(1) Structure of Income Tax Assessment Act 1997
ITAA 1997, Part 3-1
CGT: Income that derives from the disposal of property or other capital receipts. E.g. where capital gains may arise are where a person disposes of shares, property etc.
A CGT is essentially a tax upon gains from the realisation of property where the realisation is not an aspect of the carrying on of a business.
There is not a separate tax levied upon capital gains. In fact, where a net capital gain arises, it is included in assessable income and will bear tax at appropriate income tax rates.
The basic structure of the CGT regime requires you to follow the decision process as follows, in order to determine whether a capital gain or a capital loss arises from a CGT event, and in order to establish the amount of the capital gain or the capital loss.
The Five Step Approach to CGT
Step One: - Identify a CGT event
Step Two: - Calculate the capital gain or loss
Step Three: - Consider any exemptions or exceptions
Step Four: - Consider any roll-overs
Step Five: - Determine the net capital gain/loss for the income year
If you dispose of an asset, and receive property in return, it is the market value of the property which is the capital proceeds. When you work out your capital gain you have to work out your net capital gain, by adding all capital gains and subtracting all capital losses. You also take into account the net capital loss of the previous year. Your net capital gain goes into assessable income. If you end up with a net capital loss, it is carried forward to next year.
E.g.:
A house is bought:
Cost of acquisition: $100,000
Capital Improvements: $20,000
Incidental Costs (e.g. legal, stamp duty etc): $10,000
= $130,000 (Cost Base)
House is sold for $200,000 (Capital proceeds)
Capital Gain = $65,000 Division 116 (Capital proceeds)
Net Capital Gain - s102-5
- - - - -
2 Main Parts 3-1 (general divisions) and 3-3 (Specialist divisions) Part 3-2 left open for expansion.
S10-5 – Talks about statutory income. It refers ‘capital gains’ to 102-5. CGT is included in assessable income under 6-10.
(2) CGT Events
ITAA 1997, Divisions 103 and 104
The first step in determining whether a capital or capital loss has arisen is to decide whether a CGT event has taken place, and if so identify the relevant CGT event(s). Division 104 ITAA 97 sets out all the CGT events that may result in capital gain/loss.
The most common CGT event is “CGT event A1” which arises where a taxpayer “disposes” of a CGT asset (i.e. there is a change of beneficial ownership) (s104-10(1), (2)). The sale or gift of a CGT asset is an obvious example of CGT event A1. The CGT event is deemed to occur when the taxpayer entered into the contract for the disposal or, if there is no contract, when the change of ownership occurs (s104-10(3))
The CGT events summarized in s104-5 comprise the following 12 (A - L) categories:
1. disposal of a CGT asset: CGT event A1
2. use and enjoyment of a CGT asset before title passes: CGT event B1 – this event happens if a taxpayer enters into an agreement with another entity under which the right to the use and enjoyment of a CGT asset owned by the taxpayer passes to the other entity and title in the asset will or may pass to the other entity at or before the end of the agreement. The time of the event is when the other entity first obtains the use and enjoyment of the asset.
3. end of a CGT asset: CGT events C1 to C3 – Subdivision 104-C ITAA97 contains the rules dealing with the occurrence of this CGT event. The three occasions where this occurs are:
a. loss or destruction of a CGT asset: (C1)
b. cancellation, surrender and similar ending of an intangible CGT asset (C2)
c. end of an option to acquire shares (C3) – This CGT event happens if an entity is granted an option by a company or the trustee of a unit trust to acquire shares or debentures of the company or units or debentures of the unit trust and the option comes to an end in one of the following ways (s104-30(1) ITAA97):
i. it is not exercised by the latest time for its exercise
ii. it is cancelled, or
iii. it is released or abandoned.
4. bringing into existence a CGT asset: CGT events D1 to D4 – Subdivision 104-D contains the rules governing the following CGT events:
a. creating contractual or other rights (e.g. not to compete, exclusive dealing agreement): (D1) – a CGT event does not take place if the right was created through the borrowing of money or the obtaining of credit from another entity, the right requires the taxpayer concerned to do something which constitutes another CGT event for the taxpayer, a company issues or allots shares, or the trustee of a unit trust issues units in a trust.
b. granting an option: (D2) – includes an option that is granted, renewed or extended. It does not apply to options granted, renewed or extended by a company or the trustee of a unit trust to acquire shares in the company or units in the unit trust or debentures of the company or of the unit trust, or options relating to personal use assets or collectables.
c. granting a right to income from mining: (D3)
d. entering into a conservation covenant over land: (D4).
