Taxation Topic 3 help notes 1 PDF

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BLB3134 Topic 3 covers CGT issues. These notes should assist you in your study. They do not follow the same format as the study guide and can be used as a skeleton for your own summary notes.

CAPITAL GAINS OR LOSSES - CHAPTER III ITAA97 Sometimes an event may not give rise to assessable income/ statutory income or fringe benefit issues. If it is capital in nature - it may be subject to capital gains tax however. Capital gains tax are covered under Chapter 111 ITAA97 and apply to disposal of property on or after 20 Sept 1985 1 2 3 4 5

Net capital gains are assessable income (s 102-5(1)). A capital gain or loss will only arise if there is a CGT event (s 102-20). The net gain or loss is determined for each event (Div 104). Capital gains may be reduced by exemptions and concessions (various provisions). Recording requirements (Div 121).

Note: Under s 118-20 CGT is a residual provision and all other provisions of the Act must be considered before the application of CGT. Net Capital gains shouldn't include amounts that are assessable under other provisions of the Act. 1. Net capital gains are assessable income Under Section 102-5 The calculation of net capital gain is a function of: • capital gains for the current year • capital losses for the current year • net capital losses carried forward from previous years. 2. For Capital gains tax to apply need a CGT asset Section 108-5(1) ITAA97 defines a CGT asset in general terms to mean 'any kind of property, or a legal or equitable right that is not property' Under s 108-5 ITAA97 , CGT asset includes personal rights, proprietary rights but not popular rights. TR 95/35. ~~ a. Consider whether the asset is 'property’ Property is a very broad term and can be used to describe everything that a person may have control over. Langdale M. R. (Jones v Skinner, 5 L. J., ch. 90) ie: Proprietary rights. Includes: tangible property and intangible property Doesn't include. Non proprietary rights, know how or personal knowledge b. Legal and equitable rights that are not property eg: personal rights such as the right to sue. eg: non-transferable rights such as a right under an employment contract or a right to compensation. Re: Hepples vFCT (199l)- (N ote that such rights w ere not a C G T asset under old s 160A definition) and O rica 1

c Statutory inclusions in the meaning of 'CGT asset' Subsection 108-5(2) specifically includes in the definition of a CGT asset: (a) part of or an interest in, an asset referred to in s 108-5(1) (b) goodwill or an interest in it (c) an interest in a partnership asset (d) an interest in a partnership not covered in (c). d. Collectables and other personal use assets Collectables which cost $500 or less - s 118-10 exempts from CGT Personal use assets are exempt from CGT if they cost $10 000 or less (s 118-10(3)), but any capital losses realized are also disregarded (s 108-20(1)). 3.

A capital gain or loss arises if there is a CGT event

Must determine whether a CGT event has occurred (s 102-20). Note that each CGT event has its own rules with regard to timing and cost base issues The steps for selecting the applicable CGT can be summarised as follows: 1 2 3 4 5 6

Select which of the CGT events apply (ignore Dl and H2—these are left to last). If more than one event applies, select the most specific. CGT event K5 depends on other CGT events applying. If no previously considered CGT event applies consider if Dl applies. If Dl does not apply consider if H2 applies. If none of the above apply there is no CGT.

We cover a number of events in this unit. You will only be required to identify when a particular event occurs ie: A1, B1, C1, C2, F1, D1, H2 and how to calculate whether a CG or CL has occurred.

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Event Al. s104 -10(1)- Change in ownership of CGT asset (disposal) (doesn't include contractual rights) Need to show 1. Disposal = change in ownership s 104-10(2) defines the point of disposal as the time when a change in ownership occurs that results from any event or act or by the operation of law. FCT v Cooling (1990). Legal change in ownership insufficient - must change beneficially s104-10(2)(a) 2. Time of CGT event: CGT event Al occurs when the contract was entered into or where there is no contract, when the change in ownership occurs: s104-10(3). •

Only assets acquired after the 19 September 1985 are subject to CGT.

3.

CGT asset –s108(5)

4.

