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Principles of Taxation Law Part 2.
Principles of Taxation Law Part 2.
Principles of compensation
Key points.................................................................................................... [10.00]
Introduction................................................................................................ [10.10]
Compensation for losses incurred by individuals.................................... [10.40]
Compensation for loss of salary or wages.......................................... [10.60]
Loss of earnings vs loss of earning capacity...................................... [10.80]
Compensation received by way of insurance or indemnity.............. [10.90]
Compensation for loss of physical abilities...................................... [10.100]
Compensation for pain, suffering or medical expenses.................. [10.110]
Compensation under anti-discrimination legislation........................ [10.120]
Compensation paid by financial institutions..................................... [10.130]
Structured settlements...................................................................... [10.140]
Compensation for business losses.......................................................... [10.150]
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Key points
[10.00]
• Generally, a compensation receipt or damages award takes on the
character of the item it replaces. This is known as the “replacement
principle”.
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306 [10.10] PRINCIPLES OF TAXATION LAW 2021
•
The common law “replacement principle” may be supplemented or
overridden by statutory provisions of the Income Tax Assessment Act
1936 (Cth) or the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
•
Compensation for loss of salary or wages will generally be assessed as
ordinary income.
•
Compensation for loss of physical abilities, pain, suffering or medical
expenses will generally be a capital receipt and exempt from income
tax consequences.
•
Compensation under anti-discrimination legislation may be assessable
income depending on the circumstances.
•
Division 54 of the ITAA 1997 provides that certain annuities and
lump sums provided under structured settlements and structured
orders to persons who have suffered personal injury are exempt from
income tax.
•
Compensation payments or damages received for breach of an
ordinary trading contract will be assessed as ordinary income.
•
Compensation payments or damages received for a breach of contract
going to the fundamental structure of the business will be assessed as
a capital gain.
•
The taxation consequences of compensation received for the loss of
an asset depends on the type of underlying asset; depreciable assets
will be dealt with under the depreciation provisions, trading stock will
be dealt with under the trading stock provisions and capital assets will
be subject to common law principles.
•
Compensation received under an insurance or indemnity policy may
be assessable under s 15-30 of the ITAA 1997.
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•
Where a composite claim cannot be dissected into its component parts,
the whole amount will be treated as capital and assessed as such.
•
The “replacement principle” does not apply to the reimbursement of
previously deducted expenses. Rather, the reimbursement itself is
considered to determine whether the receipt is income or capital.
Introduction
[10.10] Compensation or damages may be received by a taxpayer for a variety
of reasons. This chapter divides compensation and damages receipts into two
categories: compensation or damages received by individual taxpayers outside
the ordinary course of a business and compensation or damages received by
taxpayers during the ordinary course of a business.
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308 [10.30] PRINCIPLES OF TAXATION LAW 2021
[10.30] The rest of the chapter considers the individual types of compensation
or damages receipts within specific categories. While the replacement principle
generally applies to these categories, there are circumstances where specific
rules have been developed and statutory provisions need to be considered.
The categories below make it possible to consider the common law application
of the principles and specific statutory provisions that supplement or override
the replacement principle.
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310 [10.70] PRINCIPLES OF TAXATION LAW 2021
payment, which was the difference between the salary paid by the
employer and the salary paid by the armed forces, was made voluntarily
and without any conditions attached.
The Commissioner assessed the taxpayer on the payments on the basis
that they constituted ordinary income. The High Court held that the receipts
were assessable as ordinary income. In particular, Fullager J concluded
that the amounts were ordinary income as they were compensation
for wages (and periodical payments) that would have otherwise been
received.
will not alter its assessability where the lump-sum payment is for loss of income
only or a portion of the lump-sum payment is identifiable and quantifiable as
income: Determination TD 93/58.
