CAPITAL GAINS TAX MINIMISATION STRATEGIES 2022
WHAT’S NEW IN 2022?
In the absence of any significant changes to CGT legislation in the last 12 months, we focus on CGT implications departing or returning ex-pats and those becoming Australian tax residents for the first time. This is considered in light of the proposed new residency tests. We examine possibilities for Australians departing to live overseas. We also consider the CGT implications of cryptocurrency sales.
The CGT implications of granny flat arrangements are examined in detail. The Victorian windfall gains tax is also covered.
We also cover in detail the Greensill case, which deals with distributions of taxable capital gains to non-beneficiaries.
- Do all you can to preserve your main residence exemption. See Issue #0113- pages 30,34,39.
- Be aware of the Main Residence 6-year temporary absence. See pages 53,59 of our annual publication.
- Some people engage in D.I.Y. home renovations to enhance the value of a CGT Exempt Asset, i.e., their main residence then sells for a profit. Note they cannot keep doing this continually.
- Focus on Superannuation for wealth accumulation. Assets held in a Super Fund for longer than 12 months generally attracts eventual Capital Gains Tax of only 10% on disposal.
- Assets in a super fund in the pension phase have no tax on earnings or capital gains – see Tax Tip #101-page 33 Issue #115.
- If this is a viable option, accept shares out of a deceased estate instead of having the Executor liquidate them. This defers the taxing point when you sell them.
- Fully utilise the CGT small business concessions. See article pages 53-54 of our annual publication.
- If there are only several parties to a venture, consider using a partnership of Discretionary Trusts used exclusively for that venture. This overcomes capital gains tax event E4, which applies to Unit Trusts.
- Get the timing right. The key date for CGT events is usually the signing of the contract, so be aware of this for the 50% individual discount. If you have a choice, consider deferring the CGT Event into the next tax year.
- See ‘Halving Tax on Shares’ Tax Tip #55-page 27, Issue #0115. This means ceasing to hold shares as trading stock even though you continue to own them.
- If you are not receiving employer superannuation contributions, it may be possible to reduce capital gain tax by making concessional contributions into a complying super fund.
- Win the capital versus income argument by careful planning, i.e., if you engage in development approvals (DAs) and large subdivisions, the ATO may argue you are a developer. It may be better to simply sell to a developer. You may wish to calculate the likely receipts and tax implications of both courses of action. You should also carefully assess the business risk of being a developer. Specialist advice should be sought. Also, see pages 24,25 and 38, Issue #0113.
- Note that Small Business Entities (SBE) turning over less than $2 million, do not have to meet the $6 million asset threshold test to access the CGT Concessions. So, if at all possible, lodge the relevant tax return as an SBE.
- Where there is a CGT event, fully investigate whether rollover relief is available. See Tax Tip 77, pages 30, Issue #0115, and our annual publication pages 49 and 510.
- In the wake of the Bamford decision, ensure your Trust Deed allows streaming of various classes of income. See Tax Tip #39-page 25, Issue #0115.
Commissioner of Taxation v Miley  FCA 1396
In this Federal Court case, the principles that should be applied in determining the market value of shares in a private company for the purposes of the capital gains tax (CGT) small business concessions were considered.
Those principles are:
- The broadly accepted definition of market value at general law is what a willing and knowledgeable but not anxious buyer would pay a willing and knowledgeable but not anxious seller for the shares.
- If there is no willing, knowledgeable but not anxious buyer for the shares, the valuation method involves a hypothesis that there is such a buyer. The focus is then on what a willing but not anxious seller could reasonably expect to obtain and what amount the hypothetical buyer could reasonably expect to have to pay in the event they got together and agreed on a price.
- Where the shares have been the subject of a recent arm’s length sale, it is not necessary to hypothesise about a willing seller and buyer. This is provided the transaction is one between willing but not anxious parties; the price that the parties actually agreed on may generally be taken to be the market price, or at least a reliable indicator, of the market price.
- Suppose it is necessary to apply the hypothesis of a willing seller and buyer. In that case, if there is or likely to be a particular buyer who is willing to pay more for the shares than other buyers because it is in a better position to exploit the shares (for example, it is able to buy all of the issued shares of the company), that buyer should not be excluded in considering the relevant market or market value.
- It is not appropriate to apply a discount for lack of control where the terms of the sale require all of the issued shares of the company to be sold contemporaneously, and the buyer is not required to buy the shares held by one of the shareholders to the exclusion of the shares held by any other shareholder.
It is the last point that is the key issue here, and as have mentioned in past editions, people and their advisers are willing to forward any argument in order to come in under the $6 million threshold. It should be said here the taxpayer had a reasonably arguable position as the A.A.T. had found in his favour, and the Commissioner had appealed the case.
This Federal Court decision provides clarity on how the market value of an asset should be determined.
In 2019, legislation was passed that significantly restricts the availability of the small business CGT concessions where shares or units are being sold. It appears the changes take effect from 1.7.2017, which means that some taxpayers have already been affected retrospectively by these measures.
In the May 2017 Federal Budget, the government announced an integrity measure to ensure that the SB concessions were appropriately targeted, namely:
“The Government will amend the small business capital gains tax (CGT) concessions to ensure that the concessions can only be accessed in relation to assets used in a small business or ownership interests in a small business.”
Here the focus is on situations where a taxpayer could access the SB concessions for the sale of a stake in a company or unit trust by qualifying as a CGT small business entity for an unrelated business venture. The changes are effective 1.7.2017.
Below are the four new criteria to be satisfied in order to access the SB concessions on the sale of shares or units.
The legislation repeals s 152-10(2) of the Income Tax Assessment Act 1997 (the ITAA 1997). It inserts a new s 152-10(2) in substitution. The conditions of the new subsection are:
- A stricter active asset test.
- If a taxpayer relies on the CGT small business entity test to qualify for the sb concessions, they must be carrying on a business just before the relevant CGT event.
- The company or trust in which the shares or units are being sold (the object entity) must be carrying on a business just before the CGT event, and
- The object entity must itself either satisfy the CGT small business entity test or a modified $6m maximum net asset value test.
Below we outline a comparison of key features of the new law and current law taken directly from the explanatory memoranda to the draft legislation.
To be eligible to apply the CGT small business concessions, a taxpayer must satisfy the basic conditions set out in subsection 152-10(1) in relation to the capital gain. Additional basic conditions apply for capital gains relating to shares in a company or interest in a trust. These are either the taxpayer must be a CGT concession stakeholder in the object entity, or unless the taxpayer satisfies the maximum net asset value test, the relevant CGT small business entity must have carried on a business just prior to the CGT event. The object entity must carry on a business just prior to the CGT event; and either be a CGT small business entity for the income year or satisfy the maximum net asset value test; and the shares or interests in the object entity must satisfy a modified active asset test that looks through shares in companies and interests in the trust to the activities and assets of the underlying entities.
To be eligible to apply the CGT small business concessions, a taxpayer must satisfy the basic conditions set out in subsection 152-10(1) in relation to the capital gain. Additional basic conditions apply for capital gains relating to shares in a company or interest in a trust – the taxpayer must be a CGT concession stakeholder in the object entity, or at least an interest of 90 per cent of the taxpayer must be held by CGT concession stakeholders.
There are changes to small business capital gains tax (CGT) concessions to improve the integrity of accessing those concessions. The changes ensure that the CGT concessions are only available for capital gains arising from CGT events that relate to rights or interests that entitle an entity to income or capital of a partnership by making that entity a partner of the partnership.
If you have made a capital gain since 8 May 2018 by assigning a right or interest to the income or capital of a partnership, you will not be able to access the small business CGT concessions unless certain conditions are met.
Those who have entered into these arrangements may need to lodge announced tax returns for 2018 and 2019 in order to ensure no shortfall penalties and interest charges are applied.
Australian residents relocating overseas or foreign residents who became Australian residents and then moved back to their home countries can trigger unexpected Australian Capital Gains Tax (CGT) issues.
Generally, the assessable income of an Australian tax resident includes income from all sources, whether in or out of Australia. In contrast, the assessable income of a foreign resident generally only includes income with an Australian source.
In the context of CGT, this means that foreign residents disregard capital gains or losses that happen in relation to a CGT asset that is not Taxable Australian Property (TAP).
Taxable Australian Property includes:
- Taxable Australian real property (TARP) – e.g., land or buildings located in Australia.
- Mining, quarrying or prospecting right to minerals, petroleum or quarry materials situated in Australia.
- An asset used in carrying on a business through an Australian permanent establishment.
- An indirect Australian real property.
- An option or right to acquire one of the above assets.
As non-TAP is a unique asset class where the ATO does not levy any CGT on it once you have left the country, a CGT event I1 is triggered when you (an Australian resident) cease your Australian tax residency.
CGT event I1 occurs when an individual or company stops being an Australian resident.
Under CGT event I1, you are deemed to have disposed of your non-taxable Australian property (TAP) at the time of your departure and stop being a tax resident. Consequently, a capital gain/loss needs to be calculated and declared in your departing year Australian tax return. This is commonly referred to as the “deemed disposal rule”.
For an individual taxpayer, this will occur when you no longer satisfy any of the four residency tests – the resides test, the domicile test, the 183-day test and the superannuation test. As new residency tests are being developed, this will need ongoing review as events unfold.
Under CGT Event I1, a capital gain or loss is to be calculated based on the difference between:
- The market value of the asset at the time that you become a non-resident, and
- The asset’s cost base.
You make a capital gain if the market value is more than the asset cost base and a capital loss if the market value is less than the reduced cost base.
If you make a capital gain based on the deemed disposal rule, you are required to pay tax at your marginal tax rates on the unrealised capital gain. There may be a cash flow issue given there is no actual sale and no proceeds received.
The potential cash flow issue can be resolved with proper planning. You may seek professional advice to make an estimated CGT calculation for you based on the actual/estimated market value of your non-TAP at the date of your departure. Once you have established your CGT position, you have a period from the date of your departure till the lodgement date of your tax return to decide whether to take the capital gain.
There are, however, exceptions to the “deemed disposal rule”:
- A capital gain or loss is disregarded if the asset was acquired before 20.9.1985 – when CGT was introduced.
- If the taxpayer is an individual, they may choose to disregard the capital gain or loss. This will be evident from whether the capital gain is included or excluded in the relevant tax return.
As an individual, you have a choice to disregard the capital gain or loss which would otherwise arise. This choice applies to all relevant CGT assets – you cannot pick or choose which assets to include.
If this choice is made, the assets are taken to be TAP until you dispose of the asset or you become an Australian resident upon repatriation. This means the assets are kept within the Australian tax system.
The result of deeming a CGT asset to be TAP is that disposal while non-resident will be taxed in Australia even if you are no longer a resident for tax purposes.
Elsewhere we have covered the CGT discount rules from 8.5.2012. From this date, when you dispose of TAP while you are a non-resident, you are no longer entitled to receive the full CGT discount (50%) for a capital gain that would have arisen from the disposal under CGT event I1. For CGT events that occur after 8.5.2012, a CGT discount is dependent on certain criteria, which include:
- Whether the CGT asset was held before or after 8 May 2012.
- The number of days foreign residents had a period of Australian residency;
- The number of days Australian residents had a period of foreign residency.
These are choices that should not be made lightly.
Note that there are special rules for the UK and USA involving Double Tax Agreements (DTA) Article 13 (Alienation of property) of the DTA between Australia and the United Kingdom. The DTA between Australia and the United States of America states that as long as the capital gain is taxable in the new country of residence. There is a suitable provision in the applicable DTA, and it is possible for a capital gain arising on the disposal to be only taxed in the new country of residence.
There needs to be careful thought and planning here, including cash flow, how long you are likely to be overseas, any relevant double tax agreements, the type of non-TAP you hold, and your best assessment of whether the market is going to rise or fall.