Calculating Gain or Loss for Al

Capital gain = Capital proceeds - Cost Base Capital loss = Reduced Cost Base - Capital Proceeds (when calculating capital gain and get a -ve figure STOP - and go to capital loss formula) Capital proceeds s116-20 = what you receive + what entitled to receive (also remember modification rules – see other sheet) Cost base (SUBJECT TO MODIFICATION RULES see below) 1. Acquisition value s 110-25 (2) (if held > 12 months can be indexed s114-10) 2. Incidental costs of acquisition and costs related to CGT event s110-25(3) (if held > 12 months can be indexed s114-10) 3. Non capital costs of ownership - interest on loan, repairs (not collectables/ personal use assets) (for assets acquired after 20/08/91 s 110-25(4)) - usually not included in the cost base b/c already deductible elsewhere s110-45 and s 110-40. No indexation available. 4. Capital expenditure increasing the value of the property s110-25(5) (if held > 12 months can be indexed s114-10) 5. Capital costs of establishing, preserving or defending title to the property s11025(6) (if held > 12 months can be indexed $114-10) Reduced Cost base Same as cost base except — no indexing and no 3rd element Any part of reduced cost base allowed as a deduction not in included in reduced cost base $110-55(4)

Indexation may be available to assets acquired prior to 21/09/99 (gain only) 50% discount may be available for assets acquired after 21/09/99

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Event Cl s 104-20 - Loss or destruction of a CGT asset owned by the taxpayer Event occurs without the CGT asset being transferred to a new owner. Time of CGT event: when compensation first received for loss/ destruction or if no compensation received when loss was discovered or destruction occurred s 104-20(2) Note: CGT payable even if no compensation received Capital gain = capital proceeds - cost base Capital loss = reduced cost base less capital proceeds Capital gain or loss is disregarded if asset was acquired b/f 20/09/85 s104-10(5) Note: Rollover provisions for involuntary loss Indexation may be available to assets acquired prior to 21/09/99 (gain only) 50% discount may be available for assets acquired after 21/09/99 Event C2, s 104-25 - Cancellation, surrender or similar endings Event occurs without the CGT asset being transferred to a new owner. FCT v Orica (1998) - a wide operation Occurs where ownership of an intangible CGT asset ends as a result of the asset: a. Being redeemed or cancelled (eg shares/ debentures) b. Being released, discharged or satisfied (a debt) c. Expiring (contractual rights) d. Being abandoned, surrendered or forfeited (contractual rights) For example: A share/ debenture in Co is cancelled/ redeemed - this can trigger C2 A C2 event occurs where a taxpayer enters into a contract that Time of CGT event: results in the asset ending or if there is no contract, when the asset ends s 104-25(4) Doesn't apply where: parties have carried out obligations under accordance with the agreement (Unilever) because this isn't within the meaning of 'discharge' - performance means that CGT asset ceases to exist and is no longer owned by any one (Unilever) BUT: If contract is terminated by breach of agreement - then this is a C2 event. Orica: Debt defeasance - the taxpayer had acquired rights and every time a payment was made, those rights diminished - a shrinking of a chose in action ie: C2 asset shrinking Capital Gain = Capital Proceeds – assets cost base. Capital Loss = Reduced cost base – capital proceeds Note a capital loss will be disregarded if the lease was not used solely or mainly to produce assessable income. S118-40 Indexation may be available to assets acquired prior to 21/09/99 (gain only) 50% discount may be available for assets acquired after 21/09/99

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CGT event F1(s. 104-110) - when a lease is granted, renewed or extended. Event F1 is aimed at taxing lease premiums (lump sum payments to the lessor). For instance, CGT event F1 will occur if a lessor enters into a three year lease, and the lessee agrees to pay an upfront premium of $20 000 as well as rent of $1000 per month. In this case, the $20 000 premium will be subject to event F1, and the $1000 rent per month will constitute ordinary income for the lessor. Time of CGT event:

A F1 event occurs when

(a) for the grant of a lease: (i) when the contract for the lease is entered into; or (ii) if there is no contract--at the start of the lease; Or (b) for a renewal or extension--at the start of the renewal or extension Capital Gain = Capital Proceeds – Expenditure Capital Loss = Expenditure – Capital Proceeds The expenditure can include giving property: see section 103-5. However, it does not include an amount you have received as * recoupment of it and that is not included in your assessable income, or an amount to the extent that you have deducted or can deduct it. Exception The lessor can choose to apply section 104- 115 to certain long term leases. If it does so, this section does not apply. Indexation/ discount NOT available