5. trusts: CGT events E1 to E9 – if a CGT event occurs in relation to the trust asset, the person who is absolutely entitled will be subject to the CGT liability, not the trustee.
6. leases: CGT events F1 to F5 – A lease is a CGT asset that confers on the lessee the rights to exclusive possession of the property, subject to native title rights. The premium that the lessee pays for obtaining the lease is the capital proceeds from the CGT event.
7. shares: CGT events G1 to G3 – These events are more concerned with events such as capital returns, value shifting and company liquidations.
8. special capital receipts: CGT events H1 and H2 – these events include forfeiture of deposits (H1) and receipt for event relating to a CGT asset (H2),
9. Australian residency ends: CGT events I1 to I2
10. reversal of roll-overs: CGT events J1 to J4
11. other CGT events: CGT events K1 to K12. The miscellaneous CGT events are:
o bankrupt pays an amount in relation to a debt (K2)
o asset passes to a tax-advantaged entity: (K3)
o CGT asset starts being trading stock: (K4)
o special collectables: (K5)
o pre-CGT shares or trust interest: (K6)
o balancing adjustment events for depreciating assets: (K7)
o direct value shifts (K8)
o carried interests: (K9)
o certain short term forex realization gains: (K10)
o certain short term forex realization losses: (K11)
o foreign hybrid loss exposure adjustment: (K12)
12. consolidated groups: CGT events L1 to L8.
Before there can be a capital gain/loss, most of the CGT events require something to happen to a “CGT Asset” that was acquired on or after 20 Sep 1985. Understanding the concept of a CGT asset is therefore an important part of the CGT process.
Section 108-5(1) of the ITAA97 defines a CGT asset in general terms to mean “any kind of property, or a legal or equitable right that is not property”.
The word “property” is a broad term and can be used to describe everything that a person may have control over. Property may be tangible or intangible.
ITAA97 - SECT 108.5
(1) A CGT asset is:
(a) any kind of property; or
(b) a legal or equitable right that is not property.
(2) To avoid doubt, these are CGT assets :
(a) part of, or an interest in, an asset referred to in subsection (1);
(b) goodwill or an interest in it;
(c) an interest in an asset of a partnership;
(d) an interest in a partnership that is not covered by paragraph (c).
Note 1: Examples of CGT assets are:
* land and buildings;
* shares in a company and units in a unit trust;
* options;
* debts owed to you;
* a right to enforce a contractual obligation;
* foreign currency.
For CGT purposes, each CGT asset needs to be classified into one of the following categories:
• collectables;
• personal use assets – there are four categories of personal use assets:
o a CGT asset (other than a collectable) used or kept mainly for the personal use or enjoyment of the taxpayer in question or an associate of the taxpayer
o an option or right to acquire such an asset
o a debt arising from a CGT event affecting such an asset, and
o a debt arising other than in the course of gaining or producing assessable income or from carrying on a business. (p369 ATL)
other assets
(4) Cost Base
Generally, a capital gains is the difference between the cost base of an asset and the capital proceeds from the CGT event in relation to that asset.
# Division 110 ITAA97 provides the rules for determining the “cost base” and definition
# *Section 110-25(1) defines “cost base” as consisting of five elements, summarised as:
1. Cost of the asset
2. Incidental costs of acquisition and disposal.
(eg professional remuneration to brokers and agents, transfer costs, stamp duty, advertising and valuation costs: s110-35)
3. Ownership costs.
Applicable to assets acquired after 20 August 1991 (but not to personal use assets or collectables: s108-17 and s108-30), is the non-capital costs of ownership of the asset (e.g. interest on money borrowed to acquire or refinance the asset; costs of maintaining, repairing or insuring the asset; and rates or land tax) s110-25(4)
4. Improvement, moving and installation expenditure, and
5. Expenditure to establish, preserve or defend title to or rights over the asset.
The first, second, fourth and fifth elements of the cost base of a CGT asset acquired before 11:45am on 21 September 1999 may be indexed to take into account changes in the CPI. Set out in s113.1 – ITAA 97
ITAA 1997 – SECT 114.1
Indexing elements of cost base
In working out the * cost base of a * CGT asset * acquired at or before 11.45 am (by legal time in the Australian Capital Territory) on 21 September 1999, index expenditure incurred at or before that time in each element. (The expenditure can include giving property: see section 103 5).
