ACCG924 Taxation Law

Lecture Notes Week 7 2018




Lecture Seven
Readings from Australian Taxation Law 2018 CCH for this week’s lecture

Capital gains tax (continued)

CGT assets – W7-500 to 7-570
Exemptions – W7-700 to 7-720; 8-050 to 8-095; 8-500 to 8-540
Calculating a capital gain or capital loss – W7-600 to 7-698
Net capital gain or loss for the income year – W7-900 to 7-960
Small business CGT concessions – W8-400 to 8-450

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 CGT assets

Section 108-5 ITAA97 defines a CGT asset as “any kind of property, or a legal
or equitable right that is not property”

Lists some examples: land, buildings, shares, debts owed to a taxpayer, a right
to enforce a contract and foreign currency.

Property
-- means anything a taxpayer can have control over, eg shares, land or an
interest in a trust.

-- can be tangible (eg, jewellery) or intangible (eg, shares or rights).

Legal or equitable right that is not property

-- means a right that a court would uphold, eg the right to compensation for
personal or property injury

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 CGT assets

A taxpayer’s CGT assets can be classified into the following categories:

1.  collectables
2.  personal use assets
3.  other assets.

Special CGT rules, eg exemptions, apply to collectables and personal use

assets.

The CGT consequences of disposing of a CGT asset can only be determined if

the asset is classified correctly.

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 CGT assets

Collectibles
Section 108-10 ITAA97 defines a collectible as an asset that:
(a)  is used or kept mainly for the personal use or enjoyment of the taxpayer or
of an associate of the taxpayer, AND
(b)  is listed in s 108-10(2), where the list includes:
•  antiques and jewellery
•  works of art (eg, paintings, sculptures);
•  rare stamps, coins etc
Special rules for collectibles:
(1) capital losses from collectibles are quarantined and can only be offset
against capital gains on other collectables: s 108-10(1)
(2) the amount of unused capital loss from collectibles is carried forward to a
future year: s 108-10(4), and
(3) capital gains are ignored if the collectible was acquired for less than $500: s
118-10(1) – there are rules in s108-15 to prevent the benefits of the $500
threshold applying when items in a set are sold separately

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 CGT assets

Personal use assets

A CGT asset is a personal use asset (other than a collectible) that is used or
kept mainly for the personal use or enjoyment of a taxpayer: s 108-20.

Special rules for personal use assets

(1) capital gains are ignored where the personal use asset was acquired for
$10,000 or less: s 118-10(3) – there are rules in s108-25 to prevent the
benefits of the $10,000 threshold applying when items in a set are sold
separately

(2) capital losses from the disposal of a personal use asset is always
disregarded: s 108-20(1).

Example at W7-535 showing how the different assets are treated.

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 CGT assets

Separate CGT assets

Separate CGT asset rules prevent the benefit of pre-CGT status extending to
structural improvements (eg, alterations or additions) to pre-CGT assets.
Once treated as a separate CGT asset, the asset is subject to the general
CGT rules.

Separate CGT assets include:

Ø  buildings erected post-CGT on pre-CGT land: s 108-55(2)
Ø  post-CGT land acquired adjacent to pre-CGT land: s 108-65
Ø  depreciating assets that are part of a building: s 108-60
Ø  capital improvement to a pre-CGT asset if the cost base of the
improvement is: (i) more than the “improvement threshold” for the relevant
year ($147,582 for 2017/18), and (ii) more than 5% of the capital
proceeds when a CGT event happens to the pre-CGT asset: s 108-70.

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 CGT assets: exemptions

Not all assets acquired on or after 20 September 1985 come within the CGT rules

Division 118 ITAA97 sets out various exemptions, covering exempt assets, exempt
transactions and anti-overlap provisions

Exempt assets include:

-- cars, motor cycles and bravery awards: s 118-5
-- collectibles acquired for $500 or less and personal use assets acquired for $10,000 or less:
s 118-10
-- CGT assets used to produce exempt income, eg an asset used by a non-profit hospital: s
118-12

Exempt transactions include:

-- compensation or damages received for wrongs or injury suffered by a taxpayer in their
occupation or by the taxpayer (or the taxpayer’s relative) personally, eg, compensation for
discrimination or harassment at work, or for mental distress: s 118-37(1)(a)
-- winnings from gambling, a game or a competition with prizes: s 118-37(1)(c)
-- foreign currency hedging gains: s 118-55

