Topic D - Australian Taxation CGT PDF

Preview

Summary

Summary Notes for Australian Taxation Law.
Capital Gains Tax
Have you made a capital gain or a capital loss?
Comprehensive Capital Gain Legislation
CGT event
Post & Pre-20 September Assets...

Description

Capital Gains Tax Key points 

        



CGT affects a taxpayer's income because assessable income includes the net capital gain for the income year. As such, there is no such thing as a separate capital gains tax. Rather, capital gains are taxed as statutory income under ITAA 1997. A taxpayer's net capital gain for an income year is the total of the capital gains for the income year minus certain capital losses for the income year. Capital losses cannot be deducted from assessable income. This is known asquarantining. However, capital losses may be carried forward to be offset against capital gains in future income years. A taxpayer makes a capital gain or capital loss only if a CGT event happens, i.e. CGT applies only to realised gains. Most CGT events involve a CGT asset. There are certain exemptions or exceptions that reduce the capital gain or loss or allow the taxpayer to disregard it altogether. Gains and losses made on assets acquired before 20 September 1985 are generally exempt from CGT. There are certain roll-overs which allow a taxpayer to defer a capital gain or loss from a CGT event. A taxpayer generally makes a capital gain if he or she receives capital amounts (known as capital proceeds) which exceed the total costs (known as the cost base) associated with the CGT event. A taxpayer generally makes a capital loss if he or she receives capital amounts (known as capital proceeds) which are less than the total costs (known as the reduced cost base) associated with the CGT event. In certain circumstances a taxpayer may be able to consider inflation or apply a general discount to a capital gain.

Equations o o o o

Capital Gains = When you cost base exceeds your disposal cost  Cost base - Disposal cost Capital Losses = When you disposal cost exceeds you cost base  Cost base - Disposal cost net capital gains = When your total capital gain exceeds your total capital Losses  total capital gains – total capital losses Net capital Losses= when your total capital losses exceeds your total capital gains  total capital gains – total capital losses

Overview -

-

the consequences of a receipt of capital or, more specifically, capital gains tax. Gains that are assessable under the CGT regime are a form of statutory income. Capital gains and capital losses provisions (commonly referred to as capital gains tax or CGT) are contained in Pts 3-1 and 3-3 of Ch 3 of ITAA 1997. o Part 3-1 deals with capital gains and losses general topics, o Pt 3-3 deals with special topics, such as roll-overs and small business concessions. important aspects of calculating a taxpayer's net capital gain is determining whether the general discount percentage applies.

Statutory Income (s.6-10) Section 6-10 provides: Your assessable income also includes some amounts that are not ordinary income. Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income (see section 10- 5 for a list of statutory income)

Taxpayer's income tax liability -

S 102-5(1): Your assessable income includes your net capital gain (if any) for the income year a net capital gains consist of the total capital gains for the year reduced by certain capital losses. o net capital gains = total capital gains - certain capital losses. o A taxpayer cannot deduct a net capital loss (s.102-10(2)) o However, a loss may be carried forward to be offset against gains in future years (102-15(3) o Net Capital losses have no effect on the tax position of a tax payer

Important divisions - Div104 which contains all the CGT events - Div 108 which provides a definition of a CGT asset, - Div 110 which provides the rules relating to the cost base of the asset, - Div 116 which provides the rules relating to the capital proceeds from the event and - Div 118 which provides many of the exemptions available.

Methodology Determining CGT effects on taxpayer

Step 1: Have you made a capital gain or a capital loss?

Comprehensive Capital Gain Legislation     

Section 100 and following contains the comprehensive CGT provisions. These provisions replace sections 26(a) (now 25A), 25A and 15.15 which were narrow in their operation. The operative provision is Section 102-5 which includes a net capital gain as assessable income. o S 102-5(1): Your assessable income includes your net capital gain (if any) for the income year A net capital gain is where all aggregated gains exceed all aggregated losses. Note that net capital losses have no effect on the tax position of a taxpayer.