Note 1: Subdivision 960 M shows you how to index amounts. The indexation does not take account of inflation after 30 September 1999.
Note 2: You have to work out the cost base of a CGT asset if a CGT event happens in relation to it or if there is a cost base modification.
Note 3: You cannot index expenditure in the third element (costs of ownership): see subsection 960 275(4).
Note 4: Indexation is not relevant to expenditure incurred after 11.45 am on 21 September 1999 or any expenditure relating to a CGT asset acquired after that time.
Example: Peter purchases a building as an investment on 1 January 1994 for $250,000. This amount forms the first element of his cost base.
He sold the building on 1 February 1996.
The index number for the quarter in which he sold the building (the March quarter 1996) is 119.0. The index number for the quarter in which he purchased the building (the March quarter 1994) is 110.4.
Reduced cost base
Subdivision 110-B ITAA97
S110-55 - General rules about reduced cost base
The reduced cost base of a CGT asset has 5 elements where 1,2, 4 and 5 are the same as for the cosy base. The third element for the reduced cost base is any amount that is assessable of a balancing adjustment for the asset or would be assessable if certain balancing adjustment relief was not available. No element in the reduced cost base is indexed.
General Modifications to Cost Base and Reduced Cost Base
The general rules for determining the cost base and the reduced cost base of a CGT asset sometimes have to be modified. Most modifications replace the first element of the cost base and reduced cost base of a CGT asset, namely, the amount paid for the CGT asset.
S112-15 General rule for replacement modifications
If a cost base modification replaces an element of the * cost base of a * CGT asset with an amount, this Part and Part 3 3 apply to you as if you had paid that amount.
Example: An individual pays $10,000 to acquire an option. The individual dies and the option devolves to his legal personal representative, who exercises the option.
Section 134 1 applies to the legal personal representative as if the representative had paid $10,000 for the option.
The general rules for working out the cost base and reduced cost base of an asset are modified by special rules in Div 112. These modifications relate to:
- Replacement of the actual cost with the market value
- Split, changed or merged assets
- Apportionment rules
- Assumption of liability
The most important of these is the “market value substitution rule” which provides that the first element of the cost base and reduced cost base of a CGT asset acquired from another entity is its market value at the time of acquisition if:
• the taxpayer did not incur expenditure to acquire it (eg the asset was received as a gift)
• 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 (s112-20).
E.g. A father gave his daughter shares as a gift. The cost base of those shares to the daughter would be the market value of the shares at the date of the gift.
Section 116-20 ITAA97 provides that the capital proceeds from a CGT event are the total of:
- the money the taxpayer has received, or is entitled to receive, in respect of the CGT event, and
- the market vale of any other property the taxpayer has received, or is entitled to receive, in respect of the CGT event.
s116 – 25. Modifications to general rule
s116 – 30 (1) & (2). Market value substitution rule. If asset disposed of for $NIL or when capital proceeds are more or less than market value, and then parties are not dealing at arms length, the capital proceeds are deemed to be market value.
s116 – 40(1). Apportionment rule. If you receive a sum relating to more than 1 CGT event, just apportion capital proceeds to each CGT event and reasonably attribute to the event.
(2) CGT event and something else, apportion on reasonable basis.
s116 – 45. Non-receipt rule – If you do not receive they money and you took reasonable steps to get the unpaid amount, then you reduce the capital proceeds by that event. (eg settlement falls through etc).
s116 – 50. Repaid rule. If you receive some capital proceeds but give some of it back for whatever reason, eg compensation, capital proceeds are reduced by that amount.
s116 – 55. Assumption of liability rule. If you sell something and someone assumes your liability that is secured over that asset, you are treated as having received that money too.
Division 118 contains all the exemptions.
(6) Calculation of Capital gain/loss
ITAA97, Division 102
The first step in determining the CGT consequences for a taxpayer involves as already notes, indentifying the appropriate CGT event. The next step is to actually calculate the capital gain or capital loss that arises.
Section 102.5 - Assessable income includes net capital gain (tells you how to work out your capital gain)
Step1 says your assessable income includes your net capital gain i.e. capital gains during the year, reduce it by the losses during the year.
