Capital Gains Tax 22 24 March 2001 15 th National Convention 2001 Mark Robertson, Barrister, Sir Henry Gibbs Chambers Presented by: Mark Robertson
Today s Paper Outline of the CGT reforms Case Studies A Basic Structure for Entity Taxation (Version 3!) CGT small business concessions Structuring Opportunities
Outline of CGT Reform Discount Capital Gains Small Business CGT relief How these concessions flow through Trusts
CGT Method Statement Assets held for more than 12 months CGT method statement 1. Gains less losses 2. Apply net capital losses 3. Reduce by discount % 4. Apply small business concessions 5. Add up. Sum is Net Capital Gain
Div 115-C - Flow through trusts An example 1. X Trust makes $100 capital gain 2. Reduced by 50% as it is a DCG 3. Reduced by further 50% under small business CGT concession 4. Net income of trust estate includes $25 net capital gain
Div 115-C - Flow through trusts 5. Y Co. is entitled to the trust income 6. Y Co. includes $25 under s.97 7. Y Co. is deemed to have a capital gain of $100 (s.115-215) 8. Y Co. gets a deduction for $25 9. Companies do not get DCG but only 50% small business concession 10. Y Co has $50 taxable income
A Teaser for the Commissioner! What if X Trust chooses a small business replacement asset rollover? Capital gain reduced to $25 but then disregarded. Latent gain under CGT events J2 or J3 Replacement asset then sold, triggering CGT event J2
Consequence of CGT event J2 1. X Trust makes capital gain of $25 2. Gain not a discount capital gain 3. CGT small business 50% reduction not available. 4. Net income of trust estate includes $25 net capital gain
Consequence of CGT event J2 5. Y Co. is entitled to the trust income 6. Y Co. includes $25 under s.97 7. Division 115-C literally does not apply! 8. Y Co has $25 taxable income!
Back to Basics How a fixed trust is established can greatly affect the CGT position down the track There are two ways: Each beneficiary subscribes for his interest A settlor establishes the trust with $10. The beneficiaries then gift funds into trust.
The usual unit trust Unit Trust A, B, C and D Subscribe for units $25,000 $25,000 $25,000 $25,000 A B C D
CGT Position - Unit Trust Trust asset increases in value to $180,000 Sold for $80,000 gain, reduced to $40,000. $40,000 cash distributed Each unitholder has $10,000 s. 97 income (Div 115-C will apply) $140,000 cash remaining, including $40,000 sheltered DCG gain
CGT Position - Unit Trust (a) Units are sold for $140,000 Unitholders make gain of $40,000 [A1] (b) Units are redeemed for $140,000 Unitholders make gain of $40,000 [C2] (c) Interim distribution of $139,996 Unitholders make gain of $39,996 [E4] (NB. From 1/7/01 no cost base adjustment for DCG distributions)
A simple fixed trust Step 1 Settlement of $10 Fixed Trust 25% 25% 25% Step 2 W, X, Y and Z Give $100,000 25% W X Y Z
CGT Position - Fixed Trust Trust asset increases in value to $180,000 Sold for $80,000 gain, reduced to $40,000. $40,000 cash distributed Each unitholder has $10,000 s. 97 income (Div 115-C will apply) $140,000 cash remaining, including $40,000 sheltered gain i.e. same as unit trust
CGT Position - Fixed Trust (a) Interests are sold for $140,000 Beneficiaries make no gain or loss [E8] (b) Units are redeemed for $140,000 Beneficiaries make no gain or loss [E7] (c) Interim distribution of $139,996 Beneficiaries make no gain or loss [E7]
Summary of Differences Unit Trust Beneficiaries have paid $25,000 each for their interests CGT events A1 and C2 and E4 apply Double tax Fixed Trust Beneficiaries are volunteers CGT events E7 and E8 apply Capital gain disregarded
Should we fix our discretionary trusts? The queen on the chessboard of tax planning Sheltered capital gains can presently be distributed tax-free Advantages go (perhaps?!) with Entity Tax in 2002 -wait and see We could fix them to advantage without adverse CGT or stamp duty consequences
Opportunities within the small business CGT concessions CGT will no longer be an impediment to investment by small business Four concessions 15 year absolute exemption 50% asset asset reduction Retirement Concession Replacement asset rollover But careful (re)structuring is required to ensure CGT is not an impediment!