15-15 Profit-making undertaking or plan Section 15-15 of ITAA 1997 states that the profits from a profit-making undertaking or plan are assessable and so will constitute statutory income. However, s 15-15 does not apply to:  gains that are ordinary income (s 15-15(2)(a)); or  gains that involve assets purchased on or after 20 September 1985 (s 15-15(2)(b)). A profit-making undertaking or plan for the purposes of s 15-15 is a course of conduct that produces a profit and involves something more complex than the taxpayer simply buying and then selling property or outlaying money in the hope of making a return: Steinberg v FCT (1975) 5 ATR 565; Clowes v FCT (1954) 91 CLR 209. In practical terms, s 15-15 will rarely apply because transactions that potentially are a profit-making undertaking or plan will often be ordinary income due to FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 and so will not be covered by s 15-15. The section also has limited application since it only applies to assets purchased before the introduction of CGT.

25A Profit from sale of asset acquired with the purpose of resale Section 25A of ITAA 1936 makes assessable certain profits from selling an asset that was initially acquired for the purpose of resale. However, s 25A will seldom apply because of the following limitations:  it only applies to assets purchased prior to 20 September 1985 (s 25(1A)); and 

it only applies where the intention to profit by resale that existed at the time of purchase was the sole or dominant purpose of the taxpayer: Eisner v FCT(1971) 2 ATR 3.

Has a CGT event occurred? Definition: A CGT is an event that arises from the occurrence those outlined in 104-5  



It is important because it triggers the operation of the legislations s 102-20 of ITAA 1997: A taxpayer makes a capital gain or loss if, and only if, a CGT event happens If more than one CGT event happens, subject to certain exceptions, you use the one that is the most specific to the situation: s 102-25(1).

Division 104 contains:   

Sets out all the CGT events for which a taxpayer can make a capital gain or loss. how to work out if a taxpayer has made a gain or loss from the CGT event and the time of the CGT event The exceptions for gains and losses, as well as some of the cost base adjustment rules.

CGT Events Summary - 104-5:            

104-A – Disposals 104-B – Use and enjoyment before title passes 104-C – End of a CGT asset 104-D – Bringing into existence a CGT asset 104-E – Trusts 104-F – Leases 104-G – Shares 104-H – Special capital receipts 104-I – Australian residency ends 104-J – CGT event relating to roll-overs 104-K – Other CGT events 104-L – Consolidated groups and MEC groups

Occurrence of CGT Event CGT event can occurrence can be summarized as: (a) Disposal of an asset (this can be by sale or otherwise) (b) Creation of a right or (c) Destruction of a right

104-A – Disposals -

A CGT event A1 happens if a taxpayer disposes of a CGT asset: s 104-10(1) of ITAA 1997. A disposal occurs where there is a change in ownership because of some act or event or by operation of law. o ownership does not occur if the taxpayer stops being the legal owner, but continues to be the beneficial owner, or merely because of a change of trustee: s 104-10(2).

Contracts - The time of CGT event A1 is when the taxpayer enters the contract or, if there is no contract, when the -

-

change of ownership occurs: s 104-10(3). More than one contract o The date of disposal will be determined by reference to the contract which gives rise to the obligation to sell or transfer the asset: FCT v Sara Lee Household & Body Care (Australia) Pty Ltd (2000) 44 ATR 370. No contract: the time of the event will be the time of the change of ownership to be determined on the facts

Capital Gain on disposals Where CGT event A1 occurs, - capital gain if the capital proceeds from the disposal are more than the asset's cost base and you make a capital loss if those proceeds are less than the asset's reduced cost base: s 104-10(4). - The cost base is generally the total costs associated with the CGT event while the capital proceeds are generally the amount the taxpayer receives, or is entitled to receive, from the CGT event - 104-10(5): Disregard any capital gain if you acquired the asset prior to 20 September 1985 or a lease was granted before that date or if it has been renewed or extended--the start of the last renewal or extension occurred before that day.

104-B – Use and enjoyment before title passes -

Occurs if a taxpayer enters an agreement under which the right to the use and the enjoyment of a CGT asset owned by the taxpayer passes to another entity and title in the asset will or may pass to that entity before the end of the agreement: s 104-15(1) of ITAA 1997. - The time of the event is when the other entity first obtains the use and enjoyment of the asset: s 10415(2). Example 11.2: Event B1 Mark agrees to rent an investment property to John for a period of two years. The agreement entered by the parties provides that at any time during the two-year period John has the right to purchase the property from Mark. Event B1 occurs when Mark starts renting the property.

