CAPITAL GAINS TAX EXEMPTIONS

Transcription

1 CAPITAL GAINS TAX EXEMPTIONS The following details the principal measures that provide relief from the full application of the CGT provisions of the Income Tax Assessment Act: Background: Generally, the disposal of assets which were acquired after 19 September 1985 triggers the operation of the capital gains tax provisions. Specifically the calculation of the capital gains on the disposal of an asset requires information in relation to: i) The capital cost of acquisition or creation of the asset (includes purchase price or costs incurred to establish the asset)(dollar amounts and dates required) i iv) The incidental costs of acquisition or creation (including stamp duty, valuation fees, legal costs, etc) (dollar amounts and dates required) The capital costs of improving/developing the asset (e.g. property extensions, fences, etc) (dollar amounts and dates required) The incidental costs of disposal (including agent selling fees, advertising fees, mortgage discharge fees, legal costs) (dollar amounts and dates required) Basically, the amount of the capital gain is added to other taxable income and taxed at the appropriate marginal tax rate. The calculation of the applicable tax liability on the gain incorporates an averaging calculation (available to trusts but not available to stand alone companies) to avoid marginal tax bracket creep. The benefit of averaging is nil if the recipient is already taxed at the highest marginal tax rate. Principal Exemptions and Relief from CGT: 1) Pursuant to current taxation law individual and trusts are entitled to claim the 50% general discount (superannuation funds can claim a 33.33% discount) on capital gains flowing from the sale of assets held for at least 12 months. Companies are not eligible to claim the general CGT discount. Note that capital losses are applied before the discount method is applied. 2) In addition, small business taxpayers (individuals, partnerships, trusts, superannuation funds and companies) are entitled to further reductions / exemptions from the operation of the capital gains tax provisions of the ITAA.

2 The Act provides certain exemptions to small business from the application of the CGT provisions re: the 15 year exemption; the 50% active asset reduction; the retirement concession; and the roll-over exemption. There are various preconditions that must be satisfied before a taxpayer can claim relief from the CGT small business exemptions. The following two preconditions always apply: i) The net assets of the taxpayer must not exceed $6,000,000.00; and The asset for which CGT exemption is sought must be an active asset immediately before the CGT event, or within the preceding 12 months and for at least half the period of ownership (to a maximum of 15 years). An asset will be deemed to be an active asset if its is used or held ready for use by the taxpayer in the course of carrying on a business or an intangible asset that is connected with the carrying on of a business (e.g. goodwill). In the case of a share in a company or an interest in a trust the market value of the active assets must be 80% or more of the market value of all assets for at least half the time that the entity has owned the asset. If the disposed asset is a share in a company or an interest in a trust, additional pre-conditions that apply are as follows: i) The company or trust must have a significant individual (replaces former controlling individual test). That is a significant individual must hold at least 20% of the votes and the rights to distributions to capital and income. In the case of discretionary trusts this precondition is satisfied if in the relevant year of income an individual beneficiary received at least 20% of any distributions of capital or income from the trust; and The taxpayer claiming the CGT exemption must be a CGT concession stakeholder in the company or trust. That is the taxpayer must be a controlling individual or the spouse (presumably legal and not common law) of a controlling individual. Where the taxpayer is a spouse, he/she must also have a legal and equitable interest in the company or be entitled to receive any of the capital or income of the trust. Having satisfied the above preconditions, a small business taxpayer can seek relief from the application of the CGT provisions in any of the following four exemptions. i) A small business taxpayer is exempt from tax on a gain arising from a CGT on an asset that is has owned for at least 15 years (S152-B). The followings conditions must be satisfied before relief can be sought re: the above preconditions must be satisfied; the asset must have been an active asset for at least half of the 15 year period of ownership; the asset must have been owned continuously; if the taxpayer is an individual they must have retired or be permanently incapacitated; if the taxpayer is a company or trust, it must have a controlling individual that retires or is permanently