Example 10.1: Lump-sum compensation
Adele manages Belinda’s business. Adele’s contract provides that Belinda
is required to pay her a 5% share of the profits from the business. Adele
calculates that Belinda has only been paying her 4% of the profits of
the business due to an error in the figures. Belinda agrees to pay Adele
$50,000 to make up for the mistake. The $50,000 is assessable income
in the hands of Adele as it is compensation for losses of an income
nature: see Determination TD 93/58. It is irrelevant that the compensation
is paid as a lump sum. The receipt is income only, as there is no capital
component. It is also not relevant that the basis of the calculation of the
lump sum cannot be determined.
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10: Principles of compensation [10.80] 311
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312 [10.90] PRINCIPLES OF TAXATION LAW 2021
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10: Principles of compensation [10.125] 313
of the payment. To illustrate the operation of the income tax law in relation to
these types of compensation payments, in Ruling IT 2424, the Commissioner
provides common examples that serve as a guide. However, it is stressed in the
Ruling that the determination of the character of a compensation payment and,
in particular, whether it is liable to tax in the hands of an employee depends
upon the nature of the payment.
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314 [10.125] PRINCIPLES OF TAXATION LAW 2021
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10: Principles of compensation [10.140] 315
Structured settlements
[10.140] Division 54 of the ITAA 1997, which applies from 26 September
2001, provides that certain annuities (periodic payments) and lump sums
provided under structured settlements and structured orders to persons
who have suffered personal injury are exempt from income tax. Division 54
applies to compensation or damages paid other than compensation paid
by an employer or under a workers’ compensation claim. A “structured
settlement” is defined as an agreed settlement in writing of a claim that is
for compensation or damages for personal injury where at least part of the
payment is in the form of an annuity. A “structured order” is defined as an
order by the court in respect of a claim for compensation or damages for
personal injury where at least part of the payment is in the form of an annuity.
Division 54 does not prevent part of the compensation being in the form of
a lump sum; however, there must be at least one annuity purchased out of
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316 [10.150] PRINCIPLES OF TAXATION LAW 2021
the compensation or damages receipt. Without Div 54, any annuity would
be assessable under s 27H of the Income Tax Assessment Act 1936 (Cth)
(ITAA 1936).
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318 [10.180] PRINCIPLES OF TAXATION LAW 2021
[10.180] A similar result was reached in Allied Mills Industries Pty Ltd v FCT
(1989) 20 ATR 457.
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10: Principles of compensation [10.190] 319
resulted
in the cessation of the taxpayer’s business.
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320 [10.200] PRINCIPLES OF TAXATION LAW 2021
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10: Principles of compensation [10.220] 321
Given that receipts from the sale of trading stock are ordinary income under
s 6-5, an amount received to replace lost trading stock will be ordinary income.
Therefore, it is difficult to see when s 70-115 would be applied. However, it
may be argued that s 70-115 extends beyond the common law proposition
with the use of the words “by way of … indemnity” to capture a statutory right
to compensation not caught by the common law principle.
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322 [10.230] PRINCIPLES OF TAXATION LAW 2021
There are specific provisions dealing with the recovery of losses under
insurance policies where the loss relates to livestock and timber. Section
385-130 provides that where the livestock is an asset of a primary production
business, the insurance payout may be included in assessable income in equal
instalments over a five-year period. A similar provision applies for the loss of
trees on land held for the purposes of manufacture or sale in the course of
carrying on a business.
Composite claims
[10.240] The above discussion assumes that a compensation or damages
payment is easily identifiable as a substitute for income or capital. Often,
however, taxpayers receive an undissected lump-sum payment representing
compensation for both a loss of income and a loss of capital or capital assets.
This will be common where there is an out-of-court compromise settlement.
Where the compensation or settlement payment received is for unliquidated
damages, the courts have been reluctant to apportion the sum received
into income and capital components. Instead, the whole amount is treated
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10: Principles of compensation [10.250] 323
Example 10.9: Composite claim
Charles, the owner of land, agrees to accept a payment of $100,000 in
compensation for its compulsory resumption. In addition, interest of 10%
on the principal sum is to be paid. The compensation paid to Charles
under the settlement includes an amount of $20,000 for interest.