Burton v Commissioner of Taxation  FCAFC141
Australian resident taxpayers who are entitled to a 50% CGT discount on capital gains on foreign assets stand to lose up to half the benefit of the CGT discount.
Full Federal Court Decision
The Full Federal Court has reaffirmed the Federal Court’s decision to allow only 50% of the foreign income tax offset (FITO) for US tax paid on the sale of long-term investments, as only 50% of the capital gains were taxable in Australia. The problem is the FITO rules do not recognise that while both the US and Australia allow concessions on capital gains made on investments held for more than 12 months, each country has different methods in applying the concessions.
A taxpayer can claim a full credit or offset for foreign income tax paid if 100% of the income (including capital gains) is included in their Australian assessable income. However, if less than 100% of the income or capital gains are assessable in Australia, such as a 50% discounted capital gain, a credit for only the same proportion of foreign tax paid (i.e., 50%) will be allowed against the Australian tax payable.
The taxpayer was an Australian resident who owned long term investments in the US which he sold, paying US tax on the capital gains. In the US, he was entitled to concessional treatment (15%) for assets held for more than 12 months, which meant he paid tax at less than half the 35% payable if it was not a long-term investment.
As an Australian tax resident, the taxpayer was also subject to CGT in Australia on the gains from the US long term investments and entitled to the 50% CGT discount resulting in 50% of the capital gain being included in the taxpayer’s assessable income and taxed at his marginal tax rate.
In his tax return, the taxpayer claimed the whole of the US tax paid as a credit against his Australian income tax. However, the ATO allowed only 50% of the US tax paid to be counted toward the FITO because only 50% of the net capital gain was included in the taxpayer’s assessable income in Australia.
Both the Federal and Full Federal Courts carefully considered the proper interpretation of the FITO provisions, in particular s 770-10 of the ITAA 1997, which states that ‘……an amount of foreign tax counts toward the FITO if it is paid in respect of an amount that is all or part of an amount included in assessable income….’
The Full Federal Court held that the words of the provision were concerned with the amounts actually included in Australia’s assessable income. This was made clear by the provision that determines what amounts of capital gains are included in assessable income (s102-5 ITAA 1997). Only net capital gains are included in assessable income when applying the provision. A net capital gain is calculated by reducing a capital gain by any capital losses first and then reducing the gain by the discount percentage. The effect of applying the discount percentage to the capital gain was to exclude 50% of the gain from the taxpayer’s Australian assessable income. As a result, the taxpayer was entitled to a FITO only in relation to 50% of the US tax paid. This meant only half of the FITO was available to reduce the taxpayer’s Australian income tax otherwise payable on the same gain.
The High Court refused special leave to appeal this decision. On 24.7.2020, the ATO released a Decision Impact Statement on this case.
In December 2019, the Federal Government announced the Board of Taxation was to undertake a review into Australia’s system of capital gains tax rollovers and associated provisions.
The terms of reference for the review asks the Board to focus on considering practical ways to simplify existing rollovers.
The Board has been asked to report to the Government by 30 November 2020. The terms of reference can be found on the Board of Taxation’s website.
From 1.7.2016, a system was implemented to assist the ATO with the collection of capital gains tax from foreign residents as part of the settlement process when selling or buying real property or interests in real property in Australia.
The procedure which also applies to Australian residents is that unless one of the exceptions applies, a purchaser is required to withhold an amount (12.5% formerly 10%) of the purchase price from the seller and pay it to the ATO (withholding payment). As this system is aimed at the collection of capital gains tax from foreign residents, there are exceptions for sellers who are not foreign residents, subject to the parties following the correct process. Australian residents selling property are required to obtain a clearance certificate from the ATO prior to settlement.
On 9 May 2017, as part of the 2017-2018 Federal Budget, the Government announced two changes to the system – to the threshold and the withholding payment rate. The changes apply to any contracts of sale entered into on or after 1 July 2017.
The two changes to note were:
- The threshold was reduced from $2 million to $750,000 – so the regime now applies all real property disposals where the market value of the property is $750,000 and above; and
- The withholding payment rate was increased to 12.5%.
Commissioner of Taxation v Thomas  HCA 31
The High Court has confirmed the crucial issue in respect of the streaming of distributions with associated franking credits via a trust.
Streaming occurs when a trustee exercises their discretion to allocate a certain type of income to one beneficiary and another type of income to another.
This can have particularly beneficial taxation result in the hands of certain beneficiaries. If a beneficiary has a capital loss from another source, then receives capital gains streamed via the trust, that beneficiary will be able to use those capital losses to offset them against the capital gains, compared to a beneficiary without capital losses paying more tax.
Currently, the nature of the franking credit regime is that it is able to refund money to taxpayers who otherwise have no taxable income and owe no tax.
Nevertheless, a strong incentive exists to stream franking credits via trusts in a tax-effective manner.
Most Trust Deeds permit streaming, and a Trustee distributes the capital gain or franked distribution to a “specifically entitled” beneficiary, allowing the notional allocation system in Subdivision 207-B of the Income Tax Assessment Act 1997 to generally operate smoothly.
In Commissioner of Taxation v Thomas, the High Court held that franking credits are not an independent source of income that can be distributed or streamed by a trustee. They must remain attached to the franked distribution itself.
Instead of streaming franked distributions, the trustee sought to distribute franking credits as discrete items of income (i.e., separate from the distribution).
The High Court observed (at ) that Subdivision 207-B ‘creates a system which “notionally allocates” the franking credits in the same proportion as the beneficiaries’ share in the franked distributions…’
The High Court held that Division 207 does not treat franking credits as a source of income capable of being dealt with and distributed, separately from the franked distribution to which they are attached. The High Court expressly labelled this argument as “wrong”.
The two resolutions made by the trustee (one dealing with the distribution of income and the other dealing with the distribution of franking credits from that income) could not operate together.
The income distribution resolution was effective and carried with the income stream the franking credit. The franking credit resolution had no effect.
CGT event K3 can occur when a person dies and a certain type of CGT asset they owned just before dying passes to a beneficiary who (among other things) is a foreign resident for tax purposes (non-tax resident). K3 only occurs in this scenario if the asset is not taxable Australian Property (“TAP”). This broadly covers ownership of and interests in real estate, so the relevant assets could be share portfolios, bank accounts and managed investments.
If a capital gain has been made on any assets that are not TAP and passed to a non-tax resident beneficiary, the estate will be liable for the tax to be paid. This can cause further problems if the will has not been drafted to allocate any applicable CGT to a particular asset: the result is that beneficiaries of the estate could be affected by the CGT attached to a gift they are not receiving.
The real sting to the K3 event is that the rule applies to estates structured to include a testamentary trust. A testamentary trust works just like a family or discretionary trust, is contained in the will and is active once the executor has completed the administration of the estate and transferred the estate’s assets to the trust. The ultimate transfer of assets from the testamentary trust to a beneficiary, which may be many years on, will attract K3.
K3 will also operate in the circumstances where the trustee of the trust is a non-tax resident and where just one of the beneficiaries or even potential beneficiaries of the trust is a non-tax resident. Given the global labour market, Australians are increasingly likely to live and work overseas at some point, increasing the chances that a future beneficiary could be a non-tax resident and may trigger event K3.
The takeout is that special care should be taken when drafting the terms of the will or testamentary trust to at least allow a trustee to exclude a potential beneficiary if they are a non-resident and ensure the executor has the power of appropriation to sell CGT assets if necessary.
Trustees Should Consider Tax Implications of Trust Splitting in Light of ATO’S TD 2019/14
In December 2019, the ATO issued draft determination TD 2019/14, maintaining that trust split arrangements of the type described in it will cause CGT event E1 in subsection 104-55(1) of the Income Tax Assessment Act 1997 to arise. This occurs when a trust is created over a CGT asset by declaration or settlement. When the draft determination is finalised, the ATO views will apply before and after the date of issue.
The trust split arrangements referred to TD 2019/14 are those where the parties to an existing trust functionally split the operation of the trust so that some assets are controlled by and held for the benefit of some of the beneficiaries, and other assets are controlled and held for the benefit of other beneficiaries. A trust split exhibits all or most of these features:
- The trustee of an existing trust is removed as trustee of some of the assets, and a new trustee is appointed to hold those assets.
- Control of the original trustee is changed so that it passes to some of the beneficiaries, and the new trustee is controlled by other beneficiaries.
- Different appointors are appointed for each trustee.
- The rights of indemnity of the trustees are segregated so that each trustee can only be indemnified out of the assets held by that trustee.
- The expectation is that each trustee will exercise its powers regarding the assets it holds independently of the other trustee to benefit the relevant beneficiaries to the exclusion of the other beneficiaries, regardless of whether the beneficiaries that can benefit from particular assets are expressly limited.
- The rights, obligations and powers of the trustees and beneficiaries remain governed by a single trust deed.
- Each trustee keeps separate books of account.
Many forms of arrangements can be described as a trust split. A trust split usually involves a discretionary trust which is part of a family group. A common reason for splitting the trust is to allow different parts of the family group to have autonomous control of their own part of the trust fund. This often involves asset protection considerations. While a detailed discussion of TD 2019/14 is beyond the scope of this paper, it is essential that you proceed with caution and receive expert advice before contemplating a trust split. Your advisor must be able to demonstrate a detailed knowledge of TD 2019/14 and clearly explain how it does not apply to your proposed arrangements.
From 1.1.2018, the Government has provided an additional 10 per cent CGT discount to resident individuals investing in qualifying affordable housing. This means investors in qualifying affordable housing will be entitled to a 60 per cent discount on capital gains tax.
To qualify for the additional discount, housing must be provided at below-market rent and made available for eligible tenants on low to moderate incomes. Tenant eligibility will be based on household income thresholds and household composition.
The affordable housing must also be managed through a registered community housing provider, and the investment held as affordable housing for a minimum period of three years.
The additional discount will be pro-rated for periods where the property is not used for affordable housing purposes.
Resident individuals investing in qualifying affordable housing will be eligible to receive the additional CGT discount. Non-residents will continue to be ineligible for the CGT discount.
The additional discount will also flow through to resident individuals investing in qualifying affordable housing through Managed Investment Trusts (MITs), where the property has been held for a minimum of three years (see next section).
Consistent with current rules, non-residents investing in eligible affordable housing through a MIT will not receive the additional CGT discount. However, they will generally be subject to a 15 per cent final withholding tax rate on capital gains after a qualifying investment period of 10 years.
For income years starting on or after 1.7.2017, the Government has introduced new rules that enable MITs to acquire, construct or redevelop property to hold for affordable housing. Under the former law, the ATO had generally taken the view that investment in residential property is active, with a primary purpose of delivering capital gains from increased property values, and therefore taxed on income at a 30 per cent rate as it is not eligible for the MIT tax concessions which apply to passive investments only.
Consistent with current MIT withholding tax rules, non-resident investors who invest in these MITs from countries Australia have a recognised exchange of information arrangement will generally be subject to a concessional 15 per cent final withholding tax rate on investment returns, including income from capital gains.
Resident investors in these MITs will continue to be taxed on investment returns at their marginal tax rates. Income from capital gains will be eligible for the increased CGT discount of 60 per cent, where applicable.
MITs must hold, and make available for rent, affordable housing assets for at least ten years.
Should these assets be held for a period of less than ten years, non-resident investors can still receive the concessional 15 per cent final withholding tax rate on investment returns. But will be subject to a 30 per cent final withholding rate on the proceeds of any capital gains.
Further, MITs must ensure that at least 80 per cent of their income is derived from affordable housing in an income year. Failing that, non-resident investors will be subject to a 30 per cent final withholding rate on all investment returns for any year if this requirement is not met.
Foreign institutions and non-resident investors will now be able to invest in affordable housing through concessionally taxed MITs.
Resident individual investors will be able to pool their money with others to invest in qualifying affordable housing and receive the CGT discount, including the additional discount.
These changes create the right incentives to make more affordable housing available for Australians.
