation for income-producing uses need not be continuous – the intermittent periods may be aggregated.
  42. 42. BUILDING, RENOVATING OR REPAIRING MAIN RESIDENCE • Main residence exemption on land owned by the taxpayer can be extended for an additional period of up to 4 years from the time the land was acquired if the taxpayer builds a dwelling on land or repairs or renovates on the land – s118-150 • If the land was acquired more than 4 years before the dwelling became the taxpayer’s main residence, the exemption period starts 4 years before the dwelling became the taxpayer’s main residence.
  43. 43. MAIN RESIDENCE - BASIC EXEMPTION • For the exemption to apply the dwelling on the land that is constructed must become the taxpayer’s main residence as soon as practicable after the work is finished and must continue to be so for at least 3 months. • A taxpayer who makes use of the additional 4 year exemption cannot claim a main residence exemption for any other dwelling during that period except for the 6 month double exemption allowed when changing main residences.
  44. 44. MAIN RESIDENCE ACCIDENTALLY DESTROYED • If a dwelling that is the taxpayer’s main residence is accidentally destroyed and another dwelling is not built on the land, the taxpayer can choose to apply the main residence exemption to the land, as if, from the time of the destruction until the time of disposal, the dwelling had not been destroyed and continued to be the taxpayer’s main residence – s118-160 • However, no other dwelling can be treated as the taxpayer’s main residence during this period.
  45. 45. CGT and Death • Death is not a CGT event and no recognition of a capital gain unless: . Gift to a tax exempt entity . A non-resident of Australia . A trustee of a superannuation fund If to these entities, the executor will have to pay income tax on any capital gain.
  46. 46. CGT and Death • Cost base of asset determined at the date of death if a pre-CGT asset – market value. • If post-CGT then cost base of asset rolled over to the beneficiary and income tax on the capital gain when asset sold is calculated using the deceased's cost base. • If assets sold and money distributed under the will then executor pays income tax on behalf of deceased.
  47. 47. CGT and Death • Main residence exempt and maintains exemption if beneficiary lives in house as a main residence • Joint tenancy and tenants in common – implications for CGT • If a beneficiary, would you prefer pre or post CGT assets to be gifted to you?
  48. 48. Thank You