3 incapacitated. If the capital gain is derived by a company or trust the payment must be made within two years of the CGT event, to a person who is a CGT concession stakeholder and must not exceed the exempt. This exemption is not affected by the operation of the $500K lifetime limit under the retirement exemption. i iv) A small business taxpayer is exempt from tax on 50% of any gain arising from a CGT on a relevant active asset (S152-C). This reduction is in addition to the 50% general discount available to individuals and trusts. Accordingly, it is possible for a small business taxpayer to access a 75% discount on any capital gain (i.e. 50% general discount on the total capital gain and then a further 50% discount on the remaining 50% of the capital gain). The remaining 25% of the gain can be further reduced by the operation of the small business retirement relief or small business replacement relief. Taxpayers can elect not to apply this exemption, for reasons such as increasing the exempt component of eligible termination payment to an employee. A small business taxpayer is exempt from tax on a gain arising from a CGT on an active asset if the capital proceeds are used in conjunction with the taxpayer s retirement (S152-D). The amount of relief here is limited to $500K. To qualify for this exemption, an individual taxpayer aged less than 55 must, in addition to satisfying the standard preconditions, receive an eligible termination payment up to the amount of the excluded gain and roll it over into an appropriate superannuation fund. If the taxpayer is a company or trust it must have a controlling individual and the CGT concession stakeholders must have received the capital payment within 7 days of the entity choosing to exclude the gain or 7 days of receipt by the stakeholder. Contributions are non-tax deductible member contributions subject to the $150K pa or $450K by aggregating 3 years of contributions until age 65. A small business taxpayer can defer the tax on a gain arising from a CGT on an active asset if the gain is rolled over into the cost base of a replacement active asset (S152-E). The gain is merely deferred (and not reduced or avoided altogether) until such time as the replacement asset is sold or any of the preconditions cease to exist. To qualify for this exemption, the taxpayer must satisfy the standard preconditions; a replacement asset must be purchased within one year before or two years after the CGT event; the replacement asset must be or become an active asset within two years of purchase; and if the replacement asset is a share in a company or interest in a trust the entity must have a controlling individual. This form of relief can be used in conjunction with the small business retirement exemption. 3) Carried forward losses can offset capital gains. Carried forward revenue losses can be used to offset revenue or capital gains. Carried forward capital losses can only be used to offset capital gains.

4 4) For capital gains tax purposes, a CGT event is triggered on the date giving legal effect to the event. For example in relation to the date of purchase / sale of real estate, that date is usually the date of the Contract giving legal effect to the transaction and not the date of settlement. Therefore, by manipulating the timing of events taxpayers can transfer the incidence of the capital gain to a financial year that best suits their situation. 5) Generally, the disposal of assets which were acquired after 19 September 1985 triggers the operation of the capital gains tax provisions. The Act does, however, offer an exemption from the provisions for sole and principal residences, owned by individuals. The exemption is limited to the land that the actual residence is built upon and any adjacent land as long as the total area does not exceed two hectares (further pre-conditions apply to the adjacent land exemption e.g. house and adjacent land must be sold at the same time). 6) It is not commonly realised that a taxpayer s main residence is not necessarily the place where they may actually live. In many circumstances a taxpayer may live in one home but have another home treated as the main residence for capital gains tax purposes. Once a property becomes a taxpayer s main residence the taxpayer may elect to continue to treat it as their home even if they subsequently move (but the taxpayer must be able to establish that they lived in the property before they moved e.g. by electoral roll records, drivers lines address records, utilities in their name at the address, tax invoice for furniture delivery to that address, mail redirection with Australia Post). The relevant deeming provisions operates until the earlier of the following times: when the taxpayer elects another main residence: or 6 years if the property is rented out; or until the taxpayer moves back in. 7) Clients who have lived in their houses for several years but for whatever reason have to move are not always in a position where they want to sell. Perhaps you may want to keep the house so that you can move back into it some day. In a rising real estate market hanging onto property can result in significant capital gains. Being aware of tax consequences of moving without selling up can maximize those gains. Current taxation law provides that an owner can rent out a house for a maximum of 6 years before the main resident exemptions expires. However, less commonly known is that he or she can obtain the benefit of an additional 6 years exemption from CGT on moving back into the house before the first 6 years expires. There is no specific length of time that a person needs to remain in a house before it can be rented out again. The only requirement is that the person and their family must actually be living in that house. Of course, while renting out the house, it may be a good opportunity to make some tax deductible repairs. Providing the repairs do not amount to a capital improvement they may be deductible. Then by the time the house is ready to be sold considerable income tax and capital gains tax savings will have been made by moving without selling.