104-C – End of a CGT asset C1 Loss or destruction of a CGT asset (s 104-20) Occurs: A C1 event occurs if a CGT asset that the taxpayer owns is lost or destroyed: s 104-20(1) of ITAA 1997. Timing: The timing of a C1 event is when the taxpayer first receives compensation for the loss or destruction or, if no compensation is received, when the loss is discovered or the destruction occurred: s 104-20(2). Example 11.3: Event C1 Erin owns a factory that burns down. She has insurance which compensates her for the loss. CGT event C1 happens when the factory is destroyed and the time of the event is when she receives the insurance payment.

C2 Cancellation, surrender and similar endings (s 104-25) Occurs: where the taxpayer's ownership of an intangible asset ends by the asset:  being redeemed or cancelled; or  being released, discharged or satisfied; or  expiring; or  being abandoned, surrendered or forfeited; or  if the asset is an option – being exercised; or  if the asset is a convertible interest – being converted: s 104-25(1). Timing of a C2 event is when the taxpayer enters the contract that results in the asset ending or, if there is no contract, when the asset ends: s 104-25(2). Example 11.4: Event C2 Tim has a contract with Acme Co to be the exclusive supplier of their widgets for the next 10 years. Acme Co terminates the agreement with Tim after five years. Tim is paid $5,000 as compensation for the early termination of the contract. CGT event C2 happens as Tim's intangible asset, ie his rights under the agreement, have come to an end.

C3 End of option to acquire shares, etc (s 104-30) Occurs: A C3 event occurs when an option that a company or trustee of a unit trust granted to an entity to acquire a CGT asset, which is shares in the company ends because it is not exercised by the latest time for its exercise, is cancelled, released or abandoned: s 104-30(1). - Event C3 only deals with company issued options. All other options are dealt with as a D2 event, with the difference being the time of the event. Timing: The time of event C3 is when the option ends: s 104-30(2). Example 11.5: Event C3 On 1 January 2016 Gina pays Acme Co $100 for the right to acquire 10,000 shares in the company for $1 per share. The option to acquire shares must be exercised within 12 months of entering into the option. Gina decides not to exercise the option. As a result, the option expires and CGT event C3 happens on 1 January 2017.

104-D – Bringing into existence a CGT asset D1 Creating contractual or other rights (s 104-35) Occurs: where a taxpayer creates a contractual or other legal right in another entity: s 104-35(1). Time: when contract is entered or right is created Example 11.6: Event D1 Bart sells his business to Lucy. As part of the agreement, Bart agrees not to operate a similar business within a 5km radius for the next two years. Lucy pays $10,000 for Bart to agree to this restraint of trade. A contractual right in favour of Lucy has been created. If Bart breaches the contract, Lucy can enforce that right. CGT event D1 happens when the contract for the restraint of trade is entered and Bart will have a capital gain. At the end of the two-year period CGT event C2 will happen and Lucy will have a capital loss. Source: Adapted from s 104-35 of ITAA 1997.

D2 Granting an option (s 104-40) Occurs: if a taxpayer grants an option to an entity or extends an option already granted: s 104-40(1). Time: when option is granted Example 11.7: Event D2 Ben pays Sara $5,000 for an option to purchase her business. The one-month option is granted on 1 January 2017. Ben decides not to exercise the option. CGT event D2 happens on 1 January 2017 and Sara has a capital gain of $5,000 less any associated expenses. If Ben exercises the option, CGT event D2 is ignored and CGT event A1 happens:

D3 Granting a right to income from mining (s 104-45) Occurs: if a taxpayer who owns a prospecting entitlement or mining entitlement grants the right to receive income from the operation of the entitlement: s 104-45(1). Time: when contract is entered or, if none, when right is granted

D4 Entering a conservation covenant (s 104-47) Occurs: if a taxpayer enters a conservation covenant over land that he or she owns: s 104-47(1). Time: when covenant is entered into

104-E – Trusts CGT event number and description

Time of event is:

E1 Creating a trust over a CGT asset (s 104-55)

when trust is created

E2 Transferring a CGT asset to a trust (s 104-60)

when asset transferred

E3 Converting a trust to a unit trust (s 104-65)

when trust is converted

E4 Capital payment for trust interest (s 104-70)

when trustee makes payment

E5 Beneficiary becoming entitled to a trust asset (s 104-75) E6 Disposal to beneficiary to end income right (s 10480) E7 Disposal to beneficiary to end capital interest (s 104-85) E8 Disposal by beneficiary of capital interest (s 10490)

when beneficiary becomes absolutely entitled

when disposal contract entered into or, if none, when beneficiary ceases to own CGT asset