Tax costs have an effect on the property pool available for distribution. In property cases, the Court may take into account CGT allowances when determining the asset pool.
Usually, CGT is payable after a change of ownership of a non-exempt asset. However, assets transferred because of the breakdown of a relationship are subject to rollover relief, which means that the recipient party can disregard or defer any capital gain which would otherwise arise until the asset is ultimately disposed of. The cost base of the asset is also transferred to the recipient party.
Rollover relief can apply where:
- an asset is transferred pursuant to a Financial Agreement or court order; and
- ownership is transferred from one spouse/party to another or from a company or trust to a spouse/party to the relationship.
Re FLZY and FCT  AATA 348, 27 May 2016
Here the taxpayer had a win in the AAT in contending that a commercial property it acquired and developed and later sold for a profit of some $40 million had been acquired as a capital asset to generate rental income. As a result, the AAT found that the profit of $40 million was assessable as a capital gain and entitled to the CGT 50% discount.
In coming to this conclusion, the AAT noted that even though the taxpayer’s property development business involved purchasing properties for resale at a profit, this was only part of the business carried on by the taxpayer. A “wide survey and an exact scrutiny of the activities” of the taxpayer showed that over a 40-year period, they involved everything from the acquisition, development, and sale of residential properties to the acquisition and development of commercial properties to hold as capital assets for the purpose of deriving rental income. Consequently, the AAT rejected the Commissioner’s basic claim that the taxpayer was carrying on “a business of the acquisition, development and disposal of properties for a profit”.
The AAT found all the evidence pointed to the fact that the taxpayer intended to develop the original vacant car park into a commercial property to lease to government agencies. This evidence included:
- The clear evidence of the father and son controllers of the business in the past had purchased property for investment purposes.
- Contemporaneous bank records (noting that the building was to be “retained on completion for investment”).
- That a 15-year lease agreement was originally entered into; and
- That the intention to eventually sell was because the offer to sell “was simply too good”.
The AAT also noted that as part of the sale deal, the purchaser offered the taxpayer a deal to acquire substitute investment commercial properties; indeed, the three properties purchased by the taxpayer as part of this arrangement were still owned by the taxpayer almost nine years after the relevant transaction. The AAT also noted that it is always possible that the owner of an asset will sell it, “but to elevate that possibility into an intention to make a profit by selling the property is to draw a longbow indeed” – particularly in the circumstances of this case and given the nature of the transaction in question.
We focus on the main residence CGT exemption because 20 years of experience has shown that the “principal residence exemption” accounted for more than 75% of the CGT enquiries received by the ATO.
Consider the Following Circumstances:
A taxpayer purchased a townhouse in Sydney and lived in the premises for 10 weeks. He then relocated to Brisbane and has been renting out the Sydney property for 5 years.
The taxpayer is aware of the 6-year temporary absence rule and wonders if he has physically occupied the dwelling long enough in order to access the CGT main residence exemption and take advantage of the 6-year rule.
Contrary to popular belief, the CGT provisions do not specify a particular period that a dwelling must be occupied in order to be the taxpayer’s main residence.
- Whether a dwelling is a taxpayer’s sole or principal residence is an issue that depends on the facts in each case, and the ATO’s view was contained in CGT Determination No. 51, which has been withdrawn.
- Some relevant factors may include, but are not limited to:
- The length of time the taxpayer has lived in the dwelling.
- The place of residence of the taxpayer’s family.
- Whether the taxpayer has moved their personal belongings into the dwelling.
- The address to which the taxpayer has their mail delivered.
- The taxpayer’s address on the Electoral Roll.
- The connection of services such as telephone, gas, and electricity.
- The taxpayer’s intention in occupying the dwelling.
- The relevance and weight to be given to each of these or other factors will depend on the circumstances of each particular case.
- On occasion, a taxpayer may elect which of two or more dwellings is his main residence. When changing main residences, it is possible to have two main residences for a maximum period of six months.
The fundamental question would be (after considering the above) – what led the taxpayer to vacate the building? For instance, if it were due to a job transfer to Brisbane, it may be possible to access the concession. In a 1993 case, the Administrative Appeals Tribunal (AAT) expressed the view that whether a dwelling is a person’s principal place of residence is a matter of fact and degree, and that, in determining this question, the decision-maker had to make a common-sense assessment taking into account a number of varying and even conflicting circumstances. Significantly, in this case, the AAT accepted as relevant, though not exhaustive, the consideration listed in TD 51.
There has been nothing to contradict TD 51 as such – it is more that a number of AAT cases have confirmed the determination rendering TD 51 surplus to needs. For instance, Couch and Anor v FCT of T 2009 ATC 10-072 (2009) AATA at paragraph 14 – the Tribunal is of the opinion that something that is only an intention by a taxpayer to occupy a property as a main residence is insufficient to give rise to the exemption in section 118-110.
Consider the following scenario. Patrick Patriarch believes Melbourne’s inner-city units are undervalued. He has a 21-year-old daughter Pricilla attending Melbourne University. Pricilla plans to complete her degree then travel overseas. She has no plans to enter the housing market in the foreseeable future. A unit is purchased in Pricilla’s name, and she lives there for six months prior to departing overseas. The unit is let out and derives a rental income.
Over the next five years, the unit doubles in value. What is the CGT situation?
No CGT will be payable on disposal. The unit is Pricilla’s sole and principal residence, and it is within the six-year temporary absence rule. This example included in past years is certainly affected by the changes that apply to foreign tax residents from 1.7.2019 discussed on pages 30 and 31. If Pricilla moves out of the unit and remains in Australia, then there is still the prospect of a tax-free capital gain.
6 Year Temporary Absence
Although most people are aware of the CGT exemption for sole and principal residence, many are unaware of the ability to “double-dip” in tax benefits even if the home has been used as an investment property at various times.
If you rent out your home for less than 6 years before the house is sold, there may be CGT consequences. As long as you started renting out your home after 20 August 1996, you can still have a partial main residence exemption apply and obtain an uplift in the cost base of your house, providing you have not treated any other property as your main residence during this period.
Note under legislation passed in December 2019, Pricilla will need to be a genuine resident of Australia at the time of the sale to access this benefit.
INCREASING YOUR COST BASE
You can obtain an uplift in the cost base of your house by having it deemed to have been acquired at market value on the day your home is first rented out. Note that the following conditions must be satisfied:
- The home has been rented out for more than 6 years (and no other property is treated as a ‘main residence’).
- The home was rented out after 20 August 1996; and
- The full main residence exemption would have been available if the house had been sold just before it was rented out.
To determine the market value of the house for CGT purposes, a person has the option of:
- Obtaining a valuation from a qualified valuer; or
- Calculating their valuation based on reasonably objective and supportable data.
Generally, if significant amounts are involved, it will be prudent to obtain a valuation from a qualified valuer, particularly if there is any doubt about the property’s market value.
Note the changes for non-residents from 1.7.2019 disposing of their main residence.
It should be noted that the main residence exemption only applies if the land is sold with a dwelling on the land. If sold as vacant land, then the main residence exemption does not apply at all – an exception to this is where the dwelling is accidentally destroyed, and the land is sold without rebuilding.
Consider the case of a couple with a home on two hectares, in matrimonial difficulties doing a property settlement by way of demolishing the family home, subdividing the land, and splitting the proceeds.
They may have lived in the family home for many years, but they miss out on the main residence exemption resulting in a less than ideal tax outcome.
Think very carefully before demolishing the main residence, making sure you fully understand the tax consequences and get your Accountant to do the sums.
This may seem obvious, yet people still get caught out. Some people may put the main residence in a company or a trust for asset protection purposes – be very clear the main residence exemption will not apply – the names(s) on the title must be those individual(s) with a family living in the dwelling.
In a case several years ago, a well-intentioned father bought a townhouse with his 23-year-old son. The father’s assets were necessary for the finance, but this could have been resolved by way of a personal guarantee. The father also took the view his son had not fully matured and might unwisely sell the dwelling without getting the full benefit of long-term home ownership. The father was on the title for 50%, and when the townhouse was eventually sold, the father’s share was subject to CGT, resulting in a substantial tax liability.
The taxpayer unsuccessfully took the matter to the AAT, who simply applied the letter of the law. These matters need to be carefully considered prior to purchase.
Mingos v FCT  FCAFC 211
Staying with the subject of ownership interest Mingos is worth considering.
It is quite possible for a person with “an ownership interest” in a dwelling to qualify for the CGT main residence exemption. A person has an “ownership interest” in a dwelling if they have a legal or equitable interest in the land on which it is erected, or a licence or right to occupy it s118-130 of the ITAA 1997.
This case considered whether the discretionary beneficiary of a trust had an ownership interest in a dwelling owned by the trust.
The taxpayer and his family had resided in the dwelling for many years, originally held on trust for the taxpayer. In 2006 it was transferred into his name and subsequently transferred to his wife. When the marriage broke down a few years later, as part of the divorce settlement, the Federal Court ordered the taxpayer to pay just over $2m to his wife, in return for the transfer of the dwelling to the taxpayer “or his nominated entity”.
The nominated entity chosen by the taxpayer was a company (Lemnian) that was the trustee of a discretionary trust (the Lemnian Trust). The taxpayer and his brother controlled the company. The transaction was financed by a bank loan secured by a mortgage over the property.
When the property was later sold, the taxpayer argued that title to the property had been transferred to Lemnian solely in order to obtain the bank loan and that the property was owned by him beneficially pursuant to a sub-trust. The taxpayer argued that he was entitled to the CGT main residence exemption, the ATO disagreed.
The primary judge held that the taxpayer did not have an ownership interest in the property. The Full Federal Court unanimously dismissed the taxpayer’s appeal.
The evidence presented did not help the taxpayer’s case. Emails showed that the bank was prepared to advance the funds on the basis of the property remaining in the taxpayer’s name (subject to obtaining a mortgage over the property) and that it was the taxpayer’s former accountant and tax agent who instructed that title to the property should be in the name of the Lemnian Trust.
There was also evidence, including signed accounts and the trust’s tax return, showing that the property was treated as an asset of the trust.
Other findings by the primary judge upheld on appeal included:
- the Federal Magistrates Court’s order in the divorce proceedings did not confer upon the taxpayer a full equitable interest in the property; and
- the taxpayer did not have an absolute entitlement to the property as against Lemnian.
With the sharing economy still in its infancy, this is definitely an issue for the future.
The ATO has confirmed that when a taxpayer rents out part or all of their residential home, they become liable for CGT when they eventually sell their principal place of residence (PPR). According to the ATO, this will be based on the proportion of floor space set aside to produce income and the period used for that purpose.
Further, if paying guests also have the use of other rooms such as lounge room, bathroom, or kitchen, then that user has to be apportioned between them and the main residents.
If a person has only been renting out rooms in their house for a short time relative to the period of ownership, then this will not be a major issue. However, over time it could be, and such a taxpayer could wind up with a significant CGT bill when their PPR is sold.
Given the ATO’s enhanced data matching capabilities, people who do not declare Airbnb or Stayz rental income do so at their peril.
All parties operating in the sharing economy need to be fully aware of their taxation obligations.
There may be capital gains to take into account when you eventually sell your holiday house, as only your “main residence” is exempt from CGT. A capital gain is calculated by subtracting, from the property’s sale price, your original outlay plus certain eligible expenses incurred over the time as a consequence of owning the property — referred to as your “cost base”.
Where the property has been owned for at least 12 months, you may be entitled to the 50% individual discount, which will be taxed at your marginal tax rate.
Keeping accurate and valid records from the time you buy your weekender is essential. But when the time comes to make your CGT liability calculation, some common expenses that may qualify to be included as part of the cost base of your holiday house are:
- legal fees and stamp duty on the purchase
- selling costs such as sales commissions and legal expenses
- certain capital improvement costs
- “holding costs”, such as water or council rates, and
- mortgage interest.
