Capital Gains Tax Learning Outcomes To be able to identify the - - PowerPoint PPT Presentation

Capital Gains Tax

MODULE 5: REVENUE LAW

2

Learning Outcomes

• To be able to identify the assets to which the capital

gains tax (CGT) applies

• To understand the impact that the capital gains tax

provisions have on the determination of assessable income

• To be able to determine the components of the cost base

and the reduced cost base, as well as their significance

• To understand the impact that the capital gains tax

provisions have on certain transactions relating to property

3

What is a Capital Gains Tax?

• Capital gains tax (CGT) is the tax paid on any capital

gain (value increase) made in the financial year when a CGT event occurs to a CGT asset

• A capital gain arises in the year when the CGT event
• ccurs and the amount received is greater than the

amount paid to acquire and maintain the asset

• A taxpayer is required to include details of any net

taxable gain or loss, in their tax return each year for gains or losses actually realised

4

General Rules for Ascertaining Liability

One of the exceptions to the rule are assets acquired prior to 19 September 1985 (not subject to CGT). The steps in determining CGT liability are: 1. Did a CGT event happen 2. Did the CGT event involve a CGT asset 3. Does an exemption apply 4. Do rollover provisions apply 5. Is there a capital gain or loss It is recommended you use this process when answering any exam question on Capital Gains Tax.

Step 1: Identifying a CGT Event

• 12 categories: summarized in s. 104-5

ITAA97 – over 50 possible separate ‘events’ applicable

• A transaction which gives rise to a CGT

event may also give rise to another CGT

• event. In these circumstances the taxpayer

must select the one that is most relevant

• Three exceptions where the Act specifies

which one will be applicable We will look at these events in the following 15 slides

5

6

CGT Event A1: Disposal of a CGT Asset

• Disposal of an asset by sale, gift or compulsory

acquisition leading to a change in the beneficial

• wnership
• The capital gain or loss made at the time of the

event

• In ‘Sale of Land’ contracts, the relevant time is

the exchange of contracts not settlement

• The timing is critical because it determines the

tax year that the gain will be taxed

CGT Event A1: Disposal of a CGT Asset continued

An ‘event’ does not occur in the following situations: – Amalgamation of titles or subdivision if the ownership remains unchanged – A change of trustee – If a land holding is converted from joint tenant to a tenant-in- common – If an asset is disposed of to provide or redeem a security (eg mortgage paid out) – Where an asset vests in a trustee or liquidator in a bankruptcy or liquidation.

7

8

CGT Event B1: Use and enjoyment of a CGT asset before title passes

• Examples:

– Purchaser has the benefit of an asset under hire-purchase before the title passes – Where there is a ‘term contract’ for sale of land – Options to purchase in leases, if exercised, the date of acquisition for CGT purposes is backdated to the date when the ‘use and enjoyment was acquired’ (that is, when the lease began)

9

CGT Event C1: Loss or destruction of an asset

• Where a CGT asset is lost or destroyed, the

capital gain or loss is determined by the level of compensation

• The Event occurs when the compensation is

received

• If no compensation is received the event occurs

when the loss or destruction happens

10

CGT Event D1: Creating contractual or other rights

Where an agreement is entered into by which rights are created, such an agreement to endorse particular products, or not to compete, or granting rights over property, then CGT event D1 occurs. Example: – In Higgs v Olivier, Sir Lawrence Olivier agreed to accept a payment $15,000 not to perform in a Shakespearian film for 18 months. Held not to be assessable income, but capital (would be subject to CGT today). – Capital gain to Olivier, $15,000 less costs incurred for the contract – Capital loss,$15,000 plus incidental costs to prepare contract, for the film producer at the end of the 18 months or earlier if a breach was litigated

11

CGT Event D2: Granting an Option

A capital gain arises if the capital proceeds from the grant, renewal or extension of the option exceeds the expenditure for the grant, renewal

• r extension.

