Taxation Theory, Practice And Law: Understanding Capital Gains Tax (CGT)

Key Elements of Capital Gains Tax

The client is investor along with the collector of musical instruments mainly violins and has  disposed given capital assets and therefore, the task is to analyse the transaction type and derived proceeds so as to find the taxation consequences.

Further, it is evident that taxpayer does not run a business of trading assets and hence, the disposal of capital assets would not result in generation of assessable income of ordinary concept and rather generate capital income. These capital proceeds would be examined and would be taken for the computation of any incurred capital gains/losses which are then taxed under the applicability of Capital Gains Tax (CGT). Therefore, the main focus of the given situation is to do analysis of the transactions incurred for the sale of vacant land block, antique bed, shares, painting and violin (Coleman, 2016).

There are key elements related to CGT implications on the respective transactions and are discussed below. These elements are pivotal and need to be considered so as to determine the net cumulative capital gains/loss that would arise from the disposed capital assets during the assessment income tax year (Barkoczy, 2017).

Key element 1: Pre-CGT Asset

Relevant section- s.140-10, ITAA 1997

The concept which can be derived from the above highlighted section is that all the respective assets of the taxpayer that he/she acquires before the enactment of CGT liability (September 20, 1985) are known as pre-CGT asset. This element is the initial aspect for the determination of CGT payable because any asset that is a pre-CGT asset will not result in any CGT implication on taxpayer when being disposed by taxpayer irrespective of the significant gains which are derived from the sale (Gilders, et. al., 2015).

Key element 2: CGT event

Relevant section- s. 104-5, ITAA 1997

This element is crucial because the calculation of capital gains/losses will be done based on the underlying method discussed for the relevant CGT event. The taxpayer’s transactions for the selling of the capital assets are part of CGT event of type A1. This method illustrates that capital proceeds received from the sale of the capital asset will be used to deduct the total cost base of the capital asset in regards to compute the net capital gains/losses subject to CGT liability of the taxpayer (Barkoczy, 2017).

Relevant section- s. 110-25, ITAA 1997

As highlighted above in key element 2, the essential variable for the computation of capital gains/loss from the disposed asset is cost base. It comprises the combination of five components which are defined as shown below. It is not necessary that taxpayer has made the transactions of all the five components and hence, the sum of the available components which is termed as cost base of the capital asset and are paid by the taxpayer only (Austlii, 2018 c).

• Cost of buying the asset
• Incidental Cost paid for increment works during the liquidation as well as at the procurement time of the asset (legal fees, brokerage fee, stamp duties and so forth)
• Capital expense for the ownership related works (taxes, interest on loan or on investment and so forth)
• Capital expenses for maintaining or appreciating the asset value
• Capital expense for maintaining the ownership (this is essential when the asset is a property)

Vacant Land Block

Relevant section –s.102-25, ITAA 1997

There may arise a case where the concerned taxpayer has received capital losses from the disposal of the capital asset.  In such situation the taxpayer’s capital losses will be adjusted with the received capital gains. Further, if the taxpayer does not receive the capital gains, then these capital losses would not be taken to negate the total taxable income of the taxpayer and rather would be shifted to next financial year (Krever, 2017). This process would be continued to five consecutive years and still there be no capital gains received by taxpayer to adjust the capital losses then the capital losses would be terminated.  

Key element 5: Discount on Capital Gains

Relevant section- s. 115-25(1), ITAA 1997

Indexation method and discount method are the two methods which are used to reduce the total CGT liability on the capital gains. The indexation is assumed to be useful when there is an asset bought before September 1999 while the discount method is quite popular and would be applied only on the long term capital gains received from sale of capital asset. In discount method, 50% discount would only be used for the capital gains taxation purpose. Further, the simple way to define the long term capital gains is that any asset which is having higher than 1 year of holding period will generate long term capital gains (Nethercott, Richardson and Devos, 2016).

It would be fair to make the decision that block of land is not a pre-CGT asset of the taxpayer as the taxpayer has purchased it well after the enactment of CGT implication and as a result, CGT will not be exempted for this transaction. Moreover, the sale of land is a CGT event of type A1 and the relevant method which includes sale income from the asset and cost base of the asset will be taken into consideration (Nethercott, Richardson and Devos, 2016). It is also imperative to note that as per TR 94/29, agreed payment of the sale would be realised in the year in which the agreement of sale of the block of land has been signed by taxpayer despite that the payment being collected by the taxpayer in the next year (ATO, 1994). 