Basic conditions for relief Two basic conditions Active asset $5 million net value threshold Also a share or unit can be an active asset if 80% of underlying assets are active assets But in that case relief only available if there is a controlling individual
An example Partnership of A, B, C and D Goodwill $4 million Service Discretionary Trust Net Assets = $8 million A, B, C, D and their respective associates
Partner A sells out Partner A sells his partnership interest for $3 million Will the $5 million net value threshold be met? No. Although Partnership is below $5 million, Partner A is connected with the Service Unit Trust, which has $8 million
Solution - Fix the Trust Partnership of A, B, C and D Goodwill $4 million Service Discretionary Trust Net Assets = $8 million 25% 25% 25% 25% A B C D
The Result Partner A beneficially owns 25% of the income and capital of the Service Discretionary Trust (worth $2 M) Partner A is not connected with the Service Discretionary Trust just prior to the CGT event Partner A comes under $5M threshold
Another Example Partnership of A, B, C and D Goodwill $4 million Service Unit Trust Net Assets = $8 million 25% 25% 25% 25% A FT B FT C FT D FT
Another Example Will the $5 million threshold be met? Possibly not. Partner A might still be connected with the Service Unit Trust Partner A might be capable of benefitting under the other partners discretionary trusts Solution: Disclaim interest
Potential Problems These solutions merely formalise the true substance of the relationships Partner A is never going to get more than 25% of the income and capital of the Service Trust Partner A is never going to benefit from his partners family trusts Will Part IVA apply?
Where do we draw the line? Part IVA should not apply to these solutions to overcome the literal words But what about the obvious transferral of assets to get below the $5 million threshold? Hopefully we will get a clue in the next session!
Practical Reality The best tax result is often uncommercial A purchaser wants a clean business, not units or shares in an existing structure Careful attention should be paid to the replacement asset rollover
The Final Example X Fixed Trust Business Market Value $2 million Cost base $2 C 50% 50% A FT B FT
The Final Example A wishes to sell for $1 million to C B wishes to remain C wants business in clean company A FT would not get small business concession anyway although interest in X Fixed Trust is an active asset, there is no controlling individual of X Fixed Trust
Step 1 - Form Newco B C 1 ord share 1 ord share New Co NB Care must be taken to ensure B is a controlling individual
Step 2 - Capitalise Newco C $1 M redeemable shares New Co NB Care must be taken to ensure B remains a controlling individual
Step 3 - sell business for $1M cash & $1M redeemable shares Cash and redeemable shares New Co X Fixed Trust Business
Final Structure B 1 ord share New Co C 1 ord share & 1 M redeemable shares X Fixed Trust 1 M redeemable shares
Step 5 - Pay out A FT X Fixed Trust $1 M cash 1 M redeemable shares A FT $ in full satisfaction B FT NB. Be careful not to leave B FT absolutely entitled e.g. have A FT sell a small % to B himself
CGT consequences X Trust makes capital gain of $2 M Reduced by 50% (DCG) Reduced by 50% (small business) Remaining gain ($500,000) is rolled over into replacement assets
CGT consequences (cont.) Redeemable shares are replacement assets because: they are active assets (underlying assets in Newco are active assets) an entity connected with X Fixed Trust (B) is a controlling individual of Newco Gain is disregarded until CGT event J2 or J3 is triggered
CGT consequences (cont.) Payout to A is CGT-free (CGT event E7) A and B can negotiate fair payout Finally, B DT can stream any future J2 $500,000 gain to a company at 30% Just teasing! Thank you.