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 CGT assets: exemptions

In some cases, CGT is made non-applicable to a capital gain because there

are other provisions in the tax law that apply instead. The CGT sections that
have this effect are called “anti-overlap provisions”.
Anti-overlap provisions include :
-- s 118-20 -- where an amount is included in assessable income under other
provisions , eg as ordinary income under s 6-5, the capital gain is reduced
by the amount that is taxed under the other provisions
-- s 118-24 – where a balancing adjustment event happens to a depreciating
asset, the balancing adjustment rules in Div 40 apply, except to the extent
that the asset has been used for a non-taxable, eg private, purpose, in
which case CGT event K7 happens (W12-250)
-- s 118-22 – superannuation lump sums and employment termination
payments taxed under Div 301 and 82 ITAA97, not under the CGT rules
-- s 118-25 – capital gain or loss from the disposal of trading stock treated
under Div 70 ITAA97, not under the CGT rules

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 CGT assets: exemptions
Main residence exemption

Capital gain or loss that happens to a dwelling that is a taxpayer’s main residence
is disregarded if:
-- the taxpayer is an individual
-- the dwelling was the taxpayer’s main residence during the ownership period,
and
-- the ownership of the dwelling did not pass to the taxpayer as a beneficiary of a
deceased estate: s 118-110.

Exemption may not apply in full if the dwelling was the taxpayer’s main residence
during part only of their ownership period, or it was used for the purpose of
producing assessable income.

Only one main residence per family: s 118-170 and 118-175

“Dwelling” includes a caravan, a houseboat, a mobile home, and up to 2 hectares

of adjacent land used for domestic purposes: s 118-115 and 118-120

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 Non-Residents and the Main residence
exemp4on
•  On 9 May 2017 the Government announced that
Australia's foreign resident capital gains tax (CGT)
regime will be extended to deny foreign and
temporary tax residents access to the CGT main
residence exemp4on.
•  This change applies from the date of announcement.
Proper4es held prior to this date will be
grandfathered un4l 30 June 2019.
•  Temporary tax residents who are Australian tax
residents will be unaffected by the change.
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 CGT assets: exemptions

Extending the main residence exemption

Moving into a dwelling – main residence period may include the period before
moving in as long as move in as soon as it is practicably possible: s 118-135
Changing main residence – two main residences for the shorter of (i) 6 months
or (ii) until dispose of existing main residence: s 118-140

Absence from main residence – remains main residence for unlimited period if
not rented – otherwise for up to 6 years: s 118-145

Only partial exemption if the dwelling:

-- is the main residence during only part of the ownership period: s 118-185, or
-- was used for income producing purposes during all or part of the ownership
period and, if interest was incurred on money borrowed to buy the dwelling,
the interest would be deductible: s 118-190. Examples at W8-057.

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 CGT assets: consequences of death

CGT consequences of Death – Div 128

Death of a taxpayer does not constitute the disposal of an asset by the
deceased (s 128-10) – so no CGT consequences
Asset is acquired by the beneficiary for CGT purposes on the date of death (s
128-15)
If the beneficiary later disposes of the asset, what is its cost base?
-- if the deceased acquired the asset before 20 September 1985, the cost base
of the asset for the beneficiary is the asset’s market value on the date of
death.
-- Table in sec 128-15(4) shows what the cost base is for the beneficiary in
other cases – either market value, or what would have been the cost base
for the deceased.

Special rules if a dwelling is acquired from a deceased estate: W8-060

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 Calculating a capital gain or capital loss

Once a CGT event has been identified as occurring for a particular CGT asset,
must calculate the capital gain or capital loss from that event.

While some CGT events have a specific formula for calculating capital
gains or losses, the following can generally be said: s 100-35

Capital gain = capital proceeds - cost base (or indexed cost base*)

Capital loss = reduced cost base - capital proceeds

* Indexation only applies to assets acquired before 21September 1999.