According to TD 1999/40, the antique items come in the domain of collectables (as capital assets). Also, the transaction for selling an antique item is CGT event of type A1. Further, the taxpayer purchases the bed after the CGT threshold date and hence, the CGT will be imposed on the act of disposal of antique bed (Nethercott, Richardson and Devos, 2016). Further, the essential condition for the CGT implication of collectable is that it must be purchased for an amount exceeded than $500 as per s. 118-10 ITAA 1997 which is true in present case because she purchased the bed for $3500. 50% rebate will also be true and would be applied after compensating the capital losses raised for sale of sculpture in year 2016/2017. 

Antique Bed

Capital proceeds received from liquation of painting will be exempted from application of CGT as it falls within the category of a pre-CGT asset.. It is because purchase of the painting was made on May 2, 1985 and the CGT implication has come into existence on September 20, 1985 and therefore, no CGT will be charged (Gilders, et. al., 2015).

It would be fair to make the decision that shares are not pre-CGT asset of the taxpayer as the taxpayer has purchased it well after the formation of CGT implication and as a result, CGT will not be exempted for this transaction. Moreover, the sale of shares is a CGT event of type A1 and the relevant method which includes sale income from the shares and cost base of the shares will be taken into account (Barkoczy, 2017). The first three shares are deriving long term capital gains and hence liable for 50% rebate on CGT implication while the last share is short term capital gains and hence, no rebate is provided for CGT.

It would be fair to make the decision that violin is not pre-CGT asset of the taxpayer as the taxpayer has purchased it well after the formation of CGT implication and as a result, CGT will not be exempted for this transaction (Sadiq, et.al., 2015). However, violin which she has liquidated in income year 2017 is personal use asset because she acquires several violins in collections and has learned it so that she could play it well. Furthermore, she used to play it every day which indicates that she has violin which would be categorised as personal use asset. The CGT will be only be levied when she purchased it for a value exceeded $10,000 as per s. 108-20(1) ITAA 1997. However, she purchased the violin for less than $10,000 and hence, the imperative condition has not been fulfilled. Hence, no CGT consequence will be validated on this. 

Question 2

• The Fringe Benefits Tax (FBT) payable needs to be furnished for the given fringe benefits to employee Jasmine by employer Rapid Heat Pty Ltd during her employment period with the company.

Fringe benefits are set of benefits of personal nature given to employee which are extended by the employer and are taxed on behalf of the employer only. The tax liability in case of fringe benefits is termed as FBT and is not applicable on employee even if the utilization of the fringe benefits is done by employee only  (ATO, 2018 a). The employer who is liable for FBT payable will also receive the tax deduction on the provided loan if employee uses the same to produce assessable income. Further, this is not applicable in the situation when the extended loan amount which has been extended to employee would then be issued to respective associated to conduct work of generating assessable income (Nethercott, Richardson and Devos, 2016).

Painting

According to the provisions of s.7 Fringe Benefits Tax Assessment Act 1986, a car which is initially owned by the company but is issued to employee to utilize for personal purposes such as taking the car on weekends or for travelling for own work would result in extension of benefits termed as car fringe benefits. This is because employer has issued a car to employee for personal work of employee. Due to this, the FBT liability will be imposed on employer (ATO, 2018 a). The total tax burden is applied on the employer only and employee is free and no liability is extended on employee. Moreover, if the car which is used for work related purposes will be extended to use for personal work also then the scope of usage of car of personal work of employee will also be taken into consideration for FBT calculation. The key factors related to car fringe benefits are discussed below (Gilders, et. al., 2015).

• Base value of car (difference between the purchasing cost and expense on minor repairing given by employer only)
• Goods and service tax is applicable on car and the employer is also liable for claim the GST credit inputs.
• Available days of car private usage of employee which will not be reduced for two cases when the car itself left by employee at the airport and the car is s taken by employee  for minor repair works.

Rapid Heat issued car to Jasmine that she can use for her own personal use. It is clear indication that car fringe benefit is issued to her.  

Loan is a type of financial support to the employee so that the respective employee can satisfy their personal need by purchasing assets or home. The essential factor in relation to the loan is that employer must choose the rate of interest which is defined by the Reserve Bank of Australia (RBA). Further, if the loan is given at the discounted rate which is lower than the benchmark rate defined by RBA, then the loan would come under the category of loan fringe benefits. As a result, the interest saving of the employee will be considered for the establishment of the FBT liability (ATO, 2018 b).

