MODULE 5: REVENUE LAW Capital Gains Tax
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 2
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 occurs 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 3
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. 4
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
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 ownership • 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 6
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
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) 8
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 9
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 10
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 or 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 11
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 12
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’ 13
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) 14
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. 15
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 16
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 17
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 18
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) 19
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 20
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
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