Expenses incurred on assets acquired after August 1991 for which a tax deduction has not been claimed, such as council rates and interest, are known as third element cost base items. Do not forget to include these in the calculation.
Ongoing expenses can be included in the property’s cost base, and through time this may result in your having a lower capital gains tax liability when you or your children sell the property.
Even though you may never rent out your holiday home, viewing it as a lifestyle possession rather than an investment, it will still be treated as an investment for capital gains tax purposes. It will be subject to CGT when sold because it is not your primary residence.
This is a major consideration for inheritance: one child may get the family home and the other the holiday home. Not only is the former invariably worth more than the latter, but the child who inherits the holiday home could also be hit for CGT.
You should keep accurate records from the moment you purchase the holiday home; this could save you thousands of dollars.
If you leave your main residence temporarily, you may want the ATO to treat it as your main residence while you are away; for example, if you:
- Move because of a temporary job transfer.
- Study overseas.
- Take an extended overseas holiday.
Under the capital gains tax (CGT) rules, if you:
- Use your vacated home to produce income; you can choose to treat that home as your main residence for a period of up to six years.
- Do not use your vacated home to produce income; you can choose to treat it as your main residence for an unlimited period after you cease living in it.
If you choose to treat that home as your main residence, you cannot nominate any other dwelling as your main residence during your period of absence, even if you actually live in that other dwelling.
There is one exception – the maximum six-month period you can qualify for the exemption on two homes when you are moving from one main residence to another.
You must make a choice by the day you lodge your tax return for the income year in which a CGT event happens, such as selling the house. The ATO will use this information on your return as evidence of your choice.
If you make a choice, it is not affected by you becoming a foreign resident during the period of absence. But note the recent changes to legislation discussed below-concerning non-residents and the six-year temporary absence rule.
If you rent out your home while away, the relevant expenses may be higher than the rental income. If this is the case, you will only make a loss for Australian tax purposes if your deductible expenditure is higher than the sum of your assessable income and net exempt income.
If you retain your residency status for tax purposes while you are overseas, you will need to offset foreign-sourced income against any Australian rental loss. For most people, this means you would generally not have any rental losses available to be carried forward if you are employed overseas. Any loss brought forward from a prior year must first be offset against any exempt foreign source income from the current year before being deducted from your assessable income.
On 9 May 2017, the government announced that Australia’s foreign resident capital gains tax (CGT) regime would be extended to deny foreign and temporary tax residents’ access to the CGT main residence exemption.
The original bill to effect these changes was introduced to parliament but lapsed when the 2019 election was called.
According to the original bill, the change was to apply from the announcement date, and properties held prior to this date would be grandfathered until 30 June 2019.
Following consultation, the government also amended the change to the main residence exemption to ensure that only Australian residents can access the exemption for tax purposes. As a result, temporary tax residents who are Australian tax residents will be unaffected by the change.
On 23 October 2019, a new bill was introduced to parliament. This new bill, which revised the original bill, provides exclusions in certain circumstances. The new bill also extends the grandfathering period from 30 June 2019 to 30 June 2020.
The changes impact certain foreign residents as follows:
- For properties held before 7:30 pm (AEST) on 9 May 2017, the CGT main residence exemption will only be claimed for disposals that happen until 30 June 2020, provided they satisfy the other existing requirements for the exemption. The disposal of these properties that happen from 1 July 2020, at the time of the CGT event, will no longer be entitled to the exemption unless any of the following life events occur within a continuous period of six years of the individual becoming a foreign resident:
- Either the foreign resident, their spouse or their child who was under 18 years of age, has a terminal medical condition.
- Their spouse, or their child who was under 18 years of age at the time of their death, dies.
- The CGT event involves the distribution of assets between the foreign resident and their spouse because of their divorce, separation, or similar maintenance agreements.
- For properties acquired at or after 7:30 pm (AEST) on 9 May 2017, the CGT main residence exemption will no longer apply to disposals from that date unless certain life events (listed above) occur within a continuous period of six years of the individual becoming a foreign resident.
If the foreign resident dies, the changes also apply to:
- legal personal representatives, trustees, and beneficiaries of deceased estates
- surviving joint tenants
- special disability trusts.
The Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures) Bill 2019 received royal assent on 12 December 2019.
If you are an individual, you may choose to disregard all capital gains and capital losses you made when you stopped being a resident.
If you ceased being a resident before 12 December 2006 and you make this choice, those assets are taken to have the necessary connection with Australia until the earlier of:
- a CGT event happening to the assets (for example, their sale or disposal), or
- you are again becoming an Australian resident.
The effect of making this choice is that when working out your capital gains and capital losses on those assets, the ATO takes into account the increase or decrease in the value of the assets from the time you cease being a resident to the time:
- Of the next CGT event, or
- You again become a resident.
The way you complete your tax return is sufficient evidence of your choice.
Assets you may own that have a necessary connection with Australia include:
- Land or a building in Australia (or an interest in land or a building).
- A CGT asset you have used in carrying on a business through a permanent establishment in Australia.
- A share in a private company that is an Australian resident company for the income year in which the CGT event happens.
- A share, or an interest in a share, in a public company that is an Australian resident company and in which you and your associates have owned at least 10% of the value of the shares at any time during the five years before the CGT event happens.
- A unit in a unit trust that is a resident trust and in which you and your associates have owned at least 10% of the issued units at any time during the five years before the CGT event happens.
- An interest (other than a unit) in a trust that is a resident trust for CGT purposes for the income year in which the CGT event happens.
- An option or right to acquire any of the assets in this list.
Assets that do not fall within one of the above categories – for example, land or a building overseas or shares in a foreign company – do not have the necessary connection with Australia.
Taxable Australian property includes:
- A direct interest in real property situated in Australia or a mining, prospecting, or quarrying right to minerals, petroleum, or quarry materials in Australia.
- A CGT asset that you have used at any time in carrying on a business through a permanent establishment in Australia.
- An indirect Australian real property interest – which is an interest in an entity, including a foreign entity, where you and your associates hold 10% or more of the entity and the value of your interest is principally attributable to Australian real property.
Taxable Australian property also includes an option or right over one of the above.
For CGT events happening on or after 20 May 2009, a leasehold interest in land situated in Australia is ‘real property situated in Australia’.
If you are a foreign resident or the trustee of a trust that was not a resident trust for CGT purposes, and you acquired a post-CGT indirect Australian real property interest before 11 May 2005, and that interest did not have the necessary connection with Australia but is taxable Australian property, the ATO treats it as though you acquired it on 10 May 2005 for its market value on that day.
The Government has removed eligibility for the 50% discount on capital gains earned after 8 May 2012 by non-residents on taxable Australian property, such as real estate and mining assets. Non-residents will still be entitled to a discount on capital gains accrued prior to this time (after offsetting any capital losses), providing they choose to value the asset at that time.
Purchasers are required to withhold and pay 12.5% of the sale proceeds of taxable Australian property to the ATO.
Schedule 2 of the Tax and Superannuation Laws Amendment (2015 Measures No. 6) Bill 2015, to apply on 1.07.2016, improved compliance with Australia’s foreign resident capital gains tax (CGT) regime. However, concerns have been expressed that these measures will adversely affect purchasers, vendors, and the property market in general.
This withholding tax (with 2017 changes included) is limited to these types of taxable Australian property:
- Real property situated in Australia (including a lease of land situated in Australia) – land, buildings, residential and commercial property.
- Mining, quarrying or prospecting rights if the minerals, petroleum, or quarry materials are situated in Australia.
- Interests in Australian entities that predominantly have such assets (called indirect interests).
If the foreign resident vendor falls within one of these exclusion categories, then there is no obligation to withhold the 12.5%:
- Taxable Australian Real Property (TARP) transactions valued under $750,000.
- Transactions that are conducted through a stock exchange.
- An arrangement that is already subject to an existing withholding obligation.
- A securities lending arrangement.
- The foreign resident vendor is under external administration or in bankruptcy.
Discretionary trusts are usually created by having a settlor contribute a nominal sum to establish the trust and are commonly used as tax-effective vehicles and in asset protection planning.
After a trust has been established, business or investment assets are then transferred into the trust. A trustee is appointed, and his powers, responsibilities and obligations are normally defined in the trust deed and at trust law. Ultimate power usually rests in the hands of a principal or appointor who has the power to change the trustee.
Discretionary trusts can be created by the terms of a Will and are known as testamentary trusts. The trustee has discretion regarding how the trust’s income and/or capital are allocated among the beneficiaries identified in the trust deed. Given this high degree of flexibility, the trustee is able to make tax-effective distributions and vary allocations to suit family circumstances.
This flexibility to allocate income to low tax beneficiaries is augmented by the fact that:
- Providing effective distributions, income flows through trust and retains its character. Thus, individuals can access the 50% general CGT discount for assets held longer than 12 months. This is not available in a company.
- The most suitable beneficiaries to access the CGT Small Business Concessions may be selected.
- It is possible that an individual or corporate beneficiary may have a capital loss to absorb the capital gain. Also, an associated trust may be a beneficiary and may also have a capital loss. Always consider this.
- More importantly, because the CGT Small Business “Active Asset” 50% exemption flows down to an individual beneficiary, a trust allows full access to all CGT Small Business Concessions. This should be compared to a company where eventually a shareholder will have to receive unfranked dividends.
In past years we discussed streaming of trust income in accordance with Taxation Ruling TR 92/13. This ruling, of course, was withdrawn in 2011 in the wake of the Bamford case.
Since then, there have been significant developments in the law relating to trusts following the Bamford decision and Colonial First State Investments Ltd v Commissioner of Taxation (2011) FCA 16. Legislation to clarify the operation of the character attribution rules is contained in Subdivisions 115-C and 207-B of the ITAA 1997. Of course, this means your trust deed must allow for this.
To recap Bamford v Commissioner of Taxation (2010) HCA 10, the High Court held that:
- Under the Act, “net income” means taxable income, that is, income after all allowable deductions have been subtracted. Accordingly, the “net income” of a trust includes capital gains; and
- “Income” of the trust estate means the trust’s income calculated according to trust law and accounting principles. While this would not generally include capital gains significantly, it was held that a trust deed could define the “income of the trust estate” to include both income and capital gains.
In Bamford’s case, applying the above principles, capital gains made by the trust could be distributed to and taxable to income beneficiaries instead of being taxable to the trustee at the highest marginal tax rate.
Review your trust deed to:
- Ensure “income of the trust” is defined.
- Ensure that the trustee has sufficient powers to permit a trustee to determine trust income in each income year.
- Ensure Trust resolutions concerning distributions are drafted in accordance with the terms of the Trust Deed.
We suggest this is a task for your lawyer.
The key extract from the 2013 ATO Decision Impact Statement on the Greenhatch case is the ATO view that streaming of amounts for trust law purposes by reference to the character of those amounts will only be effective for tax law purposes where specific statutory rules facilitate that result.
In addition to capital gains forming part of the income of a trust, questions as to the tax effectiveness of streaming of amounts for trust law purposes, by reference to character, arise from time to time in other contexts, for example, in relation to:
- Franked dividend income.
- Foreign sourced income streamed to non-residents.
- Income streamed to non-residents that is subject to non-resident withholding; and
- Foreign source income on which foreign tax has been paid.
As with Subdivision 115-C of the ITAA 1997, Subdivision 207-B of the ITAA 1997 (concerning franked distributions and trusts) was likewise significantly amended in 2011 with the express intent of facilitating the tax-effective streaming of franked distributions through trusts.
- We have seen in an earlier example that CGT events are triggered not by a change of ownership (on settlement) but by contract.
- Always be aware of this when seeking to access the 12-month 50% reduction.
- If selling some (but not all) shares in a particular company, carefully review each parcel of shares held to determine which parcel gives the best CGT outcome.
- If possible, defer a disposal subsequent to 30 June in order to defer the tax liability for another 12 months.
