Tutorial No. 5 Capital Gains and Losses

(Starting the week beginning Monday 28 August 2017)

Q 1 Income vs Capital

- Why is the distinction important to individuals?

Jeremiah and Jaini were walking away from their income tax lecture that had just discussed Capital Gains Tax.Jeremiah said

'You see Jaini, the government has stitched everything up - for the last few weeks we learnt we have to declare all our ordinary and statutory income, and this week, to top it off, if we make any capital gains, we have to declare all of that as well.So whatever receipts we get, we get taxed on!So why even bother distinguishing income and capital, they all amount to assessable income?'

Scenario 1

Jeremiah had purchased a block of land in 1984 but never got to use the land as he had intended and only recently sold the property in its original undeveloped state.There was a significant capital gain on the property but Jeremiah did not declare the capital gain.But his friend Jaini who purchased an adjacent block of land in 1986 and also recently sold the land did declare the capital gain.

Scenario 2

Jeremiah had purchased a block of land in 1986 but never got to use the land as he had intended and only recently sold the property in its original undeveloped state.He made a significant capital gain on the property but Jeremiah only declared half the capital gain.

Scenario 3

Jeremiah had purchased a block of land in 1986 but never got to use the land as he had intended and sold the property in its original undeveloped state.He declared a significant capital gain that was reduced to take into account the effects of inflation.

Scenario 4

Jeremiah purchased his home in 1986 and sold it recently for a large capital gain, but did not declare the significant capital gain in his tax return at all.

Required

(1)Do you agree with Jeremiah, Yes or No? Give reasons

(2)Elaborate by reference to each of the scenarios, and:

advise the relevant CGT rule that you see applies, and

comment on whether there is a similar rule for ordinary income.

*For another problem question on the 'income/ capital distinction' refer to the Self Study Problem on Canvas.

Q2CGT Event A1 - Disposal of property

- Sale of intended holiday home (a garage on land at Milang)

Scenario - John

John is a keen fisherman, and he purchased a block of land at Milang with the intention of building a holiday home on the property.

John erected a garage on the Milang property in March 1987 costing $5000 in order to garage his boat.He used the land and garage mainly on weekends to enable his fishing hobby. John then made renovations to the garage, obtaining permission from the council to include a studio room so that he could have overnight sleeps on the weekend.The studio was fitted in September 1987 at a cost of $5,000.

The purchase price of the land was $20,000 as shown in the contract entered into, dated March1986.Fees on purchase of $1,000 included stamp duty, legal fees, conveyancing and transfer fees and borrowing expenses.

John entered into a contract to sell the block of land from Milang on 1 June 2017 for $100,000, and he received this money on settlement in August 2017.Selling costs of $4,000 included commission and legal fees and conveyancing fees.

Required

In relation to the sale of the land for the 2017 financial year, you are to advise John if he needs to include an amount in his assessable income that would be ordinary or statutory income.If it is a capital gaincompare the discounting method and indexation.

Provide a full explanation citing relevant statute law and case law to support your answers.