The $20,000 is assessable income under s 6-5 of the ITAA 1997 as it can
be identified and quantified by the parties.
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324 [10.260] PRINCIPLES OF TAXATION LAW 2021
Where there is no underlying asset, CGT events H2 (see [11.120]) and C2 (see
[11.70]) should be considered.
The High Court in FCT v Rowe clearly rejected the notion that a reimbursement
of a previously deducted expense is itself income. Rather, the courts have
adopted the approach that the assessability of a reimbursement of a previously
deducted expense is determined by reference to the receipt itself and the
ordinary concepts of income, which are discussed in Chapter 5. Several
cases have discussed the application of the common law concepts where a
taxpayer has received a reimbursement of a previously deducted expense. The
cases generally centre on the question of whether the reimbursement can be
considered as received in the ordinary course of carrying on a business.
[10.270] The cases of Allsop v FCT (1965) 113 CLR 341, HR Sinclair & Son
Pty Ltd v FCT (1966) 114 CLR 537 and Warner Music Australia Pty Ltd v FCT
(1996) 34 ATR 171 all demonstrate the application of the common law principle
of income according to ordinary concepts to reimbursements of previously
deducted expenses.
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10: Principles of compensation [10.280] 325
[10.280] A year later, the High Court was again faced with a similar issue.
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326 [10.290] PRINCIPLES OF TAXATION LAW 2021
Questions
[10.300]
10.1 David disturbed two prison escapees who were attempting to break
into his car. He suffered serious head injuries as a result of being
bashed by the men and spent three months recuperating in hospital.
The escapees were later recaptured, found guilty of the assault and
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10: Principles of compensation [10.300] 327
sentenced to an additional two years in jail. David applied for and was
awarded $30,000 compensation under the Victims Compensation Act
1987 (NSW) for his pain and suffering resulting from the assault. Marina,
David’s wife also received $20,000 compensation under this Act. She
was able to establish that the fear she now had of driving a car alone
was attributable to the assault on her husband and she was therefore
entitled to compensation for the loss of enjoyment of life. What are the
tax consequences of the compensation receipts?
10.2 While cycling home from work, Mark is hit by a car and seriously injured.
He spends the next three months in hospital. Due to the severity of
his injuries, at the end of the three months, Mark is declared unable
to work again. After protracted legal proceedings, Mark receives the
following sums of money:
• $500,000 from the insurer of the driver who hit Mark;
• $15,000 in lost wages through a workers’ compensation
payment; and
• $100,000 for the permanent loss of the sight in one eye.
How is each of these amounts assessed?
10.3 Alice, an employee of Acme Co, is sexually harassed by a workmate.
Alice complains to the company and seeks compensation for the
humiliation and indignity she has suffered. In return for signing an
agreement in which she surrenders any rights she may have against
the company, Alice receives from the company an amount of $35,000
and resigns from the company. The payment is calculated on the
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basis of six months’ salary, including long service and annual leave
entitlements. What are the tax consequences of the compensation
receipt?
10.4 Jenny and Mark have their own business producing furniture for both
wholesale and retail clients. Unfortunately, their factory was burned
to the ground because of an electrical fault. Jenny and Mark lost
everything. They had various insurance policies that provided for the
following amounts of compensation:
• $1 million for the loss of the factory;
• $500,000 for the loss of machinery and other depreciable assets;
• $200,000 for loss of trading stock; and
• $50,000 each to Jenny and Mark for loss of income while the
business was not operating.
What are the tax consequences of each of these amounts?
10.5 At the start of the current tax year, Colin installs a water tank at his
rental property for $3,000. Colin claims a deduction for the decline
in value of the water tank under Div 40 of the ITAA 1997 using the
prime cost method and an effective life of 10 years. Colin also applies
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328 [10.300] PRINCIPLES OF TAXATION LAW 2021
to ensure the money was “safe”, the advice should have been to invest
in a conservative “low-risk” fund. As a consequence, the Bank paid
Felicity $200,000 in compensation, including a refund of $5,000 on the
fee for the original financial advice and $50,000 in lost interest. Felicity
had claimed a tax deduction for the fee.