There are a number of instances where rollover relief may be available. The most commonly accessed is CGT rollovers caused by marital breakdown.
A compulsory same-asset rollover will occur if a CGT event involves an individual taxpayer disposing of an asset to or creating an asset in the name of their spouse (or former spouse) because of:
- A court order under the Family Law Act 1975 or an equivalent foreign law.
- A court-approved maintenance agreement under the Family Law Act 1975 or equivalent agreement under a foreign law.
- A court order under a state, territory or foreign law relating to de facto marriage breakdowns.
In December 2006, the Government improved the CGT marriage breakdown roll-over provisions by extending the roll-overs to include assets transferred under binding financial agreements and arbitral awards.
This measure has encouraged separating couples to settle their own affairs rather than involve the courts.
The amendments have also ensured that the CGT main residence exemption rules interact appropriately with the CGT rollover and that marriage breakdown settlements do not give rise to CGT liabilities. In relation to the CGT main residence exemption, the amendment has taken into account the way in which both the transferor and transferee spouses have used the dwelling when determining the transferee spouse’s eligibility for the main residence exemption.
In 1999 the Commissioner released a number of determinations relating to marriage breakdown roll-overs (TD 1999/47 to TD 1999/61). All of these are still current.
When a marriage breakdown rollover occurs, any capital gain or loss from the CGT event made by the transferor is ignored.
However, the first element of the asset’s cost base (or reduced cost base) in the hands of the transferee is the assets cost base (or reduced cost base) in the hands of the transferor at the time the transferee acquired it.
It should be noted that automatic rollover relief from CGT also applies where assets are transferred from a company or trust to the trust if the transfer is court directed (or sanctioned or subject to binding financial agreements or arbitral awards.
You may find that a useful way to keep records of assets is to keep a CGT asset register. This is a register of information about your CGT assets that you have transferred from your CGT records (for example, invoices, receipts, and contracts).
For most assets, this information includes:
- The date the asset was acquired.
- The cost of the asset.
- A description, amount and date for each cost associated with purchasing the asset (for example, stamp duty and legal fees).
- The date the asset was disposed of.
- The amount received on disposal of the asset; and
- Any other information is relevant to calculating your CGT obligation.
You can discard your CGT records five years after having an asset register entry certified if:
- You enter all the necessary information about an asset in your CGT asset register.
- The entry is in English and is certified in writing by an approved person (for example, a registered tax agent); and
- The asset register entry is certified after 31 December 1997 (although the asset itself may have been acquired before this date).
If you do not keep an asset register, you generally must keep CGT records for at least five years after you dispose of an asset. For example, if you hold an asset for 10 years and then sell it, you will have to keep the records for 15 years.
Thus, the retention of records is something you should take personal responsibility for. Request copies from your current accountant’s working paper files.
This is prudent given that taxpayers change accountants over the years, and Taxation Determination TD 2007/2 bears this out. Your CGT asset register is permanent. Safeguard this register – otherwise, you may pay too much CGT.
TD 2007/2 made it clear that for the ascertainment of a capital loss, records should be kept beyond the statutory retention period (5 years) because, as a practical matter, it may be necessary to demonstrate the basis of the tax loss deducted or net capital loss applied if a dispute arises, or continues on foot, outside that period in respect of the claim.
Capital Gains Tax record keeping assumes even greater importance due to the latest ATO project on testing the losses of small to medium enterprises (SME).
Note that capital losses can be carried forward indefinitely and in the wake of the global financial meltdown, plenty of us have them. If these are not carefully documented, you may wind up paying too much tax in the future. Always consider entities you own (e.g., companies and trusts) may have capital losses in them, and every effort should be made to offset these losses before you consider making investment decisions within your family structures.
However, be very careful about claiming capital losses where the transactions involve associated parties. Also, be aware that you cannot claim capital losses on personal use items.
In the past, we have done detailed case studies showing how capital gains tax may be reduced in limited circumstances by making large superannuation contributions. However, in the May 2009 Budget, maximum concessional (deductible) contributions were effectively halved from 1st July 2009. Clearly, the potential savings have diminished, but the principles remain.
- Suppose you are aged less than 65 years or age and not receiving substantial employer support (salary <10% of taxable income), you can make tax-deductible contributions to superannuation. So, if you have a taxable capital gain, this may be diminished by making a concessional contribution to a complying superannuation fund. Under the current regime, this is a maximum of $25,000. Note, however, that “catch up” contributions from prior years commencing 1.7.2018 may also be available. These catch up contributions can substantially reduce your CGT bill.
- If you are an employee and cash flows allow, consider salary sacrificing additional funds into superannuation up to the maximum allowable limits outlined above. Note that salary sacrifice will keep you in a lower marginal tax bracket and that if you have sold an asset for a capital gain, you may well have sufficient cash reserves to draw down on in lieu of wages.
In order to assist small businesses, a number of concessions are available for CGT purposes. The main criteria for eligibility are:
- A capital gain would have resulted from a CGT event in regard to an asset owned by the entity.
- Just prior to the CGT event, the net assets of the business and its related entities did not exceed $6 million.
- The CGT asset must be an active asset.
- There must be a “significant individual” with the right to at least 20% of the distribution of income from the entity or has 20% of the voting power.
The concept of ‘active asset’ is very important. An active asset is one that the taxpayer uses in carrying on the business (e.g., Plant, goodwill). The asset must be active at the time of disposal or sold within 12 months after. The asset must also be an active asset for at least half of the ownership period or 7.5 years.
When determining the $6 million net assets threshold, net assets also include assets held by business affiliates, i.e., the spouse or children of the taxpayer.
The four available small business concessions are:
- 15-year exemption
- 50% reduction
- Retirement concession
A small business can disregard a capital gain rising from a CGT event concerning a CGT asset that it has owned for periods totalling 15 years or more, provided:
- If the entity is an individual, the individual is over the age of 55 and permanently retires or is incapacitated.
- If the entity is a trust or company, the controlling individual permanently retires or is incapacitated.
- The asset was an active asset at the time of its disposal.
- The active asset was active for at least half of the period of ownership or 7.5 years.
Where the 15-year Exemption applies, none of the other small business concessions apply.
A 50% active asset exemption is available to active assets of a small business with net assets up to $6 million. This 50% exemption is applied to the net capital gain after making adjustments for any capital losses.
A full CGT exemption may be able to be claimed by a taxpayer up to a lifetime maximum of $500,000, where those proceeds are used for retirement. If the significant individual is over 55, the gain can be disregarded. If the significant individual is under 55, the capital proceeds must be rolled into a complying superannuation fund until the preservation age.
The CGT exempt amount becomes an Employment Termination Payment and, if deposited into a superannuation fund, will not be treated as taxable contributions and will not be subject to tax on withdrawal in retirement. The superannuation fund must receive the capital proceeds during the period beginning one year prior and ending two years after the sale.
The capital gain made on the disposal of a small business can be rolled over into a new business provided that the new active assets are acquired during the period commencing one year before and ending two years after the CGT event occurred.
One of the most important aspects of the concessional treatment of CGT for small businesses is that multiple concessions can be used to obtain the optimal outcome for the taxpayer.
An individual operating a small business could be eligible for:
50% CGT discount for individuals.
50% active asset exemption on the balance of the capital gain.
The remaining 25% of the gain could be rolled over into replacement assets or applied to the $500,000 CGT retirement exemption.
Rollover relief allows a taxpayer to preserve the pre-CGT status of some assets or defer CGT payable on assets in certain circumstances. The main areas of rollover relief are:
- Rollover to a company.
- Replacement Asset Rollovers.
- Same Asset Rollovers.
- Small Business Disposal.
Rollover relief is available when a CGT asset is transferred into a company, and the consideration is non-redeemable shares are that of a comparable value of the net assets transferred. After the event, the transferor must own all the shares in the company.
FOR EXAMPLE: The GPR Partnership has two partners, Steve and Jane – each with a 50% share in the partnership. The partnership has net assets (excluding trading stock) of $20,000, and the partners wish to roll the assets into a company and continue trading in the corporate entity GPR Pty Ltd. For rollover relief to be available, Steve and Jane should be each issued 10,000 $1 shares each in the company.
Rollover relief is generally available in the following circumstances:
- Involuntary disposal (and subsequent replacement) of a CGT asset, for example, is lost or destroyed or becomes part of compulsory acquisition by the Government.
- Renewal or extension of a statutory licence or Crown lease.
- Exchange of shares, rights, or options.
- Strata title conversions.
- Replacement of a mining or prospecting licence after its expiry or surrender; or
- Scrip for scrip rollover where an interest in an entity is replaced by shares or an interest in the acquiring entity. The acquiring entity must hold at least 80% of the voting rights in the original (target) entity.
Rollover relief is available for the following same asset rollovers:
- A CGT asset is transferred to a spouse as a result of a court order after a marriage breakdown.
- A CGT asset is transferred to a spouse under a binding financial agreement; or
- A CGT asset is transferred between companies with 100% common ownership at the time of the CGT event.
Where rollover relief is available to the taxpayer, any capital gain that would have resulted from the transfer is disregarded, and the CGT asset retains its original cost base.
Once the asset is sold to a third party, the taxpayer’s capital gain is based on the difference between the selling price and the original cost base of that asset. If the original asset had been purchased pre-CGT, no assessable gain would arise.
Small businesses can change their legal structure without attracting liability for capital gains tax (CGT).
Small Business owners who find they are using a legal structure that does not suit their needs do not have to be stuck with the structure. They may restructure their business without incurring an immediate CGT liability. The roll-over applies where:
Each party to the transfer is:
- A small business entity (SBE) that satisfies the maximum net asset value (MNAV) test; or
- An affiliate of, or an entity that is connected with, such an entity.
- And the transferee is not an exempt entity (such as a charity) or a complying super fund.
The relevant asset(s) either:
- Are CGT assets used in a business carried on by the SBE; or
- (If the relevant party is an affiliate or connected entity of the SBE) satisfy either subsection 152-10(1A) or (1B) (which deem the “used in business” condition to be satisfied indirectly through use by your affiliate or connected entity).
The transferor transfers one or more CGT assets, or all the assets of its business, for no consideration, to the transferee (both of whom are Australian tax residents), and the transaction is part of a restructure of the business that has the effect of either (or both):
- Changing the type or any of the entities through which the business (or a part of it) is carried on; or
- Changing the number of entities through which the business (or part of it) is operated; and
- The transaction does not have the effect of changing an individual’s Ultimate Economic Ownership (UEO) of the asset (or any individual’s share of the UEO), and any individual with UEO after the transfer is an Australian tax resident.
The asset will then be deemed to have been disposed of for consideration at which neither a capital gain nor loss is incurred.
The new roll-over will benefit business owners wishing to implement a more efficient structure. It is not intended to enable the transfer of valuable assets to other individuals – hence the requirement for UEO (which can only be held by individuals) to remain the same before and after the transfer.
Identifying who holds the UEO in an asset through interposed companies, unit trusts, and partnerships is “relatively straightforward” because “the degree to which they can benefit from the asset will be expressly set out in the documents and agreements that support the business”.
There are specific provisions relating to discretionary trusts, prescribing that UEO will not change if:
- Just before or after the transaction took effect, the asset was included in the property of a non-fixed trust that was a “Family Trust”; and
- Every individual with UEO before and after the transfer was a member of that trust’s “Family Group”.
Consequently, discretionary trusts may access the roll-over simply by making a “Family Trust Election,” whereby its Family Group members will be UEOs of its assets.
“Family Trust”, “Family Group”, and “Family Trust Election” are defined in Schedule 2F to the Income Tax Assessment Act 1936, which prescribe the rules by which a trust may carry forward losses.
Pre-CGT assets will retain their exempt status in the hands of the transferee following the transfer.