Example: – Option to purchase land granted for $5,000. If not exercised, the amount is recognized in the tax year when received. – Once the option is exercised the option amount is added to the purchase price and taxable in the year the contract is entered into. (Possibly need to lodge amended tax return if already included in the previous year.) Capital gain: for grantor of option less costs associated with the option Capital loss: for option purchaser if not exercised, plus incidental costs

12

CGT Events E1 to E9: Trust dealings Generally

• Rights split between the trustee (legal owner)

and the beneficiaries (equitable owners entitled to the income or to occupy property)

• If the beneficiary is ‘absolutely entitled’ to the

property he will be treated as liable to pay tax as if he had carried out the transaction

• 9 CGT Events concerning trusts

13

CGT Event E1: Creating a trust over a CGT Asset

• This occurs when there is a transfer of a CGT asset to a trust by

way of declaration or settlement

• The capital gain liability is the difference between the cost base

(see later) and the capital value on entry

• If you wished to transfer an investment property you owned to a

trust or superannuation fund, CGT would be payable on the increase in value since purchase

• Concessions and exemptions facilitate transfer of small business

assets but not investment assets

• ‘Blind’ trust exempt because the original owner is the sole

beneficiary and ‘absolutely entitled’

14

CGT Events F1 to F5: Leases Generally

• A lease is a CGT asset that confers on the lessee

the rights to exclusive possession

• If the lessee pays the lessor a premium

(in addition to rent) for granting the lease the premium (not the rent) is classified as capital proceeds from the CGT event There are 5 CGT events concerning leases

(see following slides 15 to 20)

15

CGT Event F1: Granting a Lease

• If the lessor grants, renews or extends a lease a CGT

event occurs if the action is for a premium

• The lessor may make a capital gain or a loss from such

an event

• If the lessee transfers or assigns a lease he/she may

also make a capital gain or loss Example:

A lessee leases office space from B and pays a premium of $25,000. The legal costs incurred are $2,000. The taxable capital gain would be $23,000 ($25,000 – $2,000) on the premium.

16

CGT Event F2: Granting a Long-Term Lease

• This CGT event occurs if the lessor grants,

renews or extends a lease over land for 50 or more years

• The time of this CGT event is the date of the

grant, renewal or extension

• The capital gain is realised if the capital

proceeds are greater than the cost base of the lessor’s interest in the land

17

CGT Events F3 & F4: Payments for variation to terms of leases

• This capital loss is the price paid by the lessor to compensate

the lessee for agreeing to make changes to the lease

• The payment made is a capital gain in the hands of the lessee

and is calculated against the ‘cost base’ of the lessee

• However the lessee can not claim a capital loss on the

variation

• The time the event occurs is when the lease term is varied or

waived See example slides 18 & 19

18

Example: CGT Implications of payments for a lease term variation

On 1 July 2013 Bill Mason granted Helen Marsh an eight-year lease for a premium of $20,000 On 4 May 2015, Mason pays Marsh $13,000 to have the term reduced to four years The CGT implications of these transactions are:

• 1. CGT event F1 arises on 1 July 2013, Mason will have a capital gain in the year

ending 30 June 2014 of $20,000 less any costs associated with the event

• 2. CGT event F3 will arise on 4 May 2015 and Mason will have a capital loss of

$13,000 during the year ending 30 June 2015

19

Example of the CGT Implications of payments for a lease term variation The CGT implications continued:

• 3. CGT event F4 will arise on 4 May 2015. The cost base of

Marsh’s lease will be reduced by $13,000 from $20,000 to $7,000

• 4. CGT event C2 will arise on 30 June 2017. Marsh will

realise a capital loss of $7,000 on the expiry of the lease (assuming she used the lease mainly to produce assessable income)

20

CGT Event F5:

Lessor receives payment for changing the lease

• If the lessor receives payment or property for

agreeing to vary the term of a lease it is a capital gain

• The gain or loss is the difference between the

costs incurred and the capital proceeds

• If property is given (a gift), then the value is

assessed at market value of the property

Step 2: Did the CGT Event involve a CGT Asset?

For there to be a capital gain or loss, something must happen to a CGT asset that was acquired after 20 September 1985. A CGT asset is: – Any kind of property – A legal or equitable right that is not property CGT assets are divided into 3 categories:

• 1. Collectables (see next slide)
• 2. Personal use assets (see next slide)
• 3. Other assets, including land, buildings and shares, etc

21

22

Categories of Assets to which CGT applies

Collectables (mainly for personal use and enjoyment) include:

• 1. Paintings and similar art works
• 2. Jewelry
• 3. Antiques
• 4. Coins and medallions
• 5. Stamp collections
• 6. Rare books
• Assets costing $500 or less are disregarded

Personal use assets

• Assets acquired for personal use or pleasure such as boats,

furniture and the like are disregarded if acquired for less than $10,000 (capital losses disregarded)

23

Categories of Assets to which CGT applies

Exercise: Some times an asset may or may not be a CGT asset Is Bitcoin a CGT asset ? Well it depends on the taxpayer’s intention, actions and activities. a) Bitcoin mining b) Trading in Bitcoin c) Investing in Bitcoin d) Receiving and Spending Bitcoin

Step 3: Does an Exemption Apply?