5 8) The property boom has provided most home owners with a tax free capital gain. In some circumstances, this gain can become partly taxable. If you have used your residence for income producing purposes after 20 August 1996, part of the exemption from capital gains tax on the profit is forfeited. The property is deemed to have been purchased for its market value at the first time it is used for income producing purposes. The onus is on the taxpayer to obtain a licensed valuation by a registered valuer (as opposed to a market appraisal by a real estate agent). 9) The capital allowances rules which apply from 1 July 2001 subtly changed the fundamental rules for the sale of business. Under the new rules where a depreciating asset is sold the excess of the termination value (consideration) over the adjustable (written-down) value will be assessable as ordinary income. Previously that part which represented a recoupment of depreciation was assessable while the profit above the cost was subject to CGT and would have been eligible for a 50% CGT discount. However from 1 July 2001 the profit will not be subject to capital gains tax and the 50% discount will not apply. This means that tax payable on profits from the sale of depreciating assets will be higher because these assets will no longer be eligible for 50% CGT discount or the small business concessions. Under the new rules, a depreciating asset is broadly defined as having an effective life and can reasonably be expected to decline in value over the time it is used. The following items are included as depreciable assets under the new rules: Plant; Certain improvements to land; Fixtures on land which constitute plant ; certain intangibles, e.g. patents; In-house software. The following items are excluded from the definition of depreciable assets: Land; trading stock; certain intangibles, e.g. goodwill and trademarks. The new rules do not apply to Div 43 capital works. Buildings and structural improvements under Div 43 will nonetheless be dealt with under the CGT provisions if sold for more than their cost base. 10) It is true that specific roll-over relief exists for CGT purposes in respect of asset transfers implementing court-sanctioned family law settlements. It is also true that the stamp duty legislation in each jurisdiction contains certain exemptions from duty for transfers implementing court-sanctioned marital settlements. However, both the tax and stamp duty concessions are in themselves incomplete and in many ways are not fully consistent. It is wrong to believe that blanket tax and stamp duty exemptions exist for transactions implementing family law orders or settlements. The reality is that the form a settlement takes can dramatically alter its tax and stamp duty consequences. Stamp duty relief is available in most States for matrimonial property transfers to either party to a marriage or to a child of the parties. By contrast, CGT relief is only available where assets are transferred to a spouse. This mismatch cause s considerable confusion which is exacerbated by the fact that the stamp duty rules themselves vary in different jurisdictions. The most common misconception is that all transactions pursuant to a family law settlement will get CGT roll-over relief. Unfortunately this is not the case.

6 CGT roll-over relief is available in a number of circumstances where a person disposes of an asset to his or her spouse including: a court order under the Family Law Act 1975 (FLA); or a court-approved maintenance agreement under Section 87 of FLA; or a court order relating to a defacto marriage breakdown under a State, Territory or foreign law. However, CGT roll-over relief is not available in relation to transfers of assets upon a marriage breakdown because of a maintenance agreement registered under Section 86 of FLA. That is because maintenance agreements registered under Section 86 do not come within the expression of a court order under the relevant CGT provisions of ITAA In addition maintenance agreements registered under Section 86 do not come within the words a maintenance agreement approved by a court under Section 87 of the FLA. The second misconception is that no tax consequences arise when roll-over relief applies to the transfer of assets under the family law provisions. This may be true in some cases but not in others. For example where a property is transferred from a company to the spouse of a person under the family law provisions, roll-over relief will apply to the company. This means the company will have no taxable capital gain. However the depletion of assets as a dividend despite the application of the capital gains tax roll-over. The ATO have released 16 tax determinations that explore the scope of the CGT roll-overs available for asset transfers occurring in consequence of a marriage breakdown. However the determinations do take a reasonably strict view of the scope of a roll over relief. For example, if properties are transferred between spouses by agreement prior to the obtaining of a court order, then CGT rollover relief will not be available even if a court later sanctions the transfer because the original transfer will not be accepted as being made because of the court order (TD 1999/53).