Bonus Issue
CAPITAL GAINS TAX MINIMISATION STRATEGIES 2018
What’s New In 2018?
Foreign investors and entities are most affected by the 2018 changes federal government policy which aims to:
address housing affordability
stop foreign nationals avoid paying capital gains tax when they sell property
attract foreign investment
We also cover in detail significant changes to the CGT small business concessions and an important federal court case on the same topic, Commissioner of
Taxation V Miley (2017) FCA 1396, won by the Commissioner on appeal.
We would also draw your attention to the following changes (rulings and guidelines) which we will not expand on… these are readily available on
the ATO legal database.
The application of the transitional CGT relief for capital gains that may arise as a result of the recent superannuation changes has been fully explained
by the ATO in (LCC 2016/8).
Where an option is exercised, CGT event A1 which occurs in relation to the asset is the date of exercise of the option (TD 2017/12).
An intangible capital asset made to pre-CGT property can be a separate CGT asset (TD 2017/1).
Retail premiums paid to eligible shareholders are treated on CGT account and eligibility for the CGT discount is based on the date shares were acquired
(TR 2017/4).
Incidental costs incurred after exchange of contracts will be incurred in the cost base if they relate to the CGT event (TD 2017/10).
So here we see these changes as they apply to overseas residents, do not affect many of our subscribers. However, what we do have is suggestions to eliminate
or lower capital gains tax:
How Are You Going to Lower or Eliminate Capital Gains Tax?
- Do all you can to preserve your main residence exemption. See Issue #0089 pages 23, 24, 32,38.
- Be aware of the Main Residence 6-year temporary absence. See Tax Tip #96-page 23 Issue #0091.
- Some people engage in D.I.Y. home renovations enhancing the value of a CGT Exempt Asset i.e. their main residence then selling 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 attract Capital Gains Tax of 10%.
- Assets in a super fund in pension phase have no tax on earnings or capital gains – see Tax Tip #95-page 23 Issue #0091.
- 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
to when you actually sell them. - Fully utilise the CGT small business concessions. See article pages 42, 43 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 #0057 page 17, Issue #0091.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
23, 24, 40 and 41 Issue #0089. - Note that Small Business Entities (SBE) do not have to meet the $6 million asset threshold test to access the CGT Concessions.So, if possible lodge
the relevant tax return as a SBE. This generally means a turnover of less than $2 million. - Where there is a CGT event, fully investigate whether rollover relief is available.See Tax Tip, pages 24, Issue #0091 and our annual publication pages
43 and 44. - In the wake of the Bamford decision, ensure your Trust Deed allows streaming of various classes income.See Tax Tip #38, page 15, Issue #0091.
MARKET VALUE OF SHARES IN A PRIVATE COMPANY
Commissioner of Taxation v Miley [2017] 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 and 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 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 - if it is necessary to apply the hypothesis of a willing seller and buyer, 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 a 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 are 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 AAT 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.
SIGNIFICANT CHANGES TO SMALL BUSINESS CGT CONCESSIONS
On 8.2.2018, Treasury recently released draft legislation that significantly restricts the availability of the small business CGT concessions where shares
or units are being sold. It appears, the changes will 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.
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.
Exposure draft
On 8.2.2018, Treasury released exposure draft legislation for consultation (Treasury Laws Amendment (Measures for a later sitting) Bill 2018: improving the small business CGT concessions).
Below are the four new criteria to be satisfied in order to access the SB concessions on the sale of shares or units.
New requirements for share or unit sales
The draft legislation repeals s 152-10(2) of the Income Tax Assessment Act 1997 (the ITAA 1997).
In substitution, it inserts a new s152-10(2). 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 proposed new law and current law taken directly from the explanatory memoranda to the draft legislation.
| New Law | Current Law |
| 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 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 |
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 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. |
CAPITAL GAINS TAX CHANGES FOR FOREIGN RESIDENTS
In brief
In the May 2017 Federal Budget, a range of reforms to reduce pressure on housing affordability were announced.
This included that as of 7:30pm (AEST) on May 9, 2017 foreign and temporary tax residents would no longer be exempt from capital gains tax (CGT) when selling
their main residence; this rule was made subject to grandfathering for existing properties held on this date and disposed of on or prior to June 30,
2019.
The Government has ensured all Australian tax residents, including those who are temporary tax residents, can continue to access the main residence exemption.
Initially it was thought that all temporary tax residents would not be able to access the concession. Temporary tax residents are individuals who hold
a temporary visa and who also meet other requirements.
However, it should be noted that the CGT main residence exemption will be denied from 7:30pm (AEST) on May 9, 2017 for foreign residents. In addition,
there will be no apportionment of the main residence exemption based on days of ownership over the whole period of ownership. Existing properties held
on May 9, 2017 will be grandfathered until June 30, 2019. For the purpose of the Exposure Draft, “foreign resident” means someone who is not a tax
resident of Australia.
Foreign residents, including Australian citizens and permanent residents who are foreign residents, should consider how these changes will impact their
circumstances.
CAPITAL GAINS TAX CHANGES FOR FOREIGN INVESTORS
As mentioned, the Government has amended the change to the main residence exemption to ensure that only Australian residents for tax purposes can access
the exemption. As a result, temporary tax residents who are Australian tax residents will be unaffected by the change.