Step 2 says apply any unapplied capital losses from prior years.
Step 3 says you then apply the concession.
Step 4 applies small business concession.
Step 5 says if you have capital gains remaining, then the sum of the capital gains is your net capital gain.
Section 102.10 - How to work out your net capital loss (Says you add up capital gains less capital losses, then you have a net capital loss for the year)
(2) you cannot deduct from you assessable income a net capital loss for any income year.
Sec 102 – 15 tells you how to apply your net capital losses.
Sec 102 – 20 – You can make a capital gain or capital loss if and only if a CGT event happens.
The calculation of capital gain or loss is spelt out individually for each CGT event in Div 104.
A taxpayer’s net capital gain for an income year is worked out according to the following five steps:
• Step 1: Any “capital gains” made during the income year are reduced by “capital losses” made during the year.
• Step 2: Any remaining capital gains are then reduced by any “net capital losses” from earlier years.
• Step 3: Any remaining capital gains which are “discount capital gains” are then reduced by the “discount percentage”.
• Step 4: Any remaining capital gains that qualify for any of the “small business concessions” are then reduced under those concessions.
• Step 5: The amount of any remaining capital gains is the taxpayer’s net capital gain for the year. (p92 CTL)
Net capital loss: A “net capital loss” arises to the extent that the taxpayer’s capital losses for the year exceed the taxpayer’s capital gains for the year (s102-10(1)).
(7) Exemptions
ITAA97, Division 118
Once it has been establish that there is a CGT event which applies and the quantum of th4e gain/loss from that event has been calculated, the next step is to establish whether any exceptions or exemptions apply to the capital gain/loss, Where exceptions or exemptions do apply, the capital gain or loss may be disregarded or in some circumstance may be reduced.
The CGT regime disregards certain capital gains and capital losses. The most important exemption applies to gains and losses relating to a dwelling that is the “main residence” of a taxpayer (s118-110). A partial exemption usually applies where the dwelling is the main residence for only part of the ownership period (s118-185) or where it also used to produce assessable income (s118-190). Other exemptions relate to:
• cars, motor cycles and similar vehicles (s118-5)
• collectables acquired for $500 or less and personal use assets acquired for less than $10,000 (s118-10)
• assets used solely to produce exempt income or certain forms of non-assessable non-exempt income (s118-12)
• shares in PDFs (s118-13)
• depreciating assets (s118-24)
• trading stock (s118-25)
• compensation or damages for personal and occupational injuries (s118-37(1)(a), (b))
• gambling or competition winnings (s118-37(1)(c))
• expiry, surrender or forfeiture of leases not used solely or mainly for the purpose of producing assessable income (s118-40)
• specified venture capital investments in Australian entities by non-residents (Sub divs 118-F and 118-G).
• decorations for valour unless they were purchased (the social and political cost of taxing heroes on awards or the descendants who inherit them is sensibly avoided).
Division 149 ITAA97 sets out the rules that govern when an asset acquired before 20 September 1985 is to be treated as acquired after that date.
Division 149 - When an asset stops being a pre-CGT asset
Covers any entities, not just property companies and trusts, that have significant pre Sept 85 assets. It says that where you can not identify continuity of the underlying interests in a group of natural persons – so trace through, etc, who at midnight on 19.09.85 held a majority underlying interest in that asset. As soon as that test fails, i.e. where there is no continuity of greater than 50% underlying ownership, that asset in the company loses its pre CGT exempt status, and becomes a post CGT asset. The cost base is the market value at the time it loses its pre CGT status.
Section 149.10 - What is a pre-CGT asset?
A CGT asset that an entity owns is a pre-CGT asset if, and only if:
(i) the entity last acquired the asset before 20 September 1985;
(ii) the entity was not, immediately before the start of 1998/99 year, taken under the CGT provisions to have acquired the asset on or after 20 September 1985; and
(iii) the asset has not stopped being a pre-CGT asset of the entity because of Div 149 (149-10)
Section149.15 - Majority underlying interests in a CGT asset
(1) Majority underlying interests in a * CGT asset consist of:
(a) more than 50% of the beneficial interests that * ultimate owners have (whether directly or * indirectly) in the asset; and
(b) more than 50% of the beneficial interests that * ultimate owners have (whether directly or * indirectly) in any * ordinary income that may be * derived from the asset.
