CLWM4100 T1 2019 Solutions 5 v2 PDF

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CLWM4100- Taxation Law

Workshop 5 Capital Gains Tax Questions before workshop Question 1 Are the following CGT assets, collectables, or personal use assets? • an engagement ring which cost $5,000? • a second-hand car purchased for $2,000? • shares in BHP? • your home? • a painting hung in the foyer of your accountant’s office? • a holiday home at Byron Bay? Suggested solution 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. (c) Shares in BHP – CGT asset. (d) Your home – CGT asset. However, your home may be exempt if it is your main residence: Subdivision 118-B. (e) A painting hung in the foyer of your accountant’s office – 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 2 Which of the following can form part of the cost base of a rental property used for income producing purposes? a. b. c. d. e. f. g. h. i. j.

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 Stamp duty on mortgage (loan) Purchase price Extensions to build extra room Concrete driveway replacing existing gravel driveway

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

k. Removal of old chimney l. Clearing old vegetation away Suggested solution a. b. c. d. e. f. g. h. i. j. k. l.

Repairs to broken window - NO Rates and land tax - NO Interest expense on loan - NO Legal fees on purchase - YES Legal fees on mortgage(loan) - YES Stamp duty of purchase -YES Stamp duty on mortgage (loan) NO Purchase price - YES Extensions to build extra room -YES Concrete driveway replacing existing gravel driveway _YES Removal of old chimney - MAYBE Clearing old vegetation away MAYBE

The specific rules of the cost base indicate a deduction is not able to be included in the cost base if a deduction has been, or could have been, claimed. Therefore, as a rental property has the purpose of producing assessable income the repairs, rates and taxes and the interest on the loan are deductible under s8-1 ITAA97. The legal fees, stamp duties on the purchase are capital in nature and form part of the cost base. The legal fees and stamp duty on the loan are borrowing costs and are not part of the cost base. Demolition costs http://law.ato.gov.au/atolaw/view.htm?docid=%22AID%2FAID201035%2F00001%22 The cost of removing the chimney would form part of the cost base only if it increases the value of the property. If not, it is not deductible if an initial repair. Otherwise it could be deductible as a repair if it is considered to be a replacement of a part rather than an improvement.

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Arguably the site clearance is also considered as part of the cost base if this occurred when the asset was acquired. Otherwise the gardening expenses will be deductible and not part of the cost base. 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? Suggested solution Subdivision Subdivision on its own does not trigger CGT as there is no change in beneficial ownership. The cost of subdivision and other fees will form part of the cost base and be assigned equally to the blocks assuming they are the same size and value to give the cost base of each block. The sale of each block is CGT event A1 and is dealt with according to CGT principles. The first fact to check is whether the land is a pre-CGT asset. Sale of granny flat This would not be a principal place of residence and so the exemption does not apply. A quirk in CGT legislation indicates the land and the house are separate assets, so theoretically an apportionment of the capital proceeds between the land and the house would need to be done. This is of particular importance if the land is a pre-CGT asset and the house is not. http://www.insightaccounting.com.au/2017/05/cgt-implications-subdividing-buildingfamilyproperty/ Question 4 Jan has capital losses carried forward of $2,000. During the 2018 income year, the following occurred:

Solutions

CLWM4100- Taxation Law

Workshop 5

Capital Gains Tax

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. Suggested solution Only the discount method is available to Jan NCG = [(CG – CL)] x 0.5 NCG = [($50,000 – $2,000 – $10,000)] x 0.5 NCG = $38,000 x 0.5 = $19,000 According to the legislation the loss must be applied before the relevant discount percentage.

Questions during workshop Question 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 Suggested solution This is not so. In order for CGT to be triggered a CGT event must occur to a CGT asset. Disposal is CGT event A1, however not all assets are CGT assets. For example a family car is an asset, however, cars are not CGT assets. Therefore disposal of a car does not trigger CGT. Question 2 On 2 June 2018, David transfers a rental property to his wife Tanya, at no cost. David acquired the property in May 2013 for $250,000. The market value on the day of disposal was $500,000. Is there a capital gain?