If no previously considered CGT event applies, then must consider event Dl and then H2 These are residual provisions only and are considered if no other CGT provision applies s!02(25(3) note: that H2 is the last event to consider Event Dl – s104-35 - Creating contractual or other legal/ equitable rights in another entity (lease inducements/ premiums) Deems a capital gain to arise where payment is received for the creation of a contractual right. Eg: applies for lease premiums where lessor receives premium for lease agreement or an amount received for entering into a restrictive covenant The time of the event: is when you enter into the contract or create the other right s10435(2). Capital gain = capital proceeds from creating the right less incidental costs in creating it s104-35(3). Capital loss = incidental costs of creating the right less capital proceeds Indexation/ discount NOT available 5

Event H2 -s 104-155 - Receipt for act/transaction/ event occurring in relation to CGT asset owned - arises if an act or transaction occurs/ happens in relation to a CGT asset, and as a result of the act or transaction, capital proceeds are received. DOESN'T APPLY: if act/ transaction/ event would result in adjustment being made to assets cost base or reduced cost base s104-155(l)(b) eg: painting or renovating a building, costs to maintain or repair the asset, advertising, maintenance, increase to the value of the asset etc. Time of CGT event: when act, transaction or event occurs s104-155(2) Capital gain = capital proceeds less incidental costs Capital loss = incidental costs less capital proceeds Indexation/ discount NOT available Examples of H2 event: (Usually when money is an inducement) • If land owned on which you intend to construct manufacturing facility and company pays 10K as an inducement to start construction early, and this is not paid pursuant to contract - H2 will apply • If Myer agrees to pay DJ so as to not to discount goods - also caught by H2 • Other restrictive covenants - trade agreements, management rights over property, inducement to vary, contract, grant of a right to use trademark.

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COST BASE NOTES Elements (subject to modification rules - see below) 1.

Acquisition value s 110-25 (2) states:

includes: money paid (or required to be paid) & market value of property given (or required to be given) -

if stream of payments to pay for CGT asset not concluded by time asset disposed of, discounted present value of remaining payments amounts to cost of asset (Ruling 93/15)

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If value of consideration is contingent & unascertainable amount, need not be recognized in cost base

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if lesser or greater sum than anticipated payments actually paid, no adjustment of cost base to reflect position

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element not reduced if part of cost allowable deduction (eg. If plant deductible through depreciation, does not affect acquisition value)

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if asset acquired for at least 12 mths, element may be indexed to CPI (s. 114-10)

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if nil consideration on acquisition, cannot be determined or is not dealing at arm's length = cost of acquisition deemed as market value (s. 112-20) eg. Gifts, family transactions etc

2. Incidental costs of acquisition of the CGT asset & costs related to the CGT event S110-25 (3) includes: remuneration to valuer, auctioneer, accountant, surveyor, broker, agent, consultant, legal adviser, transfer costs, stamp duty etc, advertising to find seller or buyer costs, valuation of apportionment costs etc - includes some tax advice: professional advice about ITAA operation, BUT only when provided by recognised tax adviser (s.995-l(l): registered tax agent or legal practitioner) - if incidental cost incurred by giving of property, market value used to work out incidental cost (s. 103-5 element reduced by amount of cost that has, or will be, allowable as deduction (s. 110-25) If asset acquired for at least 12 mths, element can be indexed to CPI (s. 114-10) 3. Non-capital costs of ownership (eg interest on loan used to finance acquisition) S110-25 (4) includes: interest on money borrowed to acquire assets, maintenance, repair or insurance costs, rates or land tax, interest on money to refinance or interest on money to refinance capital expenditure to increase asset's value element only applies if asset acquired after 20 August 1991 s110-25(4) -

if cost incurred by giving property, market value used to work out cost (s. 103-5)

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Costs qualifying as deduction excluded from being non-capital costs of ownership (s. 110-25(7)) element not indexed but element reduced by amount of cost that has, or will be, allowable as deduction (s. 110-25), 110-40, 110-45

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4. Capital expenditure increasing the value of the property S110-25 (5) Not necessary to be reflected in state/nature of asset @ time of CGT event if asset acquired for at least 12 mths, element can be indexed CPI (s. 114-10) If cost incurred by giving property, market value used to work out cost (s. 103-5) 5. Capital costs of establishing, preserving, or defending title to the property S110-25 (6) includes: establish preserve or defend title to asset or right over asset, & if asset acquired for at least 12 mths, Element can be indexed to CPI (s. 114-10) If cost incurred by giving property, market value used to work out cost (s. 103-5) Reduced Cost base" - same to definition to cost base apart from: -

reduced cost base not indexed (s. 110-55(1)) any part of reduced cost base allowed as deduction not included in reduced cost base (s. 11055(4))