E9 Creating a trust over future property (s 104-105)

when entity makes agreement

E10 Annual cost base reduction exceeds cost base of interest in AMIT (s 104-107A)

when reduction happens

the time of the disposal the time of the disposal

104-F – Leases CGT event number and description F1 Granting a lease (s 104-110)

Time of event is: for grant of lease — when entity enters into lease contract or, if none, at start of lease; for lease renewal or extension — at start of renewal or extension

F2 Granting a long-term lease (s 104-115)

for grant of lease — when lessor grants lease; for lease renewal or extension — at start of renewal or extension

F3 Lessor pays lessee to get lease changed (s 104-120) F4 Lessee receives payment for changing lease (s 104-125) F5 Lessor receives payment for changing lease (s 104-130)

when lease term is varied or waived when lease term is varied or waived when lease term is varied or waived

Example 11.8: Event F4 On 1 January 2017, Jake (the lessee) enters a lease. On 1 May 2017, Jake agrees to waive a term. Eastfield (the lessor) pays Jake $1,000 for this. If Jake's cost base at the time of the waiver is $2,500, it is reduced from $2,500 to $1,500. On 1 September 2017, Jake agrees to waive another term. Eastfield pays Jake $2,000 for this. If Jake's cost base at the time of the waiver is $1,500, Jake makes a capital gain of $500 and the cost base is reduced to nil. Source: Adapted from s 104-125 of ITAA 1997. Example 11.9: Event F5 Eastfield owns a shopping centre. Con (the lessee of a shop in the centre) pays Eastfield $10,000 for agreeing to change the terms of its lease. Eastfield incurs expenses of $1,000 for a solicitor and $500 for a valuer. Eastfield makes a capital gain of $8,500. Source: Adapted from s 104-130 of ITAA 1997.

104-G – Shares G1 Capital payment for shares (s 104-135) Occurs: if a company makes a payment to a taxpayer in respect of shares the taxpayer owns in the company and the payment is not a dividend: s 104-135(1). Timing: when company pays non-assessable amount

G3 Liquidator declares shares worthless (s 104-145) Occurs: if a taxpayer owns shares in a company and a liquidator or administrator declares the shares worthless: s 104-145(1). Timing: when liquidator makes declaration

104-H – Special capital receipts H1 Forfeiture of a deposit (s 104-150) Occurs: if a deposit paid to a taxpayer is forfeited because a prospective sale or other transaction does not proceed: s 104-150(1).

Timing: when deposit is forfeited

H2 Receipt for event relating to a CGT asset (s 104-155) Occurs: happens if an act, transaction or event occurs in relation to a CGT asset that the taxpayer owns and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base: s 104-155(1). Timing: when act, transaction or event occurred Example 11.10: Event H1 Barry decides to sell land to Judy. A contract of sale for $120,000 is entered and Judy pays Barry a 10% deposit. Judy fails to complete the contract and the deposit is forfeited. CGT event H1 happens and Barry has a capital gain of $12,000 less any costs associated with the failed transaction. CGT event H2 happens if an act, transaction or event occurs in relation to a CGT asset that the taxpayer owns and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base: s 104-155(1). Example 11.11: Event H2 Max owns land on which he intends to construct a manufacturing facility. A business promotion organisation pays Max $50,000 as an inducement to start work early. No contractual rights or obligations are created by the arrangement. The payment is made because of an event (the inducement to start construction early) in relation to Max's land so a CGT event H2 happens and Max has a capital gain of $50,000 (less any costs associated with starting early). Source: Adapted from s 104-155 of ITAA 1997.

104-I – Australian residency ends I1 Individual or company stops being a resident (s 104-160) Occurs: when a taxpayer stops being an Australian resident: s 104-160(1). - However, an Australian resident individual may choose to disregard making a capital gain or capital loss, in which case the assets will be deemed to be taxable Australian property until a CGT event happens to those assets or the taxpayer becomes an Australian resident again. Timing: when individual or company stops being Australian resident I2 Trust stops being a resident trust (s 104-170) Occurs: if a trust stops being a resident trust for CGT purposes: s 104-170(1). Timing: when trust ceases to be resident trust for CGT purposes

104-J – CGT event relating to roll-overs CGT event numbe...