Rapid Heat the employer of Jasmine issues loan to the tune of $500,000 on September 1, 2017. The loan fringe benefit will be considered when the employer has taken discounted rate of interest when compared to the applicable RBA’s rate. It is apparent as per TD 2017/3 that the rate of interest for loan should have been 5.25% while Rapid Heat’s rate of interest is 4.25%. This provided evidence to the conclusion that Rapid Heat has saved the interest amount of the employee by issuing loan fringe benefits (ATO, 2017). 

Jasmine used the loan fringe benefit’s amount to purchase the home for herself. If the home is used by her for personal residence purpose, then $450,000 will not amount to any tax deduction for Rapid Heat. However, if she offers the purchased home to other party so that the rent income can be earned, then the rent income would be part of the assessable income of the employee and hence, tax deduction can be claimed on behalf of the employer  (ATO, 2018 a).

Shares

Further, Jasmine used the net remaining amount $50,000 to extend to husband with zero interest payment so as to purchase the shares. This is noteworthy that dividend income derived from $50,000 will not extend tax deduction claim for employer because Jasmine herself does not purchase shares.

Any act of the employer which directly/indirectly limits the personal level expense liability of the employee would be considered under expense fringe benefit (Krever, 2017). Moreover, the same can be reflected by the fact that paying any expenses for the product of company would reduce the personal expenses of employee and therefore, the employee has to pay lesser amount and is the process receives the internal expense fringe benefit. The FBT liability will only be charged on employer (Coleman, 2016).

The circumstances define that Rapid Heat is manufacturing company of electric heater and also sold it to customers for a set price of $2600. However, they provided concession to Jasmine and sold her for $1300. The company is providing internal expense fringe benefits because they would not reduce the price of heater if the customer is not Jasmine (Employee). Hence, the discount is offered so that the personal expense of Jasmine could be decreased. 

• Jasmine used the net remaining amount $50,000 to purchase the shares. This is noteworthy that dividend income derived from $50,000 will extend tax deduction claim for employer because Jasmine herself does purchase shares which may result in deriving of ordinary income in terms of dividend. The deduction from this case is computed below.

The FBT payable will be reduced of Rapid Heat because of the deduction computed above.    

References

ATO, (1994) Taxation Ruling –TR 94/29  [Online]. Available at: Income tax: capital gains tax consequences of a contract for the sale of land falling through. https://www.ato.gov.au/law/view/document?DocID=TXR/TR9429/NAT/ATO/00001&PiT=99991231235958 (Accessed: 26 September 2018)

ATO, (2017) Taxation Determination –TD 2017/3 [Online]. https://law.ato.gov.au/atolaw/view.htm?docid=%22TXD%2FTD20173%2FNAT%2FATO%2F00001%22 (Accessed: 26 September 2018)

ATO, (2018 a) Fringe Benefits Tax- A Guide For Employers. https://law.ato.gov.au/atolaw/view.htm?DocID=SAV%2FFBTGEMP%2F00010 (Accessed: 26 September 2018)

ATO, (2018 b) Loan Fringe Benefits https://www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/Types-of-fringe-benefits/Loan-fringe-benefits/ (Accessed: 26 September 2018)

Austlii, (2018 b) FRINGE BENEFITS TAX ASSESSMENT ACT 1986- SECT 148.[Online] https://classic.austlii.edu.au/au/legis/cth/consol_act/fbtaa1986312/s148.html (Accessed: 26 September 2018)

Austlii, (2018 c) Income Tax Assessment Act 1997- SECT 110.25.General Rules About Cost Base [Online]. Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s104.5.html (Accessed: 26 September 2018)

Barkoczy, S. (2017) Foundation of Taxation Law 2017. 9^th ed. Sydney: Oxford University Press.

Coleman, C. (2016) Australian Tax Analysis. 4^th ed. Sydney: Thomson Reuters (Professional) Australia.

Gilders, F., Taylor, J., Walpole, M., Burton, M. and Ciro, T. (2016) Understanding taxation law 2016. 9^th ed.  Sydney: LexisNexis/Butterworths.

Krever, R. (2016) Australian Taxation Law Cases 2017. 2^nd ed. Brisbane: THOMSON LAWBOOK Company.

Nethercott, L., Richardson, G., and Devos, K. (2016)  Australian Taxation Study Manual 2016. 8^th ed. Sydney: Oxford University Press.

Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., and Ting, A. (2015) Principles of Taxation Law 2015. 7th ed. Pymont: Thomson Reuters.