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Suggested solution Yes there is. The market substitution rule indicates the capital proceeds = $500,000 Therefore, the capital gain = $500,000 – $250,000 = $250,000 Question 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 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 1990 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. (6) Jewellery sold in July 2017 for $12,000. The jewellery was purchased for 29/09/09 for $20,000. Calculate Aramis’s net capital gain or loss for the year

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Suggested solution (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 instalments of $25,000, however the purchaser has declared bankruptcy and the last two instalments due next financial year will not be paid. Aramis can apply the discount method. The capital proceeds will be $250,000 as the instalments will not be received. As the asset is land there is no income production associated, therefore the interest deductions can be added to the cost base. Capital gain = $250,000 – $85,000 = $165,000 (2) An exempt asset therefore not relevant = 0 . (3) A personal use asset acquired for less than $10,000 therefore any capital gain or loss will be disregarded =0 (4) Aramis has the choice of the discount or indexation method on the sale. Best result is discount method. Capital gain = $180,000 – $95,000 = $85,000 (5) A collectible. The gain can be calculated by either the indexation or discount method Best result is indexation $6,000 x 68.7/51.2 = 1.341, indexed cost base = $8,046, therefore capital gain of $11,000 – $8,046 = $2,954 Apply capital loss of 2954 = 0 capital gain for collectibles, CFL loss of $5,046 Discount If the discount method is used the loss is applied first then the discount = ($11,000 - $6,000) = capital gain of $5,000 – $5,000 = 0 and a carry forward loss of $8,000 – $5,000 = $3,000 (6) A collectible resulting in a capital loss of $8,000 which may only be offset against gains from a collectible. 5 and 6 interact Apply capital loss of $2,954 = 0 for collectibles, CFL loss of $5,046

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Discount If the discount method is used the loss is applied first then the discount = ($11,000 - $6,000) = capital gain of $5,000 – $5,000 = 0 and a carry forward loss of $8,000 – $5,000 = $3,000 Overall net capital gain ($165,000) x 0.5 = $82,500 ($85,000) x 0.5 = $42,500 Net capital gain = $125,000 and a carry forward collectible loss of $5,046

Questions after workshop Question 1 Monty owns 3000 Class A shares in Rockhead Ltd, originally acquired in 1996. In March of the current year Rockhead cancels the Class A shares and issues 1500 Z Class shares which have the same market value. Provide advice whether the transaction will have CGT implications Suggested solution Basically, as there is equivalent value there will be a rollover relief and no CGT implications at the time of replacement. The cost base of the old shares will be the first element of the cost base of the new shares

Question 2 Calculate the relevant net capital gain or loss, if any, under both the indexation and discount methods for the following: 500 shares in ABC Ltd purchased by an individual and a company on 1/11/90 for $2.75 each plus $825 brokerage and sold on 1/7/18 for: 1) $5 each 2) $2.50 each 3) $7.50 each Which approach would you advise for your client at each selling price? Explain with reference to the concept of cost base, indexed cost base and reduced cost base.

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Suggested solution $5 each Element 1 = $2.75 x 500 = $1,375 Element 2 = $825 Cost base = $1,375 + $825 = $2,200 Factor = 68.7/59 = 1.164 Indexed cost base = $2,200 x 1.164 = $2,560.80 Capital proceeds = 500 x 5 = $2,500 Therefore, the capital proceeds falls between the cost base and the indexed cost base. This is the tax free zone, and as it does not meet the definition of a capital gain or a capital loss it is a tax nothing. Your advice to your client would be to use the indexation method and have no tax implications. It is not necessary to consider the discount method, you will not get a better outcome than cash in pocket no tax. $2.50 each Element 1 = $2.75 x 500 = $1,375 Element 2 =$ 825 Cost base = $1,375 + $825 = $2,200 = Reduced cost base Capital proceeds = 500 x $2.5 = $1,250 This is a capital loss situation, therefore the reduced cost base must be used. The reduced cost base is the cost base without the third element costs. As there are no third element costs the cost base = reduced cost base. Capital loss = $2,200 – $1,250 = $950 Capital losses are not discounted so under both methods the outcome is the same, CL = 950 $7.50 each Element 1 = $2.75 x 500 = $1,375 Element 2 = $825

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Cost base = $1,375 + $825 = $2,200 Factor = 68.7/59 = 1.164 Indexed cost base = $2,200 x 1.164 = $2,560.80 Capital proceeds = 500 x $7.50 = $3,750 Indexation method Capital gain = $3,750 – $2,560.80 = $1,189.20 Discount method Capital gain = $3,750 – $2,200 = $1,550 x0.5 = $775,therefore, choose the discount method