Cost Base and Reduced Cost Base Modification Rules i. Market Value substitution rule s 112-20 The first element of the cost base and the reduced cost base of a CGT asset acquired from another entity is its market value — at the time of the acquisition — if: -

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the taxpayer did not incur any expenditure to acquire it (except where the acquisition was a result of either CGT event Dl happening, or another entity did something that did not constitute a CGT event happening) some or all of the expenditure incurred to acquire it cannot be valued, or the taxpayer did not deal at arm's length with the other entity in connection with the acquisition (s 112-20ITAA97).

ii. Split, changed or merged assets s112-25 Special cost base rules apply if a CGT asset is split into two or more assets or if it changes in whole or in part into an asset of a different nature, but only if the taxpayer remains the beneficial owner of the new assets after the change (s 112-25 ITAA97). The splitting, changing or merging of a CGT asset is not a CGT event. Each element in the cost base and the reduced cost base is simply added if assets are merged and apportioned in a reasonable way where the asset is split into two or more assets (s 11225). iii. Apportionment rules s112-30 Apportionment may be necessary where an asset is acquired and only part of the expenditure involved in the transaction relates to the acquisition of that asset. In this case, the relevant element of the cost base and reduced cost base of the asset only includes that part of the expenditure that is reasonably attributable to the acquisition of the asset (s 112-30ITAA97). 8

iv. Assumption of liability rule If a CGT asset is acquired from another entity and it is subject to a liability, the first element of the cost base and reduced cost base of the asset includes the amount of the assumed liability (s 112-35 ITAA97). There are other specific rules for modifying the cost base and reduced cost base a. when the CGT asset is a main residence In this situation any capital gain or loss is disregarded for CGT purposes. The exemption applies where: a. the taxpayer is an individual b. the dwelling was the taxpayers main residence through the ownership period and c. interest didn’t pass to the taxpayer as a beneficiary in or as a trustee of the estate of a deceased person. S118- 110. b. when an exemption is given for a gift of property and the property is later acquired by an associate for less than the market value s 112-48 c. when a taxpayer dies Generally the death of a taxpayer doesn’t result in a disposal. The recognition of gain or loss is deferred until the estate or the beneficiary to whom the CGT asset passes subsequently disposes of that CGT asset. s128-10 d. e. f. i. ii. iii. iv.

when the CGT asset relates to a lease when a CGT asset relates to an option Rollover – deferral of CGT liability Compensation transfer of assets b/w spouses on breakup of marriage transfer of assets to wholly owned coys transfer of assets b/w coys in same group.

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CAPITAL PROCEEDS NOTES Section 116-20 refers to those proceeds received or entitled to receive from a CGT event happening. Capital proceeds may be in the form of cash or other property and will be taken into account at the time the event occurs regardless of whether actually received. S103-10 The general rule determining the value of capital proceeds may be modified in five ways. Modification 1 – market value substitution rule The market value of a CGT asset is substituted for the actual capital proceeds if the taxpayer received no capital proceeds for a CGT event OR any part of the proceeds cannot 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 arms length or the CGT event is C2 (about cancellation, surrender or similar endings to an asset) s 116-30. s. 116-30 deems capital proceeds to be the ‘*market value’ of the CGT asset transferred. Modification 2 – apportionment rule (s. 116-40) requires that a single amount, which relates to two or more CGT events, must be apportioned between the events. Apportionment is also required if an amount relates to a CGT event and something else that is not a CGT event. Taxation Determinations (TD 9 and TD 94/64) take the view that market value should be used in determining the apportionment amounts. Modification 3 – non receipt rule (s. 116-45) allows the capital proceeds to be reduced by any amount that is not likely to be paid and you have made every reasonable attempt to collect the payment. Modification 4 – repaid rule (s. 116-50) reduces the capital proceeds by any non-deductible amount that is repaid or paid as compensation resulting from the CGT event. Modification 5 – Assumption of liability rule (s. 116-55 )increases the capital proceeds if the person acquiring the CGT asset also...