Exemptions:

• Principle residence (slides 26 to 29)
• Specific assets listed next slide
• Anti-overlap provisions to prevent double taxation
• Exempt loss-denying transactions such as expiry of a lease or

compensation for any wrong, injury or illness, etc (Woellner,

• para. 7-715)

Small business exemptions:

• Full exemption for an active asset held 15 yrs
• A 50% exemption for active assets owned under 15 yrs
• Small business retirement exemption up to $500k one-off

24

25

Step 3: Does an Exemption Apply?

Exempt Assets include:

1. Motor vehicle of less than 1 tonne (carrying capacity) 2. A decoration awarded for valour or bravery 3. Compensation for personal injury or wrong suffered in your occupation 4. Winnings or losses from gambling 5. Collectables acquired for less than $500 6. Personal use assets acquired for less than $10,000 7. Main residence (see following 4 slides)

26

Main Residence Exemption

Policy reasons:

– Home ownership to be encouraged – If CGT imposed it may affect mobility of work force within Australia and regional areas – Difficulty of record keeping (many years ownership) – If proceeds used to purchase other property any gain would be illusory – It would discourage older Australians from down sizing from larger homes to smaller homes, contrary to public policy

27

Main Residence Exemption continued

• Taxpayers dwelling exempt if:

– The taxpayer is an individual (not trust or company

• wnership)

– The property is the main residence – The residence passes to the taxpayer as a beneficiary

• r trustee of a deceased estate
• There can sometimes be a time gap between the

acquisition of a residence and moving in. If the taxpayer moved in as soon as reasonably possible then the liability will not be affected (eg repairs and renovations).

• The exemption does not apply to foreign or

temporary visa resident owners as from 9 May 2017.

28

Main Residence Exemption continued

• Change of main residence: both treated as main

residence where the taxpayer needs to dispose of previous main residence (up to 6 months)

• Absence from the main residence: up to 6 years

when rented out or indefinitely if not rented out (overseas postings).

• Where the taxpayer renovates, alters or builds a

property, entitled to treat that property as his main residence for up to 4 years before taking up residence (must not already have a main residence).

29

Main Residence Exemption continued

• Partial exemption:

– If the property was used as the main residence for part only of the ownership period (excluding previous exemptions), in case of owning another property. – Where the premises were used for income producing activities for part of the period (eg rental property) – Part of the property is used continuously for income producing activities and part as main residence (eg home based business, home office occupany deduction or AirBNB)

Step 4: Do Rollover Provisions Apply?

• Allows for a gain or loss to be deferred until a

future event

• Commonly occurs when:

– The funds are used to acquire a replacement asset or business – In the transfer of assets following a marriage breakdown – When a sole trader transfers his/her business to a wholly owned company (setting up a trust) – Transfer after death (subject to 2 year limitation for real estate)

30

31

Small Business Relief

Basic pre-conditions for CGT relief:

• 1. Business turnover less than $2 million dollar
• 2. Maximum net asset value test ($6m)
• 3. Active asset test used in the business
• 4. Controlling individual/concession stakeholder test (20% control)

Note dealing with an investment property(s) does not constitute a small business asset, even if you own a number of properties.

Small Business Relief Continued

• 1. Small business 15 year total exemption on active assets

An active asset is used in the business or held ready for use. The asset must have been used for at least half of the period of ownership by the business or connected entity.

• 2. Small business 50% reduction (partial relief)

If less than 15 years but more than one year. Any capital gains are offset by losses first before applying the discount. Note: This is in addition to the 50% general discount for individuals from September 1999, so up to 75% CGT discount is possible.

• 3. Small business retirement exemption (lifetime limit of $500,000)

The business owner is 55 years + or under 55 years and funds contributed to complying superannuation fund or retirement savings account. Taxpayer must satisfy sub-div 152-A for threshold test (Net asset value test, less than $6M).