(2) . . .
An asset ceases to be a pre-CGT asset in specified circumstances. There are different rules relating to the assets of non-public entities, public entities and demutualised public entities.
1. When asset of a non-public entity stops being a pre-CGT asset. An asset of a non-public entity stops being a pre-CGT asset if the majority underlying interests in it are not held by ultimate owners who held those assets just before 20 September 1985. The entity is taken to have acquired the asset at the earliest time when majority underlying interests in the asset were no longer held by ultimate owners who had held majority underlying interests immediately before 20 September 1985.
2. When asset of public entity stops being a pre-CGT asset. Subdivision 149-C applies to a company if its shares are listed on an approved stock exchange, to a publicly traded unit trust, to a mutual insurance or mutual affiliate company and to certain related entities.
3. How to treat a demutualised public entity. Subdivision 149-F contains rules for determining the underlying interests in assets of certain entities that were mutual companies at the starting day but have demutualised since that time.
(9) Other Provisions
ITAA97, Division 109 & 128
Division 109--Acquisition of CGT assets
Division 128--Effect of death
There are many other CGT acquisition rules which apply in specific situations and which are dealt with by specific provisions covering these situations (s109-55 ITAA97). These situations are where:
1. a CGT asset devolves to a legal personal representative or a beneficiary because someone dies;
2. a CGT asset passes to the taxpayer as beneficiary in the estate of a deceased individual;
3. a surviving joint tenant acquires a deceased joint tenant’s interest in a CGT asset;
4. a taxpayer gets only a partial main residence exemption on a dwelling but would have got a full exemption if a CGT event happened to it just before the first time it became income-producing;
5. the trustee of a deceased estate acquires a dwelling under a will for a taxpayer to occupy it and the taxpayer obtains an interest in it;
6. a replacement-asset roll-over happens for a pre-CGT asset;
7. a replacement-asset roll-over happens for a Crown lease, or for a prospecting or mining entitlement, that is renewed or replaced and part of the new entitlement relates to a part of a pre-CGT entitlement;
8. the taxpayer obtains a same-asset roll-over for a pre-CGT asset;
9. there is a same-asset roll-over for a post-CGT asset because the trust deed of a complying superannuation fund or approved deposit fund is changed;
10. a company or unit trust issues bonus equities to a taxpayer and no amount is included in the taxpayer’s assessable income;
11. a taxpayer owns shares in a company or units in a unit trust and exercises rights to acquire new equities in the company or trust;
12. a taxpayer acquires shares in a company or units in a unit trust by converting a convertible note;
13. a taxpayer acquires a qualifying share or right under an employee share scheme and a CGT event does not happen to it at the cessation time or within 30 days after that time;
14. a lessee of land acquires the reversionary interest of the lessor and there is no roll-over for the acquisition;
15. the taxpayer owns a pre-CGT asset and there has been a change in the majority underlying interests in the asset;
16. the taxpayer becomes a resident while owning a post-CGT asset that did not have the necessary connection with Australia;
17. an asset is rolled over between companies in the same wholly-owned group and the recipient company stops being a 100% owned subsidiary of the wholly-owned group.
The provisions of ITAA97 that deal with the effect of death are contained in Div 128.
Section 128-1 provides a guide to the Division.
It indicates that the Division sets out what happens when a taxpayer dies and his or her CGT assets devolve to a legal personal representative or pass to a beneficiary of the estate. The death of a person results in the necessity for the apportionment of either an executor or administrator. Generally, the death of a taxpayer does not constitute the disposal of an asset by the deceased. The general rule is that when a taxpayer dies, the death does not constitute a disposal. The effect is set out in s128-10 ITAA97 as:
“When you die, a capital gain or capital loss from a CGT event that results for a CGT asset you owned just before dying is disregarded.”
There is an exception to the rule in s128-10. The exception applies if the CGT asset passes to a beneficiary in the taxpayer’s estate who is: (1) an exempt entity; (ii) the trustee of a complying superannuation entity; or (iii) not an Australian resident.
Division 128 of the ITAA97 provides that a CGT event arising from death is disregarded and instead gives a rollover of the cost base of post-property to the new owners for the purpose of calculating their gains or losses. The new owners are deemed to have acquired pre-assets at their market value on the date of death so that gains on pre-assets up to the time of death are exempt from taxation.