Access Threshold – Differs from CGT Small Business Concessions (Div 152)
The legislation states the parties must be SBEs (i.e., satisfying the $2 million aggregated turnover test) and satisfy the Maximum Net Asset Value (MNAV) “$6 million” test.
Significantly, the new rules will enable trustees of discretionary trusts to transfer active assets to other discretionary trusts without triggering capital gains.
This concession is notable because such transfers have triggered CGT consequences since the repeal of the “trust cloning” exception in 2008.
Subdivision 328-G provides opportunities to small and family business groups currently utilising trust structures, providing considerable flexibility when separating ownership for business or family reasons.
The new rules will also provide opportunities for small businesses to shift to a more efficient business structure by making demergers easier.
Additionally, the changes may facilitate (if strict requirements are satisfied) the “break up” of small businesses operating through trusts which are in danger of failing the MNAV test, enabling future access to the CGT small business concessions.
Since 1.7.2016, there has been a foreign resident capital gains tax withholding (Withholding Tax) regime to all contracts for the sale of Australian property, which is entered into on or after that date.
Where the property’s market value exceeds $750,000, the Purchaser of certain taxable Australian assets from a foreign resident is required to withhold and remit 12.5% of the total consideration to the Commissioner of Taxation.
The Purchaser is obliged to comply with a Withholding Tax (even if the Vendor is not a foreign resident) unless the Vendor has supplied a clearance certificate from the ATO.
The Withholding Tax applies to the following assets:
- Real property in Australia with a market value of $750,000 or more including:
- – Land, buildings, residential and commercial property
- – Lease over real property in Australia
- – Mining, quarrying or prospecting rights.
The withholding tax will not apply when the vendor disposes of either:
- Australian real property and provides the purchaser with a clearance certificate from the ATO; or
- Any other asset (other than Australian real property) where the purchaser is given a vendor declaration:
- – As to the vendor’s Australian tax residency; and
- – Confirming that interest being disposed of in an Australian entity is not an indirect Australian real property interest.
The Purchaser can rely on the declarations unless they know the declaration is false. Penalties apply where the Vendor has knowingly, recklessly or failed to take reasonable care in making a false or misleading declaration.
Essentially capital gains or losses arising out of qualifying earn-out arrangements will be viewed as part of the initial transaction and disregarded for the purposes of CGT until and to the extent that they become certain providing greater certainty to sellers in merger and acquisition (M&A) transactions that are subject to earn-out arrangements in respect of the tax treatment of the earn-out.
Formerly, the only guidance on how an earn-out arrangement should be treated was draft taxation ruling TR 2007/D10, Income tax: capital gains: capital gains tax consequences of earn-out arrangements issued by the Commissioner in 2007.
Earn-out arrangements may arise between a buyer and seller in a M&A transaction where consideration may be paid to the seller after completion of the transaction based on specific conditions being met, including the business’s future performance.
A reverse earn-out arrangement occurs when the seller undertakes to make repayments to the buyer if the business or asset does not perform to those standards within a specific timeframe.
Earn-out arrangements are often used in transactions where the value of the assets or business are not agreed on or depend on future events. They reduce the buyer’s risk for a portion of the transaction and provide a mechanism for the seller to maximise its return.
Seek specialist advice before considering whether your arrangements qualify for “look though” treatment. Both sides of an M&A transaction will generally have lawyers advising them.
As discussed, a discretionary trust normally gives the best outcome for capital gains tax.
If you have a business owned by a company and believe there is a likelihood of it being sold for a capital gain, you need to assess your options carefully.
The ideal outcome when selling the business is to see if the buyer will purchase the shares in the company.
As the company may have a “past”, a potential buyer will sometimes baulk at this step into the unknown, notwithstanding the fact that the directors may be willing to provide indemnities.
However, if the company has been operated cleanly and has maintained a good set of books, this is still a possible outcome.
- First, examine whether the CGT 15-year exemption applies.
- If not, consider the CGT Small Business Retirement Exemption. Under the new changes, up to 5 “Significant Individuals” can assess this concession, allowing $500,000 per individual.
- However, under this concession, if you are aged less than 55 years of age, the $500,000 has to be contributed to a complying super fund.
- Note that each significant individual may only access this concession once in their lifetime.
- Another option may be to access the “Active Asset” 50% exemption.
- Note that this exemption’s ultimate outcome clearly shows why companies are not the vehicle of choice where capital gains are concerned.
- It is all well and good to access this concession, but eventually, dividends have to be paid, and to the extent, company tax has not been paid, these dividends are unfranked, leaving tax to be paid by the shareholder. In this instance, companies are merely a mechanism to defer tax compared to trusts where much better outcomes can be achieved.
- The benefits of legitimate tax deferrals are still worthwhile. Careful planning in the staggering of dividends over a number of years can still save significant amounts of tax.
Also, refer to tax tip #71- page 25 in Issue #0109. This applies to assets purchased prior to September 1985 in a Company and deals with the Archer Bros Principle.
Non-Australian assets are considered to have been acquired at their market value at the time of becoming an Australian resident. Although the taxpayer may have owned such an asset for more than 12 months, the 50% discount is only available if they have been an Australian resident for more than 12 months.
The ATO has effectively reset the purchase date at the time of becoming a resident.
To qualify for the 12-month 50% CGT discount, 12 months must have elapsed from the deceased contracting to purchase the asset regardless of whether the asset is held by the trustee or the beneficiary when disposed of.
It should be noted that the effective date of introduction of CGT is 19.9.1985. Assets purchased prior to that date are not subject to CGT.
In most cases, death does not trigger CGT, but the clock does start ticking on these pre-CGT assets. As such, it is important to have these valued at the date of death, and this becomes the cost base.
If sold within two years, the deceased’s main residence will not attract CGT.
Pre 19.9.1985, main residences enjoyed the two-year concession even if they were rented out before or after death.
Those purchased after that date only receive the concession if the dwelling was the deceased main residence just before death and was not income producing at that time.
If this is not the case, then market value becomes the cost base at the date of death.
Any capital loss accumulated by the deceased can only be offset against actual capital gains crystallised prior to the date of death. This is worth thinking about because neither the trustee nor beneficiary can take advantage of the deceased’s carried forward losses.
Division 128-10 states that passing an asset from the deceased to either Executor or the Beneficiary will not trigger a CGT event, nor will the transfer from the Executor to the Beneficiary.
A testamentary trust is designed to provide maximum flexibility and allow for tax-effective distribution of capital and income and provide possible protection of your beneficiaries from third parties such as creditors.
These trusts allow for optimum allocation of income and capital, which in turn may permit beneficiaries to qualify for aged, disability and sole parent pensions, Austudy or the like, for which they would otherwise not have qualified under a normal inheritance.
In practice statement PS LA 2003/12, the ATO has recently confirmed they will treat the Trustee of a Testamentary Trust similarly to a legal personal representative (LPR).
Such carried forward (and current years) capital losses a taxpayer has incurred are effectively lost at the date of death.
They cannot be transferred to a beneficiary of the deceased estate or be utilised by the LPR – see Taxation Determination TD 95/47.
If taxpayers know of a terminal condition, they could consider getting CGT assets to intended beneficiaries before death. This means the carried forward losses will lower the actual capital gain. The market value substitution rule will also step up the recipient’s cost base to market value on the date in question.
Note that SMSFs have similar considerations for post-death distributions to non-dependents, which is dealt with in-depth in bonus issue #0114 page 43.
A detailed discussion of CGT event K3 is beyond the scope of this paper.
However, if your will contains a non-resident beneficiary, be aware that s104-215 ITAA97 operates to tax a capital gain on an asset passing under a will from a deceased person to a non-resident beneficiary.
It should be noted the section also applies to assets passing to exempt entities and complying with superannuation funds.
A perusal of the text of s104-215 reveals the unfortunate consequence: the taxation of an unrealised capital gain on death.
There are drafting and non-drafting techniques that may alleviate the threat of CGT Event K3, and you will need to raise these with a lawyer that specialises in Estate Planning.
When two or more arm’s length parties need a business structure, a unit trust is often recommended due to the fact that it is a flow-through for taxation purposes – this means that the income of the trust flows to the beneficiaries in untaxed form and is taxed at the beneficiary level.
Usually, the beneficiary of a fixed trust is a discretionary trust allowing family interests flexibility in distributing income.
What is often overlooked is the application of capital gains tax event E4 (section 104-70 of the ITAA 1997). Apart from some limited exemptions, this has the effect of reducing the cost base of units in the trust held by the discretionary trust where the accounting profit exceeds the taxable profit for the year.
In the event the cost base is eventually reduced to nil, this can lead to all subsequent distributions of accounting profit being made assessable pursuant to section 97 or as a capital gain where CGT Event E4 is triggered.
In the event of a business sale, the double discount (12 month and active asset discount) may not eventually flow down in full to the ultimate individual beneficiaries.
It is clear CGT Event E4 occurs where amounts are paid to unit holders that represent a distribution attributable to the active asset 50% discount.
For this reason, if at all possible and if all parties agree, consideration should be given to forming a partnership of newly formed discretionary trusts. For asset protection purposes, avoid using existing trusts with assets in them.
If this occurs, CGT Event E4 will not be an issue, and with careful planning, full individual access to all the CGT Small Business Concessions will be available.
Commissioner of Taxation v Eichmann (2019) FCA 2155
This case dealt with the CGT small business concessions and whether the essential active asset” test was valid.
The taxpayer carried on a business of building, bricklaying and paving through a trust. The land that had no business signage had been acquired next to their home contained sheds, and the open space was used to store materials, tools, and park work vehicles.
The ATO had issued an unfavourable private ruling that the use of the property in the taxpayer’s business was incidental and not sufficient for the land to be an ‘active asset’ for these purposes. However, the AAT held that the use of the land was sufficient to be ‘in the course of’ carrying on the business, and it did not need to be integral to the business, which meant the active asset test was satisfied.
The ATO appealed to the Federal Court, which held that the active asset test requires the use of the land to have direct functional relevance to the carrying on of the normal day-to-day activities of the business. As the use for storage was a preparatory activity and not acting in the ordinary course of the taxpayer’s business, the land was not an active asset.
On 18.9.2020, the Full Federal Court overturned this decision resulting in a win for the taxpayer. In short, it was found that “use was enough”- meaning that at some point, the asset was used in the course and conduct of the business.
Excellar Pty Ltd v FCT (2015) AATA 282
Excellar dealt with the maximum net asset value test (MNAVT) calculation.
The taxpayer was a private company that sold a boarding house. In this case, the taxpayer was not entitled to the small business CGT concessions in respect of the capital gain it made on the sale of the boarding as the MNAVT was not met.
The AAT considered a number of issues:
- The appropriate market value of the boarding house.
- Whether cash at the bank was a CGT asset.
- Whether the liabilities related to the CGT assets were the GST-inclusive amounts for the purpose of the MNAVT calculation.
- Whether a holiday home owned by Mr A (a connected entity of the taxpayer) should be included in the MNAVT calculation.
- Whether guarantees provided by Mr A constituted related liabilities for the MNAVT.
In establishing the correct market value of the boarding house, the AAT did not accept the property’s market value was lower than its sale price. The AAT held that the property’s market value was to be determined in accordance with the principles stated by the High Court in Spencer v Commissioner (1907) 5 CLR 418. This often-quoted case deals with the willing but not anxious seller and the willing but not anxious buyer.
Accordingly, the sale price is the appropriate value.
Federal Commissioner of Taxation v Devuba Pty Ltd (2015) FCAFC 168
The Full Federal Court decided in favour of the taxpayer that the capital gains tax (CGT) small business concessions applied to reduce a capital gain that arose from the sale of shares. The Court also clarified the application of the small business CGT concession rules in section 152 of the Income Tax Assessment Act 1997.
The taxpayer, Devuba Pty Ltd (Devuba), sold 45% of its shareholding in Primacy Underwriting Agency Pty Ltd (Primacy). The share sale caused Devuba to make a capital gain of over $4 million. Devuba contended that a number of CGT concessions for small businesses applied with the effect that the capital gain was reduced to nil.
