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Principles of Taxation Law 2020 Answers to Questions CHAPTER 11 – CAPITAL GAINS TAX Question 11.1 Anita is a client of yours. To fund her career as an artist Anita sold some of her art collection by other artists. It consisted of: (a) An antique ceramic bowl purchased in February 1985 for $4,000. She sold the bowl on 1 December of the current tax year for $12,000. (b) A sculpture purchased in December 1993 for $5,500. She sold the sculpture on 1 January of the current tax year for $6,000. (c) A bronze figure purchased in October 1987 for $14,000. She sold the bronze figure on 20 March of the current tax year for $13,000. (d) A painting purchased in March 1987 for $470. She sold the painting on 1 July of the current tax year for $5,000. Consider the CGT consequences of the above transactions. Answer It is necessary to consider the capital gains tax consequences of the sale of Anita’s art collection. There is the disposal of CGT assets and CGT event A1 happens: s 104-10(1) of ITAA97. It is necessary to determine whether the assets are CGT assets, collectables or personal use assets. The assets are considered collectables as defined in s 108-10(2). Dealing with each asset in turn: (a) Antique ceramic bowl: Even though the bowl was acquired for more than $500 (meaning any gain on this collectable is assessable), it was acquired before 20 September 1985. Therefore the gain of $8,000 is exempt from CGT: s 104-10(5). (b) Sculpture: The sculpture was purchased in December 1993 and sold on 1 January of the current year. As the sculpture was acquired for more than $500 and acquired after 20 September 1985, any gain from the CGT event will be a taxable capital gain. Anita may use the indexation method to determine the gain or apply the 50% CGT discount. If she uses the discount method her capital gain is $500. The 50% discount can only be applied after any losses are taken into account, so that will be done at a later stage. If she uses the indexation method, the capital gain is determined as follows: Indexation figure for December 1993 = 61.2 Indexation figure for September 1999 = 68.7 This gives an indexation factor of 1.123 (rounded to 3 decimal places). The indexed cost base is $5,500 x 1.123 = $6,176 1 © 2020 Thomson Reuters (Professional) Australia Limited

As indexation cannot be used to create a capital loss, the result is taken to be 0 Anita will have neither a capital gain nor a capital loss using the indexation method. Under discounting, there is a capital gain. Anita can use whichever method gives her the best result. For this event she will use indexation. (c) Bronze figure: The bronze figure was purchased in October 1987 and sold in March of the current year. Anita has a capital loss of $1,000 on the sale. As the bronze figure was sold at a loss, the cost base cannot be indexed to take into account inflation. (d) Painting: The painting was purchased in March 1987 for $470. Therefore, the gain on sale is disregarded because the first element of the cost base is less than $500: s118-10(1). Anita has a net capital loss of $1,000. Therefore, $1,000 may be carried forward to be offset against any capital loss from collectables in future years.

Question 11.2 Other than the examples provided in this chapter, provide an example for each of CGT events A1, B1, C1, C2, D1 and D2. Answer Students need to provide their own examples.

Question 11.3 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 accounting firm? (f) A holiday house at Byron Bay?

Answer Are the following CGT assets, collectables or personal use assets? (a) an engagement ring which cost $5,000 – collectable: s 108-10(2) of ITAA97 includes jewellery in the definition. (b) a second-hand car purchased for $2,000 – if it is for personal use the car will be a personal use asset: s 108-20(2). However, a capital gain or loss made from a car is exempt. 2 © 2020 Thomson Reuters (Professional) Australia Limited

(c) shares in BHP – CGT asset. (d) your home – CGT asset. However, your home may be exempt if it is your main residence: Subdiv 118-B. (e) a painting hung in the foyer of your accounting firm – a CGT asset. It is not a collectable as it is not used or kept mainly for your personal use or enjoyment. (f)

a holiday house at Byron Bay – CGT asset.

Question 11.4 List five things that you own that are considered personal use assets. Can you think of any collectables that you may own? Answer Students need to provide their own examples.

Question 11.5 What CGT events apply to the following transactions: (a) You sell shares in BHP for $5,000. (b) You receive $100,000 in return for signing a three-year contract to play AFL with the Brisbane Lions. (c) You sell your holiday home at Byron Bay for $750,000. (d) You sell your hairdressing salon for $200,000 and receive an additional $20,000 for agreeing not to open another salon within a 10 km radius for the next three years. (e) You pay Shelby $50,000 for the option to purchase her hairdressing salon in three years’ time. (f) In three years’ time you exercise the option to purchase Shelby’s salon for $300,000. (g) You sell a diamond ring for $20,000. You paid $12,000 for the ring in 1984.