Question 3 Comparison of Discount and Indexation CGT calculations Lucky acquired a holiday beach house on 23 December 1991 for $90,000. The contract was signed on that date, but settlement only took place on 23 January 1992. The legal fees, stamp duty and search fees incurred and paid on 23 January 1992 later totalled $2,000. On 3 July 1992, a dispute arose between Lucky and his neighbour over the boundary between Lucky’s holiday beach house and the neighbour’s property. Lucky paid a solicitor $10,000 during the next two months to settle the matter. Lucky is also a lawyer by training,and estimates that he spent about 20 hours resolving the dispute. He estimates that he would have charged $2,000 if he were to perform a similar service for a client. On 1 January 1995, Lucky spent $23,000 improving the beach house by adding an internal staircase. On 1 March 2000, he spent $8,000 to extend the verandah to the house. Unfortunately, Lucky failed to consult his wife on the extensions, and was forced to demolish the verandah extension on 1 September 2000. On 1 February 2008, he spent $2,000 on ordinary repairs to some of the windows in the house following a severe thunderstorm. The house was sold on 21 October CIY for $500,000. Advertising costs and legal fees amounted to $1,400.

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Assume that the house does not qualify for the main residence exemption and that it was not used at any time to produce assessable income. For the purposes of this question, ignore any potential implications arising from CGT event C1 happening in relation to the demolition of the verandah extension on 1 September 2000. Relevant indexation factors: Dec 1991 59.9 Mar 1992 59.9 Sep 1992 59.8 Mar 1995 63.8 Sep 1999 68.7

Required a) Calculate the capital gain in the CIY for Lucky as a result of the sale of the holiday beach house. b) How would your answer to question a) change if the taxpayer was Lucky Pty Ltd? c) How would your answer to questions a) and b) change if the house was sold on 21 October CIY for $120,000 and not $500,000? Suggested solution

a) The capital gain arising on the sale of the house is: $500,000 Less: Cost base – Div 110 includes : Acquisition cost

(92,000)

(inc incidentals s 110-25 Elements 1 and 2) Capital expenditure regarding title to the house (s 100-25 Element 5, also see [Note 1])

(10,000)

Solutions

CLWM4100- Taxation Law

Workshop 5

Capital Gains Tax

Cost of improvements ($23,000 + $8,000)

(31,000)

(s 110-25 Element 4) [Note 2] Repairs (s 110-25 Element 3) Incidental costs of disposal (s 110-25 Element 2) Taxable capital gain

(2,000) (1,400) (136,400) $363,600

Note 1: Lucky’s personal efforts worth $2,000 cannot be included. Note 2: The cost of extending the verandah can now be included. There is no longer the need to have the improvement reflected in the asset at the time of the sale of the beach house. Taxable capital gain $363,600 Less 50% CGT discount ($181,800) NET CAPITAL GAIN (s 102-5) $181,800 Indexation method The capital arising on sale of the house is calculated as follows: Capital proceeds (s 116-20)

$500,000

Less: Indexed cost base (div 114) Note 1

Acquisition cost (s 110-25 Element 1) $90,000 x 68.7 = (1.147) 59.9

$103,230

Solutions Workshop 5

CLWM4100- Taxation Law Capital Gains Tax

Incidental acquisition costs (s 110-25 Element 2)

$2,000 x 68.7 / 59.9 = (1.147)

$2,294

The capital arising on sale of the house is calculated as follows: Summary Capital proceeds $500,000 Less: Acquisition cost $103,230 Incidental acquisition costs $2,294 Capital expenditure regarding title 11,490 Cost of improvements 24,771 Verandah 8,000 Repairs 2,000 Incidental disposal costs 1,400 (153,185) Taxable net capital gain $346,815 b) The answer would change under the discount method as companies cannot apply the general 50% discount. The indexation method would not change. c)The reduced cost base would need to be calculated as there is a capital loss.  The reduced cost base would be the same as the unindexed cost base except that the expenditure incurred on repairs on 1 February 2008 would not be included (see s110-55(1) and 110-55(2)). The reduced cost base is $134,400 and the capital proceeds are $120,000, so the capital loss is $14,400....