The Commissioner of Taxation (Commissioner) argued that the CGT small business concessions did not apply in this case. The AAT was found for the taxpayer, and the Commissioner appealed to the Federal Court.
The key issue in dispute was whether the CGT concession stakeholders in Primacy held a small business participation percentage (SBPP) in Devuba of at least 90%. A CGT concession stakeholder is an individual or their spouse who holds at least a 20% SBPP in the company. An SBPP includes the percentage voting power held in the company and the percentage of dividends that the company may pay to a particular person.
The issued shares in Devuba included one share to an individual, one to trust and one ‘dividend access share’ to an individual who did not have any voting rights but gave an entitlement to dividends only when determined by the directors. Devuba argued that the CGT concession stakeholders were the two individual shareholders, and together they had a 95% SBPP, which was greater than the required threshold.
The Commissioner argued that the directors had a discretion to pay a dividend on the dividend access share to the exclusion of all ordinary shareholders such that the ordinary shareholders may not obtain a dividend and therefore, their SBPP interest is nil. The question for the Full Federal Court was whether Devuba’s Articles of Association operated to give the dividend access shareholder a right to dividends to the exclusion of ordinary shareholders.
The Full Federal Court dismissed the Commissioner’s appeal, finding that if Devuba was to declare a dividend just before the sale of Primacy, it would have been to the ordinary shareholders, not the dividend access shareholder. No determination had been made at the time of the CGT event that would allow a dividend to be paid to the dividend access shareholder. As such, the SBPP was not reduced to nil, and the small business concession was available to reduce Devuba’s capital gain.
This case shows the importance of carefully considering the details of each transaction before applying the small business CGT concession provisions.
Breakwell v Commissioner of Taxation (2015) FCA 1471
The Federal Court dismissed the applicant’s appeal, holding that the pre-1998 loan from Mr Breakwell’s family trust to Mr Breakwell was not statute-barred under s35(a) of the Limitation of Actions Act 1936 (SA). Therefore, the applicants exceeded the $6 million threshold in the maximum net asset value test (MNAVT) and could not claim the small business CGT relief.
The taxpayer has appealed to the Federal Court against the Tribunal’s decision in PFGG and Commissioner of Taxation (Taxation) (2015) AATA 972. The Tribunal had affirmed the ATO’s decision to deny the taxpayer’s claim for small business CGT relief as the annual turnover exceeded the $2 million thresholds for a “small business entity.”
The sole director and shareholder of trustee company did not “control” trust – Gutteridge and FCT (2013) AATA 947 (AAT, O’Loughlin SM, 24 December 2013)
Here, the tribunal held that a trust was not controlled by Sarah McKenzie, the sole director and shareholder of the company acting as a trustee but was controlled by her father, Timothy Gutteridge.
In the relevant year, the trust sold 50% of its business and, consistent with years, distributed all of the trust’s income, including its capital gain on the sale of the business, to Mr Gutteridge and his wife. Mr and Mrs Gutteridge claimed the 50% small business reduction provided for by s152-205, the small business retirement exemption provided by s152-305 and the small business roll-over provided for by s152-410.
The Commissioner contended that Ms McKenzie, as the sole director and shareholder of the trustee company, was a controller of the trust and, therefore, the trust was connected with another entity owned and controlled by Ms McKenzie (Jigsaw). Accordingly, the trust was not eligible for Small Business Relief under Division 152. The reason being, taken together, the aggregated turnover of Jigsaw and the trust exceeded $2 million, and the asset values owned by them at the time of the CGT event in question exceeded $6 million. However, if Ms McKenzie did not control the trust, neither threshold was exceeded.
Evidence Submitted Included:
In the relevant period, Mr Gutteridge gave advice and support to Ms McKenzie on the running of the business of the trust, and she needed that advice.
Notwithstanding that he was not a director on the ASIC database, Mr Gutteridge attended the trustee company directors’ meetings with the relevant personnel accepting that he played a major advisory role in ensuring the trust’s business was successful.
During the relevant period, the trust was considered by those with relevant knowledge to be a “Tim Gutteridge entity” with all non-bank funding provided by Mr and Mrs Gutteridge.
The appointor of the trust, Mr Coffey, had the power to remove the trustee company.
Crucially Mr Coffey gave evidence that Mr Gutteridge controlled the trust from behind the scenes with no action taken in relation to the trust unless in accordance with Mr Gutteridge’s wishes and directions.
In the event that there were disagreements in the running of the trust, or there were steps to be taken in the running of the trust contrary to Mr Gutteridge’s wishes, Mr Coffey would have acted in accordance with any directions from Mr Gutteridge including, if required, removing a trustee from that role.
Mr Coffey was clear that he would disregard any instructions or entreaties from Ms McKenzie to the contrary.
In finding for the taxpayers, the AAT said at paragraphs 23-24:
“The circumstances of the present case call for conclusions that the Trust was not accustomed to act in accordance with Ms McKenzie’s wishes independently of her father’s wishes in circumstances where her wishes and directions were her father’s. She was acting as the director of the trustee in circumstances where the trustee could be removed at the will of Mr Coffey (sic), and Mr Coffey (sic) regarded himself bound by the wishes and directions of Mr Gutteridge. Further, suppose it was necessary to find that Ms McKenzie was a puppet director, or that Mr Gutteridge was a shadow or de facto director. In that case, there is ample material on which to rest such a finding….
The facts as found above require a finding that Mr Gutteridge alone was the person who controlled the Trust within the meaning of s328-125(3) of the 1997 Assessment Act. Accordingly, as that was the only matter in controversy, the Applicants have demonstrated that the Trust is entitled to the Small Business Relief as claimed.”
DECISION IMPACT STATEMENT
August v Commissioner of Taxation
This Decision Impact Statement issued 16.02.2015 outlines the ATO’s response to this case concerning whether the profit from the sale of properties was income according to ordinary concepts or income of a capital nature.
In 1995, Helen and Peter August established various companies and trusts, including Toorak Management Pty Ltd (Toorak) and Toorak Unit Trust. Toorak was the sole trustee of the Toorak Unit Trust. Each taxpayer held 50% of the issued units in the trust. Helen and Peter August were the sole directors and shareholders of Toorak.
Directional Developments Pty Ltd (Directional Developments) was a company in which Mr August had an interest as a shareholder. He was also a director of the company.
As trustee for Toorak Unit Trust, Toorak acquired a number of properties between late 1997 and the middle of 2000 (the Melba Properties). The properties were developed and ultimately sold for a profit in early 2007.
Directional Developments acquired a lease of land (the Hume Property) in late 2001. The property was sold in late 2005 for a profit.
The issue at first instance was whether the profits on the sale of the Melba Properties and the sale of the Hume Property was income according to ordinary concepts or income of a capital nature. The trial judge found in favour of the Commissioner.
Issues Decided by the Court
In their reasons for the decision, the Full Court considered the three issues raised by the applicants and on each issue found for the Commissioner.
Firstly, in respect of the applicant’s application to adduce three further expert reports to address the authenticity of a document relied on by the taxpayers and rejected by the trial judge, the Full Court dismissed their application. Their Honors’ found that the trial did not miscarry in relation to the document and that it was not appropriate for the Court to determine the issue of the document’s authenticity.
Secondly, the Full Court rejected the applicant’s argument that the trial judge erred in law in that he applied the incorrect test for determining what income according to ordinary concepts was.
Thirdly, the Full Court rejected each of the applicant’s submissions on the findings of fact.
ATO View of Decision
The Full Court applied settled principles of law to the facts in this case. The decision has no wider ramifications.
In the October 2020 Federal Budget, the Morrison Government introduced a targeted Capital Gains Tax (CGT) exemption for granny flat arrangements with a formal written agreement.
Tax consequences can be a key impediment to families creating formal and legally enforceable granny flat arrangements.
When faced with a potentially significant CGT liability, families may opt for informal arrangements, which can leave open the risk of financial abuse and exploitation, for example, following a family or relationship breakdown.
Under the measure, CGT will not apply to the creation, variation or termination of a formal written granny flat arrangement providing accommodation for older Australians or people with disabilities.
This measure which is now law commenced on 1.7.2021.
This change will only apply to agreements entered into because of family relationships or other personal ties and will not apply to commercial rental arrangements.
Currently, around 3.9 million pensioners and around 4 million Australians with a disability could be eligible for this exemption under this change.
Under Division 137 of the Income Tax Assessment Act, a CGT event does not happen on entering into, varying or terminating a granny flat arrangement if the following apply:
- the person has or will have the right to occupy a dwelling for life (called a “granny flat interest”). This includes the dwelling’s adjacent land and structures, up to a limit of 2 hectares.
- the person who holds the right either:
- Has reached pension age at or before that time. Pension age is the same age threshold that is used in determining eligibly for the Age Pension and varies according to date of birth and gender; or alternatively
- For the next 12 months, needs and are likely to continue needing assistance to carry out most day-to-day activities of a disability. Disability takes its ordinary meaning. The ability to recover from a disability is not an impediment to accessing the CGT exemption, nor is the ability to undertake employment while having the disability.
If the person meets either of the above two requirements relating to age or needing assistance, then they will be “eligible for a granny flat interest”.
- Another person (“the owner”) owns the dwelling, which will be the subject of the granny flat arrangement. This can be prospective with both parties entering an arrangement that the owner will acquire a dwelling where the other party will hold their granny flat interest at a future time.
- The owner and the holder of the granny flat interest must be parties to the arrangement, which must be in writing and indicate an intention for the parties to be legally bound by it.
- The arrangement must not be commercial in nature, and this is determined on a case-by-case basis. For instance, the requirement to pay market rent might indicate that the arrangement is of a commercial nature. If the granny flat interest holder merely contributes to the costs of running the household, this might indicate that the arrangement is not of a commercial nature.
This article is definitely aimed at tax practitioners and advisers. Carefully consider the situation before making a distribution to a non-resident beneficiary, particularly if the case distribution results from a capital gain relating to non “taxable” Australian property. These were the facts in Greensill, and recently the taxpayer was denied leave to appeal to the High Court.
The facts in Greensill are as follows:
An Australian resident trust made a series of capital gains. The CGT assets were not ‘taxable Australian property’. The trustees distributed those capital gains to a non-resident beneficiary.
The Commissioner issued assessments to the trustee for the capital gains.
Different parts of the legislation deal with the tax treatment of capital gains made by trusts, which are then distributed to non-resident beneficiaries.
- Division 6 of the 1936 Act contains the primary provisions for taxing trust income.
- Division 115-C of the 1997 Act contains the relevant provisions for taxing capital gains that may be streamed to specified beneficiaries.
- Division 6E of the 1936 Act excludes capital gains from being taxed under Division 6 (given they would be taxed under Division 115-C).
- Division 855 of the 1997 Act contains provisions that allow foreign residents to disregard capital gains from CGT assets that are not ‘taxable Australian property’.
In Greensill and Martin, the Full Federal Court concluded that:
- Division 115-C applied so that the non-resident beneficiary was deemed to have capital gains that reflected the trust’s capital gains; and
- Division 855 did not apply to disregard those capital gains because the non-resident beneficiary did not make the relevant capital gains.
Here is the inconsistency – there is no taxing point in Australia where an Australian resident trust distributes trust income with a foreign source (that is not capital gains and not franked dividends) to a beneficiary who has been a non-resident for the whole income year.
The foreign source income is not included in the non-resident beneficiary’s income under section 97. This is because section 97 tests both the beneficiary’s residence and the source of the income. The foreign source income is also not included in the trustee’s assessable income under section 98 for the same reason: section 98 also tests both the beneficiary’s residence and the source of the income.
The inconsistency for capital gains being treated differently to other trust income arises because there is no equivalent provision in Division 115-C for testing the source of the capital gains.