• 4. Small business rollover exemption – a company has 2 years to buy a replacement

active asset of equal or greater value from the capital gain. If no asset is acquired within 2 years or the asset cost is less than the capital gain then CGT events J5 or J6, respectively.

32

Step 5: Is there a Capital Gain or Loss?

In general terms, the capital gain or loss is determined by the following formula Capital Proceeds from CGT Event (-) Less Cost Base of the Asset = Capital Gain or Loss

33

34

To Determine the Cost Base : 5 elements

• The cost of the asset +
• Incidental costs of acquisition and disposal +
• Non-capital holding costs +
• Enhancement expenditure +
• Expenditure to establish, preserve or defend

title to or rights over the asset

35

Establishing the Cost Base and Capital Gain in Real Estate Transactions

1. The amount paid for the property acquisition or if a gift, the market value at time of acquisition

+

2. Legal costs, stamp duty on purchase and selling costs (incidental to purchase and sale)

+

• 3. Non-capital holding costs such as insurance premiums, interest on

loans and water and council rates (as long as these amounts have not been off-set previously against income derived from the property)

+

• 4. Cost of renovations or additions or improvements

+

(continued next slide)

Establishing the Cost Base and Capital Gain in Real Estate Transactions continued

• 5. Payments to defend the title or value of the

property (e.g. challenging the Valier General’s valuation)

= THE COST BASE

A Capital Gain is the difference between the ‘cost base’ and the sale proceeds A Capital Loss is the difference between the ‘reduced cost base’ and the sales proceeds, also excludes cost element 3.

36

Establishing the Cost Base and Capital Gain in Real Estate Transactions

Example:

1. Purchase of investment unit 1986 $-125,000 2. Legal costs, stamp duty on purchase -37,200 Legal, sales commission on sale

• 35,900
• 3. Non-capital holding costs claimed
• 4. New kitchen and painting
• 28,400
• 5. Payments to defend title

Cost base

• 226,500

Sale of investment unit in 2015 728,000 Capital gain 501,500 Less 50% discount

• 250,750

Net capital gain $250,750

000037

38

Determine the Net Capital Gain

Stage 1: Reduce capital gain by any capital loss from same year* Stage 2: Reduce capital gain by carrying over losses from previous years* Stage 3: Reduce capital gain by any discount percentage applicable (usually 50% general discount or indexing, if

• wned for more than 12 months)

Stage 4: Apply any small business CGT concessions Stage 5: Calculate the net capital gain for the income tax year and add to assessable income * Must be the same category, you cannot use a capital loss on collectables as an off-set for a capital profit on the sale of land or

• ther CGT assets. Losses on collectibles quarantined for use

against gains on collectibles.

39

Methods of Calculating the CGT

Methods to use when Capital Gain calcuated:

• Indexing method - available for assets held prior to 21 September 1999.

Apply the published CPI index factor to the costs based upon the dates and quarter incurred. The asset must have been held for 12 months. (Woellner,

• para. 7-690 to 7-698)
• Discounting method - available for assets after 21 September 1999, held for

12 months or more. Apply 50% discount after calculating the capital gain and applying any capital losses in current year or carried forward from prior

• years. Available to individual, trust and superannuation (33.3%) taxpayers

(Woellner, para. 7-915 to 7-935)

• Other method – no indexing or discount on cost available, because asset

held less than 12 months. (s. 102-5 ITAA97) When eligible to both indexing and discounting use the one for best result

40

Maintain Appropriate Records

Records must be kept to show:

– Acquisition costs – The CGT event and any incidental costs involved – Calculations of depreciation and other costs deducted – The capital proceeds from the CGT event – Records in English and for minimum of 5 years

Asset Register Information can be transferred and certified by a registered tax agent. It is then only necessary to keep supporting documents for 5 years.

Practice CGT Calculations 1 CGT gain or loss?

• Sold a gold coin for A$ 2,200 (30/6/2019),

purchased for A$600 (1/7/1989). CGT gain ?

• Sold a boat for $20,000 (30/6/2019),

purchased for $30,000 (1/7/2016). Rented out the boat on Air Tasker during 50% of

• wnership. Ignore depreciation of original
• cost. CGT loss ?

Practice CGT Calculations 2 CGT gain or loss?

• Vacant land held for 5 years to develop as

main residence but it never happened. Cost was $85,000, sold for $125,000. Land taxes

• f $25,000; council rates of $5,000 and costs

to sell $6,250 incurred.