Advise Felicity of the tax consequences.
10.8 Ozzie Bank has agreed to pay thousands of its customers compensation
for charging interest above the agreed rate, failing to activate offset
accounts and failing to switch customers from an interest-only loan to
a principle and interest loan. Compensation is in the form of damages
for poor advice, additional interest charges and lost opportunity.
Advise the recipients of the compensation of their tax liability. Would
it make any difference if the loan related to their main residence or a
rental property?
10.9 Erin is a professional Australian Football League (AFL) player. She
was suspended for three games due to a breach of the AFL Code. Erin
challenged her suspension and, as she was playing professionally at
the time of the suspension, she was able to deduct her legal expenses
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10: Principles of compensation [10.300] 329
against her AFL income. It was found that she should not have been
suspended and the AFL reimbursed her by way of an ex gratia payment
for the legal expenses.
Erin has asked for advice on whether the reimbursement of the legal
expenses is assessable income.
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11
Capital gains tax
Key points.................................................................................................... [11.00]
Introduction................................................................................................ [11.10]
Step 1 –Have you made a capital gain or a capital loss?....................... [11.30]
Question 1: Has a CGT event happened to the taxpayer?................. [11.40]
Subdivision 104-A: Disposals.................................................................. [11.50]
Subdivision 104-B: Use and enjoyment before title passes.................. [11.60]
Subdivision 104-C: End of a CGT asset................................................... [11.70]
Subdivision 104-D: Bringing into existence a CGT asset....................... [11.80]
Subdivision 104-E: Trusts........................................................................ [11.90]
Subdivision 104-F: Leases..................................................................... [11.100]
Subdivision 104-G: Shares.................................................................... [11.110]
Subdivision 104-H: Special capital receipts......................................... [11.120]
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332 [11.00] PRINCIPLES OF TAXATION LAW 2021
Key points
[11.00]
• Capital gains tax (CGT) affects a taxpayer’s income because assessable
income includes the net capital gain for the income year. As such,
there is no such thing as a separate CGT. Rather, capital gains are
taxed as statutory income under the Income Tax Assessment Act
1997 (Cth).
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• A taxpayer’s net capital gain for an income year is the total of the
capital gains for the income year minus certain capital losses for the
income year.
• Capital losses cannot be deducted from assessable income. This is
known as quarantining. However, capital losses may be carried
forward to be offset against capital gains in future income years.
• A taxpayer makes a capital gain or a capital loss only if a CGT event
happens; that is, CGT applies only to realised gains.
• Most CGT events involve a CGT asset.
• There are certain exemptions or exceptions that reduce the capital
gain or loss or allow the taxpayer to disregard it altogether.
• Gains and losses made on assets acquired before 20 September 1985
are generally exempt from CGT.
• There are certain rollovers that allow a taxpayer to defer a capital gain
or loss from a CGT event.
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11: Capital gains tax [11.15] 333
•
A taxpayer generally makes a capital gain if he or she receives capital
amounts (known as capital proceeds) that exceed the total costs
(known as the cost base) associated with the CGT event.
•
A taxpayer generally makes a capital loss if he or she receives
capital amounts (known as capital proceeds) that are less than the
total costs (known as the reduced cost base) associated with the
CGT event.
•
In certain circumstances, a taxpayer may be able to take into account
inflation or apply a general discount to a capital gain.
Introduction
[11.10] The topics covered so far have considered whether a receipt is income
or capital and whether that receipt is ordinary or statutory income. The focus
has then been on the tax consequences of a receipt of income. This chapter
considers the consequences of a receipt of capital or, more specifically, capital
gains tax (CGT). Gains that are assessable under the CGT regime are a form of
statutory income.