Separately, the effect of Division 855 is that there is no taxing point in Australia where either:
- A non-resident has a capital gain in relation to a CGT asset of theirs that is not ‘taxable Australian property, or
- A non-resident beneficiary has an interest in a fixed trust, and that fixed trust has a capital gain about a CGT asset that is not ‘taxable Australian property’.
However, there is no relief for non-resident beneficiaries of discretionary trusts or unit trusts that are not fixed trusts, who receive capital gains distributions.
An exhaustive discussion of Greensill and Martin is beyond the scope of this publication but is important for practitioners to be aware of this anomaly in the tax law. If there is a closely held discretionary trust, the remedy may be to allocate non-capital gains (normal income) to the non-resident beneficiary. This may not be possible, of course, in the case of fixed (unit) trust. In this event, seek specialist advice, and there may be remedies in double tax agreements if a skilful submission is made.
GREIG v COMMISSIONER OF TAXATION
On 8.7.2020, the ATO released its Decision Impact Statement (DIS) on the Full Federal Court decision of Greig v Commissioner of Taxation  FCAFC 25.
Mr Greig was confident that his investment in Nexus Energy Limited (Nexus) would be successful despite declining share prices spent $11.8 million making 65 separate acquisitions of Nexus shares. However, in 2014, Nexus was placed into administration, and his shares were transferred for nil consideration.
The Full Federal Court found that Greig held Nexus shares on revenue account and was entitled to deductions for their cost. Individual shareholders with significant investments may have some concern at this point, particularly where hopes of claiming the capital gains tax discount are cast into doubt.
The Decision Impact Statement outlines in full:
- The issues decided by the court
- The ATO views of the decision and
- The implications for impacted advice or guidance.
For a detailed analysis of Greig, refer to page 43, Issue #113.
This issue comes up frequently. It is common to be a beneficiary to an estate that holds some shares in a range of companies. The choice is whether to have the inheritance paid in cash or have ownership of the shares transferred to the beneficiary.
There are two main issues. First, the taxation of the shares and second, whether the beneficiary wishes to retain the shares long-term in your portfolio.
The shares held in the estate will have a cost base being the price paid for the shares. If the shares were purchased before capital gains tax (CGT) was introduced, pre-September 20, 1985, they can be transferred to the estate without CGT applying. If the shares are transferred into your name, then your cost base will be the market value of the shares as at the date of death of the deceased.
Where the shares were purchased post-September 19, 2005, the cost base will be the price paid by the deceased. If you then sell the shares in the estate, the capital gain or loss will be assessed in the estate’s income tax return if you have the shares transferred to your name, the cost base when sold will be the same as the deceased. Essentially you inherit the deceased cost base.
The second issue is if you do not wish to retain the shares long-term in your portfolio and that the shares have an accrued capital gain, here it will be necessary to calculate the tax payable should they be sold in the estate versus the tax payable if you transferred them into your own name and then sold them. The shares would then be sold where the lowest amount of tax would be paid.
Do not forget to take into account how the capital gain in your tax return could affect other issues such as your entitlement to superannuation co-contribution, family tax benefits or other income-tested benefits.
If you want to hold the shares long term in your portfolio, follow the steps above and if the lower tax is payable by selling in the estate, then have the estate sell them, receive the cash, and repurchase them in your own name. If not, just transfer them to your own name.
Make sure you do the analysis for each share, as it may be better to sell some in the estate. But if a capital loss applies, it may be better to realise the loss in your own name.
In summary, there are plenty of calculations to undertake to determine the best outcome for you from a tax perspective, and this will need to be done on each share parcel separately.
Many of you may ponder the relevance of the following example in what has been a turbulent market. However, we should note that markets always recover, and capital gains could once again become an issue sooner than you think.
With the stock market enjoying a bull run in recent years, many share traders are sitting on substantial accrued profits. Did you know that if you hold these shares long term, you can legally halve your tax bill on not only future gains but also the substantial gains already accrued?
The trading stock provisions of the Tax Act allow you to change the manner in which you hold your shares. This means you can cease to hold shares as your trading stock even though you continue to own them.
This ‘change of use’ has no tax implications as the original shares are treated as having been disposed of and immediately ‘re-acquired’ as a capital asset at their original tax cost. Effectively, an item that was originally trading stock then becomes a capital asset upon the change of use. No formal written election is required to evidence the change.
Below is an example of ceasing to hold an item as trading stock and beginning to hold it as a capital asset.
EXAMPLE: You are a share trader and purchased 20,000 shares in Gold Ltd in November 2019 as trading stock at the cost of $5 per share. In January 2022, the shares were worth $9 per share. You are considering holding the shares as a long-term dividend-yielding investment, as commodity demand is likely to underpin the value and yield on the shares for the foreseeable future.
If you sell the shares now, you will pay a tax of $39,200 (i.e., a profit of $80,000 at the 49% tax rate). However, if there has been a genuine change of intention with respect to specifically identified shares and those shares are subsequently retained for more than 12 months, you are entitled to claim the CGT discount upon a sale of those shares.
Assuming the value of the shares remains unchanged, the tax on the eventual share sale will be only $19,600 (i.e., $80,000 x 50% CGT discount x 49%).
The trading stock provisions apply only to a genuine change of intention regarding your ownership of items previously held as trading stock. Whether there has been a bona fide change of use may be evidenced by conduct before and after applying the trading stock ‘change of use’ rule.
If you invest in a qualifying early-stage innovation company (ESIC), you may be eligible for tax incentives.
The tax incentives provide eligible investors who purchase new shares in an ESIC with a:
- Non-refundable carry forward tax offset equal to 20% of the amount paid for their qualifying investments. This is capped at a maximum tax offset amount of $200,000 for the investor and their affiliates combined in each income year.
- Modified capital gains tax (CGT) treatment, under which capital gains on qualifying shares that are continuously held for at least 12 months and less than ten years may be disregarded. Capital losses on shares held less than ten years must be disregarded.
The maximum tax offset cap of $200,000 does not limit the shares that qualify for the modified CGT treatment.
Investors that do not meet the ‘sophisticated investor’ test under the Corporations Act 2001 will not be eligible for any tax incentives if their total investment in qualifying ESICs in an income year is more than $50,000.
The tax incentives for early-stage investors (sometimes referred to as ‘angel investors’) are contained in Division 360 of the Income Tax Assessment Act 1997.
To qualify for the tax incentives, investors must have purchased new shares in a company that meets the requirements of an ESIC immediately after the shares are issued. The shares must be issued on or after 1 July 2016.
If, after the company has satisfied these requirements, it ceases to be an ESIC, this will not affect the investor’s entitlement to the early-stage investor tax incentives for the shares.
The early-stage investor tax incentives are available to both Australian resident and non-resident investors.
If the investor is a trust or partnership, special rules apply so that the entitlement to the tax offset flows through to the member of the trust or partnership (or the ultimate member if there is a chain of trusts or partnerships).
If the investor is a superannuation fund, the trustee of the fund and not the fund members would be entitled to the tax incentives (tax offset and the modified CGT treatment).
This is very much a niche market situation for incentives, and a detailed discussion is beyond the scope of this publication.
Forgiveness of related party loans and CGT event c2
Some taxpayers are of the mistaken belief that if an entity forgives a debt to a related party, it will give rise to a capital loss.
This is not the case if a related party loan is a personal use asset under subdivision 108-C ITAA97. In such an event, any capital loss is disregarded.
Another misconception is that if the lender is not a natural person, they cannot have a personal use asset!
Clearly, a Company or Trust can have a personal use asset just as a natural person can.
Section 108-20(2) ITAA97 deals with a lender’s loan assets stating that:
“A personal use asset is:
- A debt arising other than:
- In the course of gaining or producing your assessable income; or
- From you carrying on a business.”
You need to establish (if relevant) that the loan was provided in the course of producing assessable income or from you carrying on a business.
Two cases worth reviewing are:
- FCT v Total Holdings (Australia) Pty Ltd
- Macquarie Finance Pty Ltd v FCT
If the loan is not a personal use asset, take legal advice on steps required to forgive a loan.
The key here is whether interest has been charged on the loan – if not, there is a problem. If the client forgives the outstanding balance of the loan, then this could potentially trigger a capital loss. A loan receivable is an asset for CGT purposes. As such, the loan could be a CGT asset of the client. When the loan is forgiven/released, CGT event C2 will be triggered as ownership of the asset will end.
There may be a capital loss if the proceeds from forgiving/releasing the loan are less than the loan’s outstanding balance. The market substitution rules apply in this situation (s116-30(2) ITAA 1997). In this instance, the client will be deemed to have received capital proceeds equal to the market value of the loan receivable just before it was forgiven.
If the company cannot repay the loan when the loan is waived, then it is arguable that the value of the forgiven portion of the loan is nil (or close to nil).
However, if the company does have the ability to repay the loan, then the value of the loan may be its face value, in which case there would be no capital loss to the client. Of course, this will depend on the facts.
Assuming the company does not have the ability to repay the loan, the forgiveness of the debt by the client should give rise to a capital loss.
However, this does not apply if the asset is a personal use asset. As mentioned, the definition of a personal use asset includes a debt arising other than:
- In the course of gaining or producing assessable income; or
- From your carrying on a business. (see s108-20 ITAA 1997).
So here, it is clear that the personal use asset rules could apply to deny a capital loss for your client. If the client has charged interest, he should be okay.
If not, the loan will be treated as a personal use asset. We would also refer you to CGT Determination Number TD2.
The value of a taxpayer’s labour included in the cost base
TD60 Capital Gains: Can the value of a taxpayer’s labour be included in the cost base of an asset constructed or created by the taxpayer?
This question comes up time and again. The answer is:
- No, where an asset is constructed or created by the taxpayer, no value can be attributed to that labour for inclusion in the asset’s cost base.
We refer you to pages 48-51, inclusive of issue #113, which deals with this topic in some detail. If you are a new subscriber and require this material, please contact us.
This Bill introduces a new windfall gains tax imposed on specific land value uplifts that arise as a result of rezoning and generally applies to Victorian landowners on or after 1.7.2023.
This was announced in the 2020-21 Victorian State Budget, with new legislation introduced into State Parliament.
The WGT will apply when the taxable value uplift of land owned by either an owner or group resulting from the same planning scheme amendment (rezoning) exceeds $100,000.
Members of a group will be assessed on the aggregated taxable value uplift of all land that is rezoned and owned by the group members, with each member being jointly and severally liable for the tax assessed to the group.
When will the tax be payable?
The following table summarises how Victoria’s WGT will be imposed under the draft legislation:
|Value uplift||Windfall gains tax payable|
|Less than $100,000||$0|
|Between $100,000 and $500,000||62.5% of the uplift exceeding $100,000|
|Exceeding $500,000||50% on the total uplift|
Victorian landowners who are liable to pay WGT will be able to defer payment of up to 100% of the tax until the earlier of:
- 30 years after the rezoning
- a dutiable transaction (other than certain excluded dutiable transactions) occurring in relation to the rezoned land; and
- a relevant acquisition (other than certain excluded relevant acquisitions) occurring in respect of a landholder who is the owner of the rezoned land.
There are exceptions to this, and specialist advice should be sought.
The WGT will be imposed on amendments to planning schemes that take effect on or after 1 July 2023. Importantly, transitional arrangements will apply for certain contracts, option arrangements and proponent-led rezonings that were underway when the windfall gains tax was announced on 15 May 2021.
Situations will arise where Victorian taxpayers become liable for the WGT in addition to other taxes imposed on the same gain (i.e., capital gains tax which is generally payable on a capital gain made by a taxpayer).
It remains to be seen whether similar legislation will be introduced in other States and Territories across Australia.
New South Wales is currently considering legislation that will introduce a new ‘development contribution regime’ payable by landowners who benefit from land value uplift as a consequence of a rezoning.