Topic 5 - Capital Gains and Losses Sylvia Villios Topic 5 - Capital Gains and Losses (follows Australian Taxation 2017 Chapter 8) Main concepts: Step 1: residence Step 2: must have a CGT event Step 3: identify the CGT asset Step 4: is the CGT event/CGT asset exempt? CGT Step 5: do the special CGT rules apply? CGT Step 6: calculating the capital gain/loss / Step 7: netting capital gains/losses / University of Adelaide 2 Introduction CGT introduced on 20 September 1985 Originally contained in Part IIIA ITAA36 ITAA36 IIIA Now contained in Parts 3-1 and 3-3 ITAA97 University of Adelaide 3 Assessable income - statutory income 6-10 Other assessable income (statutory income) (1)Your assessable income also includes some amounts that are not *ordinary income. ... assessable income (2)Amounts that are not *ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income. ... assessment income, University of Adelaide 4 CGT operative provisions CGT 102-5 Assessable income includes net capital gain (1)Your assessable income includes your net capital gain (if any) for the income year. '' ... CGT affects your income tax liability because your assessable income includes your net capital gain for the income year. (CGT liability assessable income net capital gain for the income year.) University of Adelaide 5 Structure of the CGT provisions in the ITAA 1997 Part 3-1 Div 100 Div 102 gain Div 103 Div 104 Div 106 Div 108 Div 109 Div 110 Div 112 Div 114 Div 115 Div 116 Div 118 Div 121 General topics A guide to capital gains and losses Assessable income includes net capital gain assessable income net capital General rules CGT events CGT Entity making the gain or loss CGT assets CGT Acquisition of CGT assets ( CGT Cost base and reduced cost base Modifications to cost base and reduced cost base Indexation of cost base Discount capital gains and trust's net capital gains Capital proceeds Exemptions Record keeping ) Part 3-3 Special topics University of Adelaide 6 Fundamentals of CGT: Section 100-10 (cont.) CGT if you are involved with any of the following, you may have a CGT liability now or at some time in the future CGT leases marriage or relationship breakdown inheritance working from home subdividing land Shares Goodwill a civil court case contracts trusts options Bankruptcy a company liquidation incorporating a company leaving Australia University of Adelaide 7 Step 1: residence Foreign residents disregard capital gains and losses from CGT events in relation to CGT assets that are not \"taxable Australian property\" capital gains and losses, taxable Australian property Main forms of CGT assets that are taxable Australian property: - CGT assets that are \"taxable Australian real property\" - CGT assets that are \"indirect Australian real property interests\" - CGT assets used in carrying on a business through \"permanent establishment\" in Australia CGT University of Adelaide 8 Step 2: must have a CGT event Capital gains and capital losses can only arise as a result of a \"CGT event\" Most CGT events happen in relation to \"CGT assets\" Over 50 different kinds of CGT events contained in Div. 104 ITAA97 \"CGT event A1\" to \"CGT event L8\" Most common CGT event CGT event A1 (disposal of CGT asset) Where more than one CGT event applies, the taxpayer must generally apply the CGT event most specific to their situation CGT CGT University of Adelaide 9 CGT events: DIV 104 A1 Disposal of a CGT asset J1-J6 Reversal of rollovers B1 Hire-purchase and similar agreements K1 Starting to hold an international emissions unit as a registered emissions unit C1-C3 End of a CGT asset K2 Bankrupt pays an amount in relation to debt D1 Creating contractual or other rights K3 Asset passing to tax advantaged entity D2 Granting an option K4 CGT asset starts being trading stock D3 Granting a right to income from mining K5 Special collectable losses D4 Entering into a conservation covenant K6 Pre-CGT shares or trust interest E1-E9 Trusts K7 Balancing adjustment events for depreciating assets F1-F5 Leases K8 Direct value shifts G1, G3 Shares K9 Venture capital investments H1 Forfeiture of a deposit K10 Forex realisation gain H2 Receipt for event relating to a CGT asset K11 Forex realisation loss I1 Individual or company stops being a resident K12 Foreign hybrid loss exposure adjustment I2 Trust stops being a resident L1-L8 Consolidated groups University of Adelaide 10 104-10 Disposal of a CGT asset : CGT event A1 (1) CGT event A1 happens if you *dispose of a *CGT asset. (2) You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. (However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner .( owner ) (3) The time of the event is: (a) when you enter into the contract for the *disposal; or (b)if there is no contract - when the change of ownership occurs. - (4)You make a capital gain if the *capital proceeds from the disposal are more than the asset's *cost base. You make a capital loss if those *capital proceeds are less than the asset's *reduced cost base. (5)A *capital gain or *capital loss you make is disregarded if: (i)you *acquired the asset before 20 September 1985; or (ii)for a lease that you granted : (i)it was granted before that day; or (ii)if it has been renewed or extended - the start of the last renewal or extension occurred before that day. University of Adelaide 11 CGT event A1: example in s104-10 In June 1999 you enter into a contract to sell land. The contract is settled in October 1999. You make a capital gain of $50,000. 1999 6 1999 10 50,000 The gain is made in the 1998-99 income year (the year you entered into the contract) and not the 1999-2000 income year (the year that settlement takes place). 