Answer What CGT events apply to the following transactions: (a) you sell shares in BHP for $5,000 – Event A1 the disposal of a CGT asset. (b) you receive $100,000 in return for signing a three-year contract to play AFL with the Brisbane Lions – Event D1 creating a contractual right. (c) you sell your holiday home at Byron Bay for $750,000 – Event A1 disposal of a CGT asset.

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(d) you sell your hairdressing salon for $200,000 and receive an additional $20,000 for agreeing not to open another salon within a 10 km radius for the next three years – Event A1 occurs in relation to the sale of the business as you have disposed of a CGT asset. Event D1 happens in relation to the restraint of trade clause as you have created a contractual right in another. (e) you pay Shelby $50,000 for the option to purchase her hairdressing salon in three years time – Event D2 happens for Shelby as you have granted an option to Shelby. She will have a capital gain of $50,000. (f)

in three years time you exercise the option to purchase Shelby’s salon for $300,000 – when you exercise the option Event D2 is ignored and Event A1 happens. Shelby’s capital proceeds are $350,000 and the first element of your cost base is $350,000.

(g) you sell a diamond ring for $20,000. You paid $12,000 for the ring in 1984 – Event A1. However, the capital gain will be disregarded as the asset was acquired before 20 September 1985. Question 11.6 Dave Solomon is 59 years of age and is planning for his retirement. Following a visit to his financial adviser in March of the current tax year, Dave wants to contribute funds to his personal superannuation fund before 30 June of the current tax year. He has decided to sell the majority of his assets to raise the $1,000,000. He then intends to rent a city apartment and withdraw tax-free amounts from his personal superannuation account once he turns 60 in August of the next year. Dave has provided you with the following details of the assets he has sold: (a) A two-storey residence at St Lucia in which he has lived since [1984]. He paid $70,000 to purchase the property and received $850,000 on 27 June of the current tax year, after the real estate agent deducted commissions of $15,000. The residence was originally sold at auction and the buyer placed an $85,000 deposit on the property. Unfortunately, two weeks later the buyer indicated that he did not have sufficient funds to proceed with the purchase, thereby forfeiting his deposit to Dave on 1 May of the current tax year. The real estate agents then negotiated the sale of the residence to another interested party. (b) A painting by Pro Hart that he purchased on 20 September 1985 for $15,000. The painting was sold at auction on 31 May of the current tax year for $125,000. (c) A luxury motor cruiser that he has moored at the Manly Yacht club. He purchased the boat in late 2004 for $110,000. He sold it on 1 June of the current tax year to a local boat broker for $60,000. (d) On 5 June of the current tax year he sold for $80,000 a parcel of shares in a newly listed mining company. He purchased these shares on 10 January of the current tax year for $75,000. He borrowed $70,000 to fund the purchase of these shares and incurred $5,000 in interest on the loan. He also paid $750 in brokerage on the sale of the shares and $250 in stamp duty on the purchase of these shares. Dave has contacted the ATO and they have advised him that the interest on the loan will not be an allowable deduction because the shares are not generating any assessable 4 © 2020 Thomson Reuters (Professional) Australia Limited

income. Dave has also indicated that his taxation return for the year ended 30 June of the previous year shows a net capital loss of $10,000 from the sale of shares. These shares were the only assets he sold in that year. (a) Based on the information above, determine Dave Solomon’s net capital gain or net capital loss for the year ended 30 June of the current tax year. (b) If Dave has a net capital gain, what does he do with this amount? (c) If Dave has a net capital loss, what does he do with this amount?

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Answer Dave’s CGT gains and losses are calculated as follows: Residence at St Lucia Sale proceeds Cost base Element 1 Element 2 Capital Gain

Forfeited Deposit Sale proceeds

865,000 85,000 70,000 15,000 780,000

55,000

Cost base Element 1 Capital Gain Pro Hart Painting Sale Proceeds Cost base Element 1 Capital Gain Capital Gain Pro Hart Painting Sale Proceeds Cost base Element 1 Capital Gain Luxury Motor Cruiser Sale Proceeds Cost Base Element 1 Capital Loss

-

125,000 15,000 110,000 55,000

CGT Event A1 Includes $15,000 commissions Asset acquired before 15 Sept 1985 Agent Commissions Disregard any gain: s 104-10(5) Main residence exemption will also disregard gain CGT event H1 but s 104-150 not applied Deemed part of sale proceeds of s 118-110(2)(b) Underlying asset acquired prior to CGT Refer to Ruling TR 1999/19 Disregard any gain: s 104-10(5)

residence:

CGT Event A1 Asset is not exempt Acquired after 20/9/85 collectible: s108-10(2) that cost more than $500 Gain is not exempt. Subject to 50% discount Choose discount method as lower gain CGT Event A1

125,000 25,965 99,035

60,000 110,000 50,000

Acquired before 1999 so indexation may apply Indexation factor = 68.7/39.7 = 1.731 Gain is not exempt: s 118-10 CGT Event A1 Personal use asset Acquired for more than $10,000 Loss is disregarded: s 108-20 CGT Event A1

Shares – Mining Company Sale Proceeds Cost Base Element 1 Element 2 Element 3 Capital Gain

80,000 76,000 75,000 1,000 5,000 -

Shares – Mining Company Sale Proceeds Cost Base Element 1 Element 2 Element 3 Capital Loss

80,000 76,000 75,000 1,000 -

Brokerage and stamp duty

CGT Event A1

No element 3 in reduced cost base. Makes Neither a capital gain nor a capital loss. Sale proceeds fall between cost base and reduced cost base.

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(a) Apply steps from s 102-5 to calculate net assessable gain: 1.

Gains from Events 1, 2 and 5 can be disregarded.

2.

Loss from Event 4 is disregarded.

3.

Reduced gains by current year losses – none available. Reduced gains by prior year losses: $ Net capital gain: Event 3 110,000 Apply prior year losses -10,000 Net gain: Event 3 100,000

4. Net gains from assets subject to 50% discount: 50% discount: -50,000 Net gains after discount: 50,000 5. Net assessable gain – s 102-5: $50,000 (b) Return net assessable gain as assessable income on the current tax return: s 102-5 or s 100-55. (c) If Dave had a net capital loss, this would be carried forward to the next year’s tax return.

Question 11.7 Your client is an investor and antique collector. You have ascertained that she is not carrying on a business. Your client provides the following information of sales of various assets during the current tax year. Based on this information, determine your client’s net capital gain or net capital loss for the year ended 30 June of the current tax year. (a) Block of vacant land. On 3 June of the current tax year your client signed a contract to sell a block of vacant land for $320,000. She acquired this land in January 2001 for $100,000 and incurred $20,000 in local council, water and sewerage rates and land taxes during her period of ownership of the land. The contract of sale stipulates that a deposit of $20,000 is payable to her when the contract of sale is signed and the balance is payable on 3 January of the next tax year, when the change of ownership will be registered. (b) Antique bed. On 12 November of the current tax year your client had an antique four-poster Louis XIV bed stolen from her house. She recently had the bed valued for insurance purposes and the market value at 31 October of the current tax year was $25,000. She purchased the bed for $3,500 on 21 July 1986. Although the furniture was in very good condition, the bed needed alterations to allow for the 7 © 2020 Thomson Reuters (Professional) Australia Limited

installation of an innerspring mattress. These alterations significantly increased the value of the bed, and cost $1,500. She paid for the alterations on 29 October 1986. On 13 November of the current tax year she lodged a claim with her insurance company seeking to recover her loss. On 16 January of the current tax year her insurance company advised her that the antique bed had not been a specified item on her insurance policy. Therefore, the maximum amount she would be paid under her household contents policy was $11,000. This amount was paid to her on 21 January of the current tax year. (c) Painting. Your client acquired a painting by a well-known Australian artist on 2 May 1985 for $2,000. The painting had significantly risen in value due to the death of the artist. She sold the painting for $125,000 at an art auction on 3 April of the current tax year. (d) Shares. Your client has a substantial share portfolio which she has acquired over many years. She sold the following shares in the relevant year of income: (i) 1,000 Common Bank Ltd shares acquired in 2001 for $15 per share and sold on 4 July of the current tax year for $47 per share. She incurred $550 in brokerage fees on the sale and $750 in stamp duty costs on purchase. (ii) 2,500 shares in PHB Iron Ore Ltd. These shares were also acquired in 2001 for $12 per share and sold on 14 February of the current tax year for $25 per share. She incurred $1,000 in brokerage fees on the sale and $1,500 in stamp duty costs on purchase (iii) 1,200 shares in Young Kids Learning Ltd. These shares were acquired in 2005 for $5 per share and sold on 14 February of the current tax year for $0.50 per share. She incurred $100 in brokerage fees on the sale and $500 in stamp duty costs on purchase. (iv) 10,000 shares in Share Build Ltd. These shares were acquired on 5 July of the current tax year for $1 per share and sold on 22 January of the current tax year for $2.50 per share. She incurred $900 in brokerage fees on the sale and $1,100 in stamp duty costs on purchase. (e) Violin. Your client also has an interest in collecting musical instruments. She plays the violin very well and has several violins in her collection, all of which she plays on a regular basis. On 1 May of the current tax year she sold one of these violins for $12,000 to neighbour who is in the Queensland Symphony Orchestra. The violin cost her $5,500 when she acquired it on 1 June 1999. Your client also has a total of $8,500 in capital losses carried forward from the previous tax year, $1,500 of which are attributable to a loss on the sale of a piece of sculpture which she sold in April of the previous year. Answer (a) Block of vacant land:  CGT Event A1 occurs when the contract is signed on 3 June: s 104-10. The fact that only $20,000 of the total sale price is paid in this tax year is irrelevant.  The land is a CGT asset: s 108-5.  Cost base of land = $100,000 + 20,000 = $120,000. 8 © 2020 Thomson Reuters (Professional) Australia Limited