The capital gains and capital losses provisions (commonly referred to as capital
gains tax or CGT) are contained in Pts 3-1 and 3-3 of Ch 3 of the Income Tax
Assessment Act 1997 (Cth) (ITAA 1997). Part 3-1 deals with capital gains and
losses general topics, while Pt 3-3 deals with special topics, such as rollovers
and small business concessions.
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The starting point for considering the application of the CGT provisions
is generally Div 104 which contains all of the CGT events. Once it has been
established that there is a CGT event, it is possible to consider the other
Divisions of the CGT Parts of the Act. For example, it will be necessary to
consider Div 108 which provides a definition of a CGT asset, Div 110 which
provides the rules relating to the cost base of the asset, Div 116 which provides
the rules relating to the capital proceeds from the event and Div 118 which
provides many of the exemptions available.
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336 [11.50] PRINCIPLES OF TAXATION LAW 2021
• 104-E – trusts;
• 104-F – leases;
• 104-G – shares;
• 104-H –special capital receipts;
• 104-I –Australian residency ends;
• 104-J –CGT event relating to rollovers;
• 104-K –other CGT events;
• 104-L –consolidated groups and multiple entry consolidated (MEC)
groups.
Subdivision 104-A: Disposals
[11.50] CGT event A1 is the most common CGT event. CGT event A1 happens
if a taxpayer disposes of a CGT asset: s 104-10(1) of the ITAA 1997. A disposal
occurs where there is a change in ownership because of some act or event or
by operation of law. However, a change of ownership does not occur if the
taxpayer stops being the legal owner, but continues to be the beneficial owner,
or merely because of a change of trustee: s 104-10(2).
The time of CGT event A1 is when the taxpayer enters into the contract or,
if there is no contract, when the change of ownership occurs: s 104-10(3).
Where there is more than one contract –for example, an original contract
and a subsequent contract varying the terms –the date of disposal will be
determined by reference to the contract that gives rise to the obligation to sell
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or transfer the asset: FCT v Sara Lee Household & Body Care (Australia) Pty Ltd
(2000) 44 ATR 370. Further, in the context of an acquisition, the court has held
that an oral contract, whether enforceable or not, will determine the date of
acquisition: McDonald v FCT (1998) 38 ATR 563. However, where the contract
is preliminary and not the actual contract for acquisition, the date of acquisition
will be the latter contract: Elmslie v FCT (1993) 26 ATR 611. Where there is no
contract, the time of the event will be the time of the change of ownership to be
determined on the facts –for example, the provision of access to the property,
such as the handing over of the keys.
Where CGT event A1 occurs, you make a capital gain if the capital proceeds
from the disposal are more than the asset’s cost base and you make a capital
loss if those proceeds are less than the asset’s reduced cost base: s 104-10(4).
The cost base is generally the total costs associated with the CGT event (see
[11.480]), while the capital proceeds are generally the amount the taxpayer
receives, or is entitled to receive, from the CGT event: see [11.470].
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11: Capital gains tax [11.60] 337
Example 11.1: Event A1
In June 2020, Kylie enters into a contract to sell land. The contract is
settled in October 2020. Kylie makes a capital gain of $50,000. The $50,000
gain is made in the 2019–2020 income year, that is, the year in which the
contract is entered into, and not the 2020–2021 income year.
Source: Adapted
from s 104-10 of the ITAA 1997.
Example 11.2: Event B1
Mark agrees to rent an investment property to John for a period of two
years. The agreement entered into by the parties provides that at any time
during the two-year period John has the right to purchase the property
from Mark. Event B1 occurs when Mark starts renting the property.
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338 [11.70] PRINCIPLES OF TAXATION LAW 2021
CGT event C1, the loss or destruction of a CGT asset, happens if a CGT asset
that the taxpayer owns is lost or destroyed: s 104-20(1) of the ITAA 1997. The
time of CGT event C1 is when the taxpayer first receives compensation for
the loss or destruction or, if no compensation is received, when the loss is