1998-99 1999-2000 University of Adelaide 12 CGT event A1 Arises where taxpayer \"disposes\" of a \"CGT asset\" Disposal occurs where there is a change of beneficial ownership (eg sale or gift of CGT asset) eg. CGT Time of CGT event is when: - A contract for disposal is entered into, or - If no contract, when change of ownership occurs Capital gains and losses made on CGT assets acquired before 20 September 1985 are disregarded Capital loss University of Adelaide Asset's reduced cost base Capital proceeds 13 104-35 Creating contractual or other rights: CGT event D1 (1) CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. CGT D1 (2)The time of the event is when you enter into the contract or create the other right. (3) You make a capital gain if the *capital proceeds from creating the right are more than the *incidental costs you incurred that relate to the event. You make a capital loss if those *capital proceeds are less. (4) The costs can include giving property: see section 103-5. However, they do not include an amount you have received as *recoupment of them and that is not included in your assessable income, or an amount to the extent that you have deducted or can deduct it. (5) CGT event D1 does not happen if: (a)you created the right by borrowing money or obtaining credit from another entity; or (b)the right requires you to do something that is another *CGT event that happens to you; or (c)a company issues or allots *equity interests or *non-equity shares in the company; or (d)the trustee of a unit trust issues units in the trust; or (e)a company grants an option to acquire equity interests, non-equity shares or *debentures in the company; or (f)the trustee of a unit trust grants an option to acquire units or debentures in the trust. ; * CGT ; ; ; * ; Universityf Adelaide 14 CGT event D1 Arises if a contractual right or some other legal or equitable right is created in another entity (eg restrictive covenants or exclusive trade ties ) Time of CGT event is when the taxpayer enters into the contract or creates the right Capital loss University of Adelaide Incidental costs Capital proceeds 15 Example of CGT event D1 (in s104-35) You enter into a contract with the purchaser of your business not to operate a similar business in the same town. The contract states that $20,000 was paid for this. You have created a contractual right in favour of the purchaser. If you breach the contract, the purchaser can enforce that right. If you paid your lawyer $1,500 to draw up the contract, you make a capital gain of $20,000 - $1,500 = $18,500. 20,000 1500 $ 20,000 - $ 1,500 = $ 18,500 University of Adelaide 16 Example of exception to CGT event D1 (in s104-35) You agree to sell land. You have created a contractual right in the buyer to enforce completion of the transaction. The sale results in you disposing of the land, an example of CGT event A1. This means that CGT event D1 does no t happen. CGT A1 CGT D1 University of Adelaide 17 Step 3: identify the CGT asset Most CGT events happen in respect of CGT assets Definition of CGT asset: - Any kind of property - A legal or equitable right that is not property Examples: - Land - Shares - Options - Goodwill University of Adelaide 18 Collectables A collectable includes artwork, jewellery, an antique, or a coin or medallion; or a rare folio, manuscript or book; or a postage stamp or first day cover; that is used or kept mainly for your personal use or enjoyment: s 118-10(2) s 118-10 2 Capital gains and capital losses are disregarded if collectables acquired for under $500: s 11810(1) 500 capital gain and losses Capital losses from collectables can only be applied against capital gains from collectables in either the current year or in a future year : s 108-10 (1) and (4) University of Adelaide 19 Personal use assets A personal use asset is a non-collectable asset, other than land or buildings, used or kept mainly for personal use or enjoyment of the taxpayer or an associate: s108-20(2) and (3) Capital gains disregarded if personal use asset acquired for $10,000 or less: s118-10(3). If a personal use asset was acquired for more than $10,000, any capital gain would be included in assessable income, but any capital loss is disregarded: s 108-20(1) University of Adelaide 20 Separate CGT assets Buildings and structures may be treated as separate CGT assets from land in certain cases CGT Land acquired post-CGT that is adjacent to land acquired pre-CGT is treated as a separate asset if amalgamated Capital improvement to land treated as a separate CGT assets if certain balancing adjustment provisions apply Capital improvements to pre-CGT assets treated as a separate asset if, when CGT event happens, the CGT asset's cost base exceeds both: CGT CGT CGT - The \"improvement threshold\" for the income year, and - 5% of the capital proceeds from the event University of Adelaide 21 Step 4: is the CGT event/CGT asset exempt ? Exempt assets - Cars, motorcycles and valour decorations : s 118-5 - Assets acquired prior to 20 September 1985: s 10410(5) - Collectables if you acquired it for a market value of $500 or less: s 118-10 - Personal use assets or part of the asset if you acquired it for $10,000 or less: 118-10 Assets used to produce exempt income: s 118-12 Shares in a pooled development fund: s 118-13 118-12 118-13 University of Adelaide 22 Anti-overlap provisions Reducing capital gains if amount otherwise assessable: s 118-20 - A capital gain is reduced where another provision of the ITAA includes an amount as assessable income. The reduction is the amount that is included as assessable income. - Thus, you disregard capital gains that constitute ordinary income under s 6-5. ordinary income capital gain - Example: Liz bought some land in 1990, as part of a profit-making scheme. In December 1998 she sells it. Her profit from the sale is $40,000 and is included in her assessable income under section 6-5 (about ordinary income). Suppose she made a capital gain from the sale of $30,000. It is reduced to zero because it is does not exceed the amount included. 