Key terms: capital proceeds and cost base

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 Calculating a capital gain or capital loss

Capital proceeds
Section 116-20 defines capital proceeds as the money or the market value of
any property received in relation to a CGT event, or which the taxpayer is
entitled to receive (eg, where the amount is payable at a later time or
payable in instalments)
In calculating the capital proceeds when a CGT asset is disposed of by a GST-
registered taxpayer, GST paid is not included: s 116-20(5)

Modifications to the definition of capital proceeds: W7-610

Market value substitution rule (s 116-30) provides that the market value of a
CGT asset is substituted for actual capital proceeds if:
(a) the taxpayer received no capital proceeds, or
(b) the capital proceeds can’t be valued or the capital proceeds are more or
less than the market value of the asset and the parties are not dealing with
each other at arm’s length or the CGT event is C2.

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 Calculating a capital gain or capital loss

Cost base
Section 110-25 ITAA97 states that the cost base of a CGT asset consists of five
elements:
1. Money paid and the market value of property given, or required to be paid or
given, in respect of acquiring the asset

2. Incidental costs incurred in acquiring or disposing of the asset

3. For assets acquired after 20 August 1991, the costs of ownership, eg, rates,
interest on loans, insurance and repairs – this element does not apply for
personal use assets or collectibles

4. Capital expenditure to increase the asset’s value (eg, an improvement) or that

relates to installing or moving the asset

5. Capital expenditure incurred in maintaining the title rights to the asset

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 Calculating the capital gain or capital loss

Cost base continued

Incidental costs (second element) relating to acquisition or disposal -- only includes

costs that are listed in s 110-35, eg:
(a) professional fees, eg to surveyor, valuer, auctioneer, accountant or legal
adviser,
(b) costs of transfer
(c) stamp duty
(d) advertising
(e) costs for any valuation or apportionment
(f) borrowing expenses (loan application fees, mortgage discharge fees)

The second and third elements of the cost base do not include an amount which the
taxpayer has deducted or could deduct: s 110-40 and 110-45 – test whether
the asset is used for an income-producing purpose and the expenditure is not
capital

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 Calculating the capital gain or capital loss
Cost base continued

Expenditure is excluded from the cost base if it relates to certain offences,

bribes to public officials, entertainment, penalties, political contributions: s
110-38

Cost base does not include the amount of input tax credit (when GST is paid
on the purchase) to which a business taxpayer is entitled: s 103-20

Apportionment of the cost base, eg if sell only part of an asset -- need to

allocate a proportion of the cost base to the part sold and a proportion to
the part remaining – formula in s 112-30

Modifications to the cost base: W7-640

Market value substitution rule (s 112-20) provides that the first element of the
cost case may be deemed to be market value if no expenditure was
incurred or expenditure can’t be valued or parties not dealing at arms
length.

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 Calculating the capital gain or capital loss
Indexation of the cost base

CGT assets acquired before 21 September 1999 and which have been owned
more than 12 months when a CGT event occurs may have four of the five
elements of the cost base of the asset indexed for inflation: s 114-10
-- this produces the “indexed cost base”

The third element of the cost base (costs of ownership) is not indexed

Indexation has been frozen as at 30 September 1999 – so the cost base can
be increased for inflation up to that date

Capital gain is calculated as the difference between the capital proceeds and
the indexed cost base. Reduced cost base, which is used to calculate a
capital loss, is never indexed.

W7-690: gives the index factors for indexing the cost base and explains how
indexation works.

Travel expenditure related to the use of residential premises for rental for which
a deduction is denied is excluded from the cost base of an asset
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 Calculating the capital gain or capital loss

Reduced cost base

Capital loss is usually calculated as the difference between the asset’s

reduced cost base and the capital proceeds.

The reduced cost base, as defined in s 110-55 ITAA97, is similar to the cost
base and has 5 elements, with elements 1, 2, 4 and 5 being the same as for
the cost base

The reduced cost base is never indexed and does not include deductible
amounts

The third element of the reduced cost base is any amount that is assessable
because of a balancing adjustment for the asset, eg because a depreciating
asset is disposed of (W12-250) or would be assessable if certain balancing
adjustment relief was not available (s 110-55(3))

Example at W7-635.