Practice CGT Calculations 2 CGT gain or loss?

Solutions:

• 1. Did a CGT event happen – Yes, A1 event
• 2. Did the CGT event involve a CGT asset –

Land is a CGT asset

• 3. Does an exemption apply – Land held

longer than 4 years, no exemption

• 4. Do rollover provisions apply - None
• 5. Is there a capital gain or loss – Calculate it

Practice CGT Calculations 2 Calculate CGT gain or loss?

1. Total purchase costs of vacant land $-85,000 2. Selling costs

• 6,250
• 3. Non-capital holding costs claimed -30,000

(land tax $25,000 + council rates $5,000)

• 4. Capital improvements
• 5. Payments to defend title

Cost base

• 121,250

Sale of vacant land 125,000 Capital gain 3,750 Less 50% discount

• 1,875

Net capital gain $1,875

000044

Practice CGT Calculations 3 CGT gain or loss?

• Sold main residence for $1,200,000
• Exchange date on sale 30/6/2019
• purchased for $550,000 (contract date 1/7/2010)
• held for 9 years
• rented out 1/3 of property on Air BNB for the last 3 years
• claimed all deductible costs in relevant tax years
• other selling costs: commissions $42,000 and legal expenses

$3,500

• no capital building works deduction available since property

was 40+ years old when acquired

• Taxable capital gain ?

Practice CGT Calculations 3 CGT gain or loss?

Solutions: 1. Did a CGT event happen – Yes, A1 event 2. Did the CGT event involve a CGT asset – residential real estate is a CGT asset 3. Does an exemption apply – main residence, full exemption 6 yrs, partial 3 yrs 4. Do rollover provisions apply - None 5. Is there a capital gain or loss – Calculate it

Practice CGT Calculations 3 CGT gain or loss?

Calculation – solutions Time period & Exemption % Total ownership period: 2192 + 1095 = 3287 days Fully exempt: 6 yrs = 365 days x 6 + 2 days (leap years) = 2192 days (2192/3287 = 66.69 %) Partially exempt: 3 yrs = 365 days x 3 = 1095 days (100% – 66.69% = 33.31% x 66.7% (1-.333=.667, AirBNB) = 22.22% Total capital gain exemption %: 88.91% (66.69+22.22)

Practice CGT Calculations 3 Calculate CGT gain or loss?

1. Total purchase costs $-550,000 2. Selling costs ($42,000+3,500)

• 45,500
• 3. Non-capital holding costs claimed 0
• 4. Capital improvements
• 5. Payments to defend title

Cost base

• 595,500

Proceeds on sale of residence 1,200,000 Capital gain 604,500 Less Exemptions (88.91%) -537,460 Capital gain – before discounting $67,040

000048

Practice CGT Calculations 3 Calculate CGT gain – cont’d

Capital gain before discount $67,040 Less 50% discount *

• 33,520

Net capital gain $33,520

If property held jointly (tenants in common) between two taxpayers then apportion capital gain: 50% x $33,520 = $16,760 each. If ownership some other % based on Torrens title then allocate on relevant % ownership. * Apply any other capital losses from current year or prior year before discounting by 50%.

000049

Foreign Resident Vendors CGT withholding tax provisions

• As from 1 July 2017 the tax legislation will require a purchaser to withhold and

pay 12.5% (previously 10% from 1 July 2016) of the purchase price to the ATO in certain circumstances. The new withholding regime will apply to a wide range of transactions relating to real estate, shares in companies and units in unit trusts.

• The rules are designed to collect tax from ‘deemed’ foreign residents vendors

that make gains from selling taxable Australian property.

50

Foreign Residence CGT withholding tax provisions (cont’d)

• The obligation on purchasers to withhold from the vendor has a broad

application

• How will the withholding provisions operate?

Conveyancers required to enforce compliance on settlement of sales contracts. (Refer reading 5.5)

• Purchasers of Australian real estate will be required to withhold and pay to

the ATO, unless:

• the market value of the real estate interest (actual or indirect) being sold is less

than $750,000, down from $2 million

• the seller obtains a clearance certificate from the ATO

Note that all taxpayers selling residential property must now disclose in their tax return (in the year of sale) that the transaction was exempt or calculate the CGT gain

• taxable. ATO collects records of real estate sales proceeds.

51