1990 1998 12 40,000 6-5 $ 30,000 Carried interests: s 118-21 Eligible termination payments and superannuation lump sums: s 118-22 118-22 Depreciating assets: s 118-24 Trading stock: s 118-25 Division 230 financial arrangements: s 118-27 Film copyright: s 118-30 Research and development: s 118-35 University of Adelaide 23 Exempt or loss-denying transactions and other exemptions Compensation, damages: s 118-37 compensation or damages you receive for any wrong or injury you suffer in your occupation ; compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally; winnings or prizes from gambling, a game or a competition with prizes; a re-establishment grant; and ; a dairy exit payment. a reimbursement or payment is disregarded for: - - - - a general practices rural incentives programme or a remote programme Sydney aircraft noise insulation M4/M5 cash back a sugar industry exit grant Other exemptions expiry of a lease: s 118-40 transfer of stratum units: s 118-42 sale of rights to mine: s 118-45 foreign currency hedging gains and losses: s 118-55 gifts under cultural bequests programme: s 118-60 later distributions of personal services income: s 118-65 transactions by exempt entities: s 118-70 marriage breakdown settlements: s 118-75 boat capital gains: s 118-80 insurance and superannuation exemptions: subdiv 118-D units in pooled superannuation trusts: subdiv 118-E venture capital exemption: subdivs 118-F, 118-G demutualisation of Tower Corporation: subdiv 118-H University of Adelaide 24 Main residence exemption Main residence exemption: subdiv 118-B You disregard a capital gain or loss from a CGT event in relation to a CGT asset that is a dwelling if you are an individual and the dwelling was your main residence throughout your ownership period A dwelling includes any building, caravan, houseboat, mobile home and any land immediately under it. The maximum area of adjacent land to the dwelling is two hectares. Special rules: - Moving into a dwelling - Separate CGT event for land - Spouses with separate main residences - Overlap when changing main residences - Absences - Building or renovating a dwelling - Partial exemption - Dwellings acquired from deceased estates University of Adelaide 25 CGT Discounts Discount capital gains reduced by discount percentage: - Individuals and trusts = 50% - Complying superannuation entities = 33% - No discount for companies Requirements: - Capital gain must be made by individual, complying superannuation entity or trust - Capital gain must result from CGT event happening after 21 September 1999 - Capital gain must have been calculated without taking into account indexation - Capital gain must result from CGT event happening to a CGT asset acquired at least 12 months before the event University of Adelaide 26 Step 5: do the special CGT rules apply? Transfer of assets to a wholly owned company : Div 122 Replacement asset rollovers : Div 124 Demerger relief : Div 125 Effect of death: Div 128 Investments: Div 130 Leases: Div 132 Options: Div 134 When an asset stops being a pre-CGT asset: Div 149 Small business CGT concessions: Div 152 University of Adelaide 27 CGT rollovers CGT roll-overs result in the \"deferral\" of CGT Same asset roll-overs (transfer of asset from one taxpayer to another) - CGT event does not generate CGT liability for transferor - CGT attributes of asset acquired by transferee Replacement asset roll-overs (replacing one asset with another) - CGT event does not generate CGT liability - CGT attributes of original asset applies to the new asset University of Adelaide 28 Effect of death: Div 128 Any notional capital gain/loss on assets held by the deceased are generally disregarded on death. A final income tax return must be completed which must include any capital gains and losses realised prior to death. A capital gain/loss on death is also generally disregarded on the passing of the asset from the deceased estate to the beneficiary. CGT asset is generally deemed to be acquired on the date of the deceased's death for: - Its market value (pre-CGT assets) - Its cost base or reduced cost base (post-CGT assets) University of Adelaide 29 Small Business Relief Div 152 Small business relief provides substantial concessions to small business owners when they retire. On 21 September 1999, Division 152 was inserted into the Income Tax Assessment Act 1997. Small businesses are unlike the majority of Australians who are employees that receive superannuation concession. Employers are required to provide 9.5% contributions of salary to a funds elected by the employees. Small businesses are self-funded and do not receive any such benefit. From a parity viewpoint with employees' superannuation, the government provided the small business concessions relief under Division 152. University of Adelaide 30 4 small business concessions under Division 152 Div 152 B - 15 year asset exemption - 100% 100% of a capital gain on the sale of a business that was held for 15 years may be completely disregarded. Div 152 C - active asset reduction 50% 50% of a capital gain may be reduced where the business disposed of was an active asset. Div 152 D - retirement exemption $500K Up to a maximum of $500K of the capital gain from disposal of a business may be deferred where monies are paid to an appropriate superfund. Div 152 E - rollover to a new business A capital gain can be deferred by rolling it over where a small business sells a business and subsequently purchases (within 2 years) a new business, so that the cost base of the new business is reduced by the capital gain (after discounting) University of Adelaide 31 Small business CGT concessions: Div 152 Stage 1 Meet the basic requirements, subdiv 