Administrative treatment
The ATO will accept tax returns as lodged during the period up until the proposed law change is passed by Parliament. Past year assessments will not be
reviewed until the outcome of the proposed amendment is known.
After the new law is enacted, taxpayers will need to review their positions:
- for properties acquired from 7:30PM (AEST) on 9 May 2017 – back to the 2016–17 income year;
- for properties held from 7:30PM (AEST) on 9 May 2017 and disposed after 30 June 2019 – back to the 2019–20 income year.
Those taxpayers who lodged their tax return in accordance with the changes do not need to do anything more.
Those taxpayers who did not return their capital gain will need to seek amendments and obtain or reconstruct records to support any costs associated with
the property.
No tax shortfall penalties will be applied, and any interest accrued will be remitted to the base interest rate up to the date of enactment of the law
change. In addition, any interest in excess of the base rate accruing after the date of enactment will be remitted where taxpayers actively seek to
amend assessments within a reasonable timeframe after enactment.
CHANGES TO THRESHOLD AND RATE FOR FOREIGN RESIDENT CAPITAL GAINS WITHHOLDING PAYMENTS
As outlined in our last CGT bonus issue #0086, 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 will apply to any contracts of sale entered into on or after 1 July 2017.
The two changes to note are:
the threshold is being reduced from $2 million to $750,000 – so the regime will now apply all real property disposals where the market value of the property
is $750,000 and above; and
the withholding payment rate will be increased to 12.5% (the current rate is 10%).
The current threshold ($2 million) and withholding payment tax rate (10%) will apply for any contracts which are entered into prior to 1 July 2017, even
if they do not settle until after 1.7.2017.
BOOSTING AFFORDABLE HOUSING FOR AUSTRALIANS THROUGH INVESTMENT TAX INCENTIVES
Increasing the capital gains tax (CGT) discount for investors in affordable housing
From 1.1.2018, the Government will provide 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.
Encouraging Managed Investment Trusts (MITs) to invest in affordable housing
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 with which Australia has 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 10 years.
Should these assets be held for a period of less than 10 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 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.
CGT ROLLOVER FOR MARRIAGE BREAKDOWNS – SANDINI Pty Ltd v Commissioner of Taxation [2017] FCA 287
Anyone interested in the exact facts and circumstances can readily review it – instead we will focus on why this case is significant.
Who This Affects
- those drafting Family Court orders dealing with assets with potentially large capital gains tax implications.
- individuals looking to place assets the subject of Family Court orders into a more protected environment.
Key Facts
- The recent Federal Court decision of Sandini Pty Ltd v Commissioner of Taxation [2017] FCA 287 has broadened the application of the CGT rollover
for marriage breakdowns. The decision also marks a potentially wider application of CGT Event A1.
Where Family Court proceedings will deal with assets with potentially significant capital gains tax consequences you should, seek tax advice on the best
approach to structuring orders.
On 22 March 2017, McKerracher J of the Federal Court of Australia handed down his decision in the case of Sandini Pty Ltd v Commissioner of Taxation [2017] FCA 287 (Sandini Case). The case marks an important change to how the marriage breakdown rollover in Subdivision 126-A of the
Income Tax Assessment Act 1997(Cth) (ITAA97) can be utilised to allow spouses to receive marital property in an asset-protected
environment.
This really is a significant change in how parties the subject of family law proceedings will be able to use the CGT rollover for marriage breakdowns to
move assets into a protected environment. Although the rollover may not be used where the Family Court orders assets to be transferred directly into
a discretionary trust, it does provide an opportunity, where the Family Court orders an asset to be transferred to a spouse directly, for that spouse
to direct the transfer of the asset to a family trust without upsetting the application of the rollover.
In the event a decision is made to transfer a rollover asset to a trust it is essential to seek expert advice. As the Commissioner has appealed this case,
it would be advisable to wait on the outcome and we will keep you informed of developments.
PROPERTY DEVELOPER ENTITLED TO CAPITAL GAIN TAX CONCESSION
Re FLZY and FCT [2016] 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 commercial property to lease
to government agencies, this evidence included:
- the clear evidence of the father and son controllers of the business who 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 long bow indeed” – particularly in the circumstances of this case and given the nature of the transaction
in question.
PRINCIPAL PLACE OF RESIDENCE
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.
1.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.
2.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 his or her personal belongings into the dwelling;
The address to which the taxpayer has his or her 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.
3.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 to the taxpayer to vacate the building?For instance, if it were due to a job
transfer to Brisbane then 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.
FAMILY MEMBERS AND THE SOLE AND PRINCIPAL RESIDENCE
Consider the following scenario.Patrick Patriarch believes Melbourne inner-city units are undervalued.He has a 21-year-old daughter Pricilla attending
Melbourne University.Pricilla’s plans are 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 is within the six years temporary absence rule.(See CGT Determination
No. 51 below which deals with sole and principal residence.)
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.
Increasing your cost base
You can obtain 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 is rented out for more than 6 years (and no other property is treated as a ‘main residence’);
- The home has been rented out after 20 August 1996; and
- The full main residence exemption would have been available if the house was sold just before it was rented out.
To determine the market value of the house for CGT purposes under a person has the option of:
- Obtaining a valuation from a qualified valuer; or
- Calculating their own 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 also any doubt
about the market value of the property.
TAX TRAP… DEMOLISHING THE FAMILY HOME – THEN SELLING THE LAND
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 being where the dwelling is accidentally destroyed,
and the land is then 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