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  

Council, water and sewerage rates + land taxes are not deductible expenses as no income is derived from the land. Included in element 3 of cost base as asset acquired after 20 August 1991: s 110-25(4). A capital gain exists as sale proceeds > cost base. Gain = $320,000 – $120,000 = $200,000. Gain is an eligible discount capital gain: Subdiv 115A.

(b) Antique bed:  CGT Event C1 occurs when the antique bed was stolen.  The timing of the event is when the insurance proceeds were received on 21 January: s 104-20.  The antique bed is a collectable: s 108-10 o Any gains or losses are not disregarded as acquisition cost > $500: s 118110(1).  The cost base of the bed = $3,500 + $1,500 = $5,000 o Alterations are included in element 4 of cost base: s110-25(5).  Indexation applies to the cost base as the bed was purchased before 21 September 1999: s 114-1 o Index number when asset purchased = 43.2 (September quarter 1986); o Index number when alterations made = 44.4 (December quarter 1986); o Index number when asset is stolen = 68.7 (Index number for the quarter ending on 30 September 1999): s 960-275; o Indexation factors: - 68.7 ÷ 43.2 = 1.590 [3 decimal places: s 960-275(5)] - 68.7 ÷ 44.4 = 1.547 [3 decimal places: s 960-275(5)] o Indexed cost base: $7,884 - Element 1 = $3,500 × 1.590 =$5,565 - Element 4 = $1,500 x 1.547 = $2,321  A capital gain exists as sale proceeds > cost base o Gain = $11,000 – 5,000 = $6,000 o Gain is an eligible discount capital gain: Subdiv 115A  A capital gain exists as Sale Proceeds > Indexed Cost Base o Gain = $11,000 – 7,886 = $3,114. (c) Painting:  CGT Event A1 occurs when the painting was sold on 3 April: s 104-10.  The painting is artwork and therefore a collectable: s 108-10.  The painting was acquired on 2 May 1985. This is prior to the commencement of CGT. Any gain is therefore disregarded: s 104-10(5). (d) Sales of shares:  1,000 share in Common Bank: o The shares are a CGT asset: s 108-5 o CGT Event A1 occurs when the shares are sold on 4 July: s 104-10 o Indexation does not apply to the cost base as shares were purchased after 21 September 1999: s 114-1. o Cost base = $16,300 - Element 1 = $15.00 X 1,000 = $15,000 - Element 2 (stamp duty) = $750 - Element 2 (brokerage) = $550 9 © 2020 Thomson Reuters (Professional) Australia Limited

o o o o

Sale proceeds = $47.00 x 1,000 = $47,000 Capital gain= sale proceeds – cost base Capital Gain = $47,000 – $16,300 = $30,700 The discount capital gain (50% discount) also applies to this CGT event: s 115-25.

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2,500 shares in PHB Iron Ore Ltd: o The shares are a CGT asset: s 108-5. o CGT Event A1 occurs when the shares are sold on 14 February: s 104-10. o Indexation does not apply to the cost base as shares were purchased after 21 September 1999: s 114-1. o Cost base = $32,500: - Element 1 = $12.00 X 2,500 = $30,000 - Element 2 (stamp duty) = $1,500 - Element 2 (brokerage) = $1,000 o Sale proceeds = $25.00 x 2,500 = $62,500. o Capital gain= sale proceeds – cost base. o Capital gain = $62,500 – $32,500 = $30,000. o The discount capital gain (50% discount) also applies to this CGT event: s 115-25.

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1,200 shares in Young Kids Learning Ltd: o The shares are a CGT asset: s 108-5. o CGT Event A1 occurs when the shares are sold on 14 February: s 104-10. o Indexation does not apply to the cost base...