152-A Step 1:A CGT event resulting in a capital gain happens in relation to an asset owned by the taxpayer: Step 2:Meet the SBE condition or the maximum net asset value test is met; or Step 3:Must be an active asset Stage 2 The four small business CGT concessions University of Adelaide Step 4: 15-year business asset exemption: subdiv 152-B Step 5: 50 per cent active asset reduction: subdiv 152-C Step 6: CGT retirement exemption: subdiv 152-D Step 7: CGT rollover: subdiv 152-E 32 Step 6: calculating the capital gain/loss Capital loss University of Adelaide Asset's reduced cost base Capital proceeds 33 S 116-20 Capital proceeds (general rule) (1) The capital proceeds from a * CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the * market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). University of Adelaide 34 Capital proceeds (modifications) General rule for calculating capital proceeds is modified by: - Market value substitution rules: 116-30 If you receive no capital proceeds you are taken to have received the market value. - Apportionment rule: s 116-40 If you receive a payment that relates to more than one CGT event the capital proceeds are so much of the payment that is reasonably attributable to that event. - Non-receipt rule: s 116-45 The capital proceeds are reduced by the unpaid amount, if you are not likely to receive some or all of the proceeds, and it is not as a result of anything you have done or omitted and you took reasonable steps to get the unpaid amount. However, if you reduce by the unpaid amount and later receive part of this amount, the capital proceeds are increased by that part. - Repayment rule: s 116-50 The capital proceeds are reduced by any part that you repay, and compensation you pay that can be reasonably regarded as a repayment of part of them. You cannot reduce the capital proceeds for any part that you can deduct. - Assumption of liability rule: s 116-55 The capital proceeds are increased if another entity acquires the CGT asset subject to a secured liability, by the amount of the liability assumed by the other entity. - Misappropriation rule: s 116-60 The capital proceeds from a CGT event are reduced if a taxpayer's employee or agent misappropriates (whether by theft, embezzlement, larceny or otherwise) all or part of those proceeds. University of Adelaide 35 Cost base Cost base is used to calculate a capital gain from certain CGT events Cost base has five elements Cost base elements may be indexed in certain cases University of Adelaide 36 Elements of the cost base 1st element - total of the money paid, or required to be paid, and the market value of any property given, or required to be given, in respect of acquiring the asset 2nd element - \"incidental costs\" incurred to acquire the asset or that relate to the CGT event For example, remuneration for a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser; costs of transfer; stamp duty or other similar duty; costs of advertising or marketing for a buyer/seller; valuation costs for apportionment for the purposes of the CGT provisions; search fees relating to a CGT asset; the cost of a conveyancing kit (or a similar cost); borrowing expenses (such as loan application fees and mortgage discharge fees) 3rd element - costs of owning the asset (only applies to assets acquired after 20 August 1991 but not personal use assets or collectables) For example interest on money you borrowed to acquire the asset; costs of maintaining, repairing or insuring it; rates of land tax, if the asset is land; interest on money you borrowed to refinance the money you borrowed to acquire the asset; interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value 4th element - capital expenditure incurred to increase or preserve the asset's value (except goodwill) 5th element - capital expenditure incurred to establish, preserve or defend taxpayer's title to asset University of Adelaide 37 Cost base exclusions and modifications The main exclusions from the cost base are: - expenditure to the extent that you can deduct it - expenditure to the extent that you have received a recoupment and it is not included in your assessable income - expenditure in the third element for personal use assets and collectables Section 110-38 also provides that the following expenditure does not form part of any element of the cost base to the extent: - - - - expenditures on illegal activities that it is a bribe to a foreign public official or a bribe to a public official that it is in respect of providing entertainment that s 26-5 prevents it being deducted (even if some other provision also prevents it being deducted) - non-business boat expenses Special modifications: - Market value substitution rule - Split or changed asset rules - Apportionment rules - Assumption of liability rule University of Adelaide 38 Indexation of cost base Elements of a cost base (other than the 3 rd element) may be indexed for inflation provided: - Asset was acquired prior to 11:45 am on 21 September 1999 - Asset was held for more than 12 months - Choice to index has been made Elements of a reduced cost base cannot be indexed Indexation cannot be used where the taxpayer chooses to use the discount capital gains treatment under Div 115 Indexation of cost base elements generally calculated by multiplying the relevant element of the cost base by the \"indexation factor\" University of Adelaide 39 Indexation of cost base If the CGT event happened before 11.45am (by legal time in the ACT) on 21 September 1999, you use this formula: If the CGT event happened on or after 11.45am (by legal time in the ACT) on 21 September 1999, you can only index the elements of your cost base up to 30 September 1999. You use this formula: Indexatio n factor Index number for the quarter ending on 30 