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 Calculating the capital gain or capital loss

CGT discount
CGT discount may apply to capital gains that arise for CGT events occurring on or
after 21 September 1999 in respect of assets held for at least 12 months: s
115-15 and 115-25
For the following taxpayers: s 115-10 and 115-100:
Ø  individuals – 50% discount
Ø  trusts – 50% discount
Ø  complying superannuation funds -- 331/3 discount
These taxpayers may choose to use the indexation method (if available) or the
discount method (if available) to calculate their capital gains.
A discount capital gain does not have an indexed cost base: s 115-20

Examples of the calculation of a capital gain using the indexation method and the
discount method: W7-698

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 Calculating the capital gain or capital loss

Companies cannot use the discount method (not on list in s 115-10)

Foreign residents are not liable to CGT unless they dispose of “taxable
Australian property”, as defined in s 855-15 (s 855-10)
Foreign resident could have discount for gain on disposal of taxable Australian
property held for at least 12 months – only for capital gains accrued up to 8
May 2012
No discount for foreign residents for capital gains accrued after 8 May 2012 (s
115-105)
If foreign resident disposes of taxable Australian property after 8 May 2012 that
was acquired before 8 May 2012 and held for at least 12 months, reduced
discount is calculated under s 115-115

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 CGT calculation

Example 1: Asset is disposed of in less than 12 months

John acquired a rental property on 1 June 2018 for $200,000 and sold the
property on 11 December 2018 for $250,000.

Calculate the capital gain or capital loss.

Capital proceeds (sale price) $250, 000

Less: cost base 200, 000
CAPITAL GAIN $50, 000

No discount is available as the property has been held for less than 12
months.

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 CGT Computa4on
Example 2: Asset is disposed of after more than 12 months

Homer acquired shares on 12 November 1995 for $4,000 and sold the shares on 20
May 2018 for $14,164. The taxpayer is an individual who has owned the shares
more than 12 months. The capital gain is calculated as follows.

Indexation Method
Capital proceeds $14,164
Less: indexed cost base ($4,000 x 1.041*) 4,164
CAPITAL GAIN $10,000

* 68.7 (index factor for September 1999 quarter

66.0 (index factor for December 1995 quarter -- s 960-280 and W 7-690)

Discount Method
Capital proceeds $14,164
Less: cost base 4,000
$10,164
Less: 50% discount 5,082
CAPITAL GAIN $5, 082
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 CGT Computa4on

Example 3: Disposal of assets results in a capital loss

14 June 2003: shares are acquired at a cost of $4,000

3 February 2018: the shares are sold for $2,500

The capital loss is calculated as follows:

Reduced cost base $4,000

Less: capital proceeds $2,500
CAPITAL LOSS $1,500

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 Net capital gain or capital loss for the year

Calculation of a net capital gain or net capital loss for the income year: s
100-50.

Apply the following steps – the order is important

1. Calculate current year capital gains

2. Less current year capital losses (losses from collectibles are quarantined
and not mingled with ordinary capital gains) -- if capital losses exceed the
capital gains, there is a net capital loss, which is carried forward
3. Less unapplied net capital losses for a previous year
4. Reduce any remaining discount capital gains by the discount percentage
5. Apply the CGT small business concessions if a small business is being
carried on
6. Add up any remaining capital gains that are not discount capital gains and
any remaining discount capital gains

The total is the net capital gain – goes into the taxpayer’s assessable income
(s 102-5) and is taxed at the taxpayer’s ordinary tax rates.
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 Small business CGT concessions

Four CGT concessions may be available for small businesses when they
dispose of their business assets:

-- the 15 year exemption – for CGT assets held for at least 15 years

-- the 50% reduction (after accessing the 50% discount if eligible)

-- the retirement concession – disregard a capital gain up to $500,000 if the

proceeds are used in connection with the taxpayer’s retirement

-- the rollover – defer the making of a capital gain on small business active
assets when replacement assets are acquired

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 Small business CGT concessions

There are always 2, and sometimes 3, conditions that must be satisfied before
a taxpayer can access any of the small business concessions.
1.  The small business eligibility test requires the entity to satisfy one of the
following:
a)  it is a small business entity as defined in Div 328 ITAA97, broadly that
it is carrying on business and has aggregated turnover of less than 2
million for the income year or
b)  it is a partner in a partnership that is a small business entity, or
c)  the net value of assets of the taxpayer and related entities does not
exceed $6 million
2.  The active asset test – the asset disposed of by the small business has
been used in carrying on the business
3.  Concessional stakeholder test -- only applies if the asset that is disposed of
is a share in a company or an interest in a trust.
So conditions 1 and 2 must always be satisfied, but condition 3 less often.

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