September 1999 Index number for the quarter in which the expenditure was incurred You work out the indexation factor to 3 decimal places (rounding up if the fourth decimal place is 5 or more). Example: If the factor is 1.102795, it would be rounded up to 1.103. University of Adelaide 40 QUARTER ENDING CPI NUMBERS YEAR 31 MARCH 30 JUNE 30 SEPTEMBER 31 DECEMBER 1985 71.3 72.7 1986 74.4 75.6 77.6 79.8 1987 81.4 82.6 84.0 85.5 1988 87.0 88.5 90.2 92.0 1989 92.9 95.2 97.4 99.2 1990 100.9 102.5 103.3 106.0 1991 105.8 106.0 106.6 107.6 1992 107.6 107.3 107.4 107.9 1993 108.9 109.3 109.8 110.0 1994 110.4 111.2 111.9 112.8 1995 114.7 116.2 117.6 118.5 1996 119.0 119.8 120.1 120.3 1997 120.5 120.2 119.7 120.0 1998 120.3 121.0 121.3 121.9 1999 121.8 122.3 123.4 University of Adelaide 41 Indexation of cost base 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. Applying section 960- 275, work out the indexation factor as follows: 119.0 = 1.078 110.4 The first indexed element of Peter's cost base is: $250,000 x 1.078 = $269,500. University of Adelaide 42 Frozen indexation example Tax in Real Life Calculate the cost base for shares purchased for $1 million incurred on 31 December 1985 and sold on 1 July of the current tax year. The indexed cost base is frozen to 30 September 1999 $1 m 123.4/72.7 (1.697) = $1,697,000. University of Adelaide 43 Reduced cost base Reduced cost base used to calculate a capital loss from certain CGT events Reduced cost base has 5 elements: - 1st, 2nd, 4th and 5th elements are same as for cost base - 3rd element: amount that is assessable as a result of a balancing adjustment in relation to the asset No indexation of elements University of Adelaide 44 Step 7: netting capital gains/losses Step 1 Capital gains - capital losses (made during the year) Step 2 Remaining capital gains - \"net capital losses\" (from earlier years) Step 3 Remaining capital gains that are \"discount capital gains\" reduced by \"discount percentage\" Step 4 Remaining capital gains that qualify for \"small business concessions\" reduced by those concessions Step 5 Remaining capital gains = taxpayer's net capital gain for the year University of Adelaide 45 Net capital gains: Div 102 102-5 Assessable income includes net capital gain (1) Your assessable income includes your net capital gain (if any) for the income year. ... University of Adelaide 46 Net capital loss You cannot deduct a capital loss from your assessable income, but it will reduce your capital gain in the current income year or later income years. University of Adelaide 47 Working out net capital gain example Kelly is an Australian resident adult individual non-business taxpayer entity. She sells the following items during the income year: 1. Vacant land for $200,000 that had been bought by her in 1984 for $20,000. 2. An investment property which she is the sole owner of, for $430,000 which she purchased as a long-term investment in November 1998 for $150,000. 3. Her car for $15,000. 4. A postage stamp for $2,000 which she purchased in August 1987 for her own use and enjoyment. She has no capital losses from earlier years. Calculate her net capital gain or loss for the income year? University of Adelaide 48 Working out net capital gain - example (cont.) Step 1: residence - Kelly is an Australian resident during the income year. Step 2: must have a CGT event - CGT event A1 in relation to the sale of items 1-4. Step 3: identify the CGT asset 1. land 2. property 3. car 4. postage stamp Step 4: is the CGT event/CGT asset exempt? Step 5: do the special CGT rules apply? Step 6: calculating the capital gain/loss Step 7: netting capital gains/losses University of Adelaide 49 Working out net capital gain - example (cont.) 1. Vacant land sold for $200,000 that had been bought by her in 1984 for $20,000. Step 4: is the CGT event/CGT asset exempt? As the land was acquired by Kelly before 20/9/85 any capital gain or capital loss made is disregarded : s1095(1), s104-10(5)(a). University of Adelaide 50 Working out net capital gain - example (cont.) 2. An investment property for $430,000 which he purchased as a long-term investment in November 1998 for $150,000. Step 4: is the CGT event/CGT asset exempt? The \"anti-overlap\" exemption in s118-20(1) does not apply to reduce any CG because the CGT event does not also result in an amount being AI under a provision outside Part 3-1. This is because: - s15-15 does not apply due to lack of profit making intension and because the profit arises in respect of the sale of property acquired on or after 20/9/85: s15-15(2)(b); and - s6-5(1) does not apply because the shares were bought for \"long term investment purposes\" therefore this would be a mere realisation of a capital asset: Scottish Australian Mining. Step 5: do the special CGT rules apply? No Step 6: calculating the capital gain/loss CPs = $430,000 money received: s116-20(1). CB = $150,000 money paid: s110-25 & s114-5(2). CG = $430,000 - $150,000 = $280,000: s104-10(4). Kelly can choose to include indexation in working out the CB: s114-5(2) because the shares were acquired before 21/9/99 and at least 12 months before the CGT event: s114-1 & s114-10(1). If indexation is chosen, the disposal of the shares gives rise to a CG worked out as follows: CB = $150,000 x 123.4/121.9 (1.012) = $151,846: s110-25, s114-1, s114-10(1), s960-275 & s960280. CG = $430,000 - $151,846 = $278,154: s104-10(4). University of Adelaide 51 Working out net capital gain - example (cont.) 3. Her car sold for $15,000. Step 4: is the CGT event/CGT asset exempt? A \"car\" that is an exempt asset. \"Car\" is defined as a motor vehicle (except a motor cycle or similar vehicle) designed to carry a load of less than 1 tonne and fewer than 9 passengers: s995-1(1). Accordingly, any capital gain or capital loss made is disregarded: s118-5(a). University of Adelaide 52 Working out net capital gain - example (cont.) 4. A postage stamp sold for $2,000 which she purchased in August 1987 for $10,000 her own use and enjoyment. Step 4: is the CGT event/CGT asset exempt? The postage stamp is a CGT asset that is a \"collectable\" because it is used or kept mainly for personal use and enjoyment: s108-10(2)(a). Capital gains and capital losses are disregarded if collectables acquired for under $500: s 118-10(1). The postage was acquired by Kelly on or after 20/9/85 in August 1987 when she became its owner by buying it: s109-5(1). Kelly acquired the postage stamp for > $500, therefore the capital loss is not disregarded. Step 5: do the special CGT rules apply? No Step 6: calculating the capital gain/loss RCB = $10,000:s110-55 CPs = $2,000 money received: s116-20(1) CL = $10,000 - $2,000 = $8,000: s104-10(4) Note that a CL from a collectable can only reduce a CG from a collectable: s108-10(1). A RCB cannot be indexed: s110-55(1) University of Adelaide 53 Working out net capital gain - example (cont.) Step 7: netting capital gains/losses Step Item Item Item Item 1 1 2 3 4 Capital gains - capital losses (made during the year) - disregarded - CG of $280,000 or indexed CG of $278,154 - disregarded - loss from a collectable (quarantined) CL from the collectable in item (4) can only reduce the CG from the collectable. It cannot be used to reduce CGs generally: s108-10(1). If a CL from a collectable exceeds CGs from collectables in an income year, the excess is carried forward indefinitely to be applied only against future CGs from collectables: s108-10(4). $8,000 will be carried forward indefinitely. CG of $280,000 or indexed CG of $278,154 Step 2 Remaining capital gains - \"net capital losses\" (from earlier years) No prior year losses CG of $280,000 or indexed CG of $278,154 University of Adelaide 54 Working out net capital gain - example (cont.) Step 3 Remaining capital gains that are \"discount capital gains\" reduced by \"discount percentage\" The CG of $280,000 made from the investment property is a discount CG because: It is made by an individual: s115-10; and It results from a CGT event that happened after 21/9/1999: s 115-15; and It is worked out without indexing the CB elements: s115-20; and It results from a CGT event that happened to a CGT asset that was acquired at least 12 months before the event: s115-25. Applying the discount percentage of 50% for individuals, the CG would be reduced to $140,000. Step 4 Remaining capital gains that qualify for \"small business concessions\" reduced by those concessions The \"Small Business\" concessions in Div 152 do not apply because Kelly is a nonbusiness taxpayer. Step 5 Remaining capital gains = taxpayer's net capital gain for the year The CG of $140,000 then remaining is a net CG that is included in Kelly's assessable as statutory income: s102-5(1). University of Adelaide 55 Concluding remarks Pre-reading for the coming week Australian Tax 2017 Chapters 7 (Non-Assessable Income) & 9 (General Deductions) University of Adelaide 56 The University of Adelaide Income Tax Law Tutorial No. 5 Capital Gains and Losses (Starting the week beginning Monday 28 August 2017) Q1 Income vs Capital - Why is the distinction important to individuals? Jeremiah and Jaini were walking away from their income tax lecture that had just discussed Capital Gains Tax. Jeremiah said 'You see Jaini, the government has stitched everything up - for the last few weeks we learnt we have to declare all our ordinary and statutory income, and this week, to top it off, if we make any capital gains, we have to declare all of that as well. So whatever receipts we get, we get taxed on! So why even bother distinguishing income and capital, they all amount to assessable income?' Scenario 1 Jeremiah had purchased a block of land in 1984 but never got to use the land as he had intended and only recently sold the property in its original undeveloped state. There was a significant capital gain on the property but Jeremiah did not declare the capital gain. But his friend Jaini who purchased an adjacent block of land in 1986 and also recently sold the land did declare the capital gain. Scenario 2 Jeremiah had purchased a block of land in 1986 but never got to use the land as he had intended and only recently sold the property in its original undeveloped state. He made a significant capital gain on the property but Jeremiah only declared half the capital gain. Scenario 3 Jeremiah had purchased a block of land in 1986 but never got to use the land as he had intended and sold the property in its original undeveloped state. He declared a significant capital gain that was reduced to take into account the effects of inflation. Scenario 4 Jeremiah purchased his home in 1986 and sold it recently for a large capital gain, but did not declare the significant capital gain in his tax return at all. Required (1) Do you agree with Jeremiah, Yes or No? Give reasons (2) Elaborate by reference to each of the scenarios, and: advise the relevant CGT rule that you see applies, and comment on whether there is a similar rule for ordinary income. *For another problem question on the 'income/ capital distinction' refer to the Self Study Problem on Canvas. 1 The University of Adelaide Q2 Income Tax Law CGT Event A1 - Disposal of property - Sale of intended holiday home (a garage on land at Milang) Scenario - John John is a keen fisherman, and he purchased a block of land at Milang with the intention of building a holiday home on the property. John erected a garage on the Milang property in March 1987 costing $5000 in order to garage his boat. He used the land and garage mainly on weekends to enable his fishing hobby. John then made renovations to the garage, obtaining permission from the council to include a studio room so that he could have overnight sleeps on the weekend. The studio was fitted in September 1987 at a cost of $5,000. The purchase price of the land was $20,000 as shown in the contract entered into, dated March 1986. Fees on purchase of $1,000 included stamp duty, legal fees, conveyancing and transfer fees and borrowing expenses. John entered into a contract to sell the block of land from Milang on 1 June 2017 for $100,000, and he received this money on settlement in August 2017. Selling costs of $4,000 included commission and legal fees and conveyancing fees. Required In relation to the sale of the land for the 2017 financial year, you are to advise John if he needs to include an amount in his assessable income that would be ordinary or statutory income. If it is a capital gain compare the discounting method and indexation. Provide a full explanation citing relevant statute law and case law to support your answers. 2 The University of Adelaide Income Tax Law Indexing - Capital Gains Tax Index Numbers (Quarter ending) Year 31 Mar 30 Jun 1985 30 Sep 31 Dec 71.3 72.7 1986 74.4 75.6 77.6 79.8 1987 81.4 82.6 84.0 85.5 1988 87.0 88.5 90.2 92.0 1989 92.9 95.2 97.4 99.2 1990 100.9 102.5 103.3 106.0 1991 105.8 106.0 106.6 107.6 1992 107.6 107.3 107.4 107.9 1993 108.9 109.3 109.8 110.0 1994 110.4 111.2 111.9 112.8 1995 114.7 116.2 117.6 118.5 1996 119.0 119.8 120.1 120.3 1997 120.5 120.2 119.7 120.0 1998 120.3 121.0 121.3 121.9 3 The University of Adelaide 1999 121.8 122.3 Income Tax Law 123.4 4 The University of Adelaide Income Tax Law Tutorial No. 5 Capital Gains and Losses (Starting the week beginning Monday 28 August 2017) Self-Study Problem Q1 Income vs Capital - Why is the distinction important to individuals? Jeremiah and Jaini were walking away from their income tax lecture that had just discussed Capital Gains Tax. Jeremiah said 'You see Jaini, the government has stitched everything up - for the last few weeks we learnt we have to declare all our ordinary and statutory income, and this week, to top it off, if we make any capital gains, we have to declare all of that as well. So whatever receipts we get, we get taxed on! So why even bother distinguishing income and capital, they all amount to assessable income?' Scenario 1 Jeremiah traded in shares and made a profit this financial year. But he declared the full amount as ordinary income, not a capital gain. Jaini who bought her shares in 1986 and sold them this year, included only half the capital gain. Scenario 2 Jeremiah sold his rental property at a loss but was not able to use it. However, his friend Jaini who traded in share property, also made a loss but was able to apply the losses against her assessable income to reduce her tax bill Scenario 3 Jeremiah was going through a divorce and his share of ownership in a share portfolio was transferred to his spouse, but he did not have to pay tax. His friend Jaini who was not divorcing her spouse, did transfer the assets into her spouse's name but had to pay tax. Required (1) Do you agree with Jeremiah, Yes or No? Give reasons (2) Elaborate by reference to each of the scenarios, and: advise the relevant CGT rule that you see applies, and comment on whether there is a similar rule for ordinary income. Suggested Solution Scenario 1 - Precedence CGT Where a receipt can be a capital gain and can also be ordinary income, the antioverlap provision s 118-20 applies. For individuals, this ensures that the ordinary income provisions prevail over the capital gains. 1 The University of Adelaide Income Tax Law So Jaini, who makes a capital gain, would declare it but as an individual claim the 50% CGT discount. However, Jeremiah who is a share trader cannot use this concession. Jeremiah who makes ordinary income from trading, is equally making capital gains, and must declare the income as ordinary income, not a capital gain. Ordinary income An amount can only be included once in your assessable income. s 6-25 Ordinary income prevails over CGT for the individual because of the antioverlap provision. s 118-20 Scenario 2 - Losses CGT Only a net capital gain is included in assessable income. s 102-5 A net capital loss can not be applied against assessable income. s102-10(1) A net capital loss can only be applied against capital gains in future years, s102-15(3) In this case Jeremiah made a capital loss, which cannot be applied against assessable income. Ordinary income Subject to certain conditions, a loss on revenue account, can be applied against assessable income. Division 36 Jaini was in the business of share trading, and her loss was therefore on revenue account. She can therefore apply her loss against assessable income. Scenario 3 - Rollovers CGT Various CGT provisions provide for a deferral of a CGT event eg transfer of assets on marriage breakdown, SBE retirement concessions such as the purchase of a new business within 2 years or transfer to a superfund etc In this case Jeremiah was able to use the concession to rollover or defer the gain when transferring assets on a marriage breakdown. Ordinary income Ordinary income is not deferred. There is limited scope otherwise to defer income in the statute legislation 2 The University of Adelaide Income Tax Law Indexing - Capital Gains Tax Index Numbers (Quarter ending) Year 31 Mar 30 Jun 1985 30 Sep 31 Dec 71.3 72.7 1986 74.4 75.6 77.6 79.8 1987 81.4 82.6 84.0 85.5 1988 87.0 88.5 90.2 92.0 1989 92.9 95.2 97.4 99.2 1990 100.9 102.5 103.3 106.0 1991 105.8 106.0 106.6 107.6 1992 107.6 107.3 107.4 107.9 1993 108.9 109.3 109.8 110.0 1994 110.4 111.2 111.9 112.8 1995 114.7 116.2 117.6 118.5 1996 119.0 119.8 120.1 120.3 1997 120.5 120.2 119.7 120.0 1998 120.3 121.0 121.3 121.9 3 The University of Adelaide 1999 121.8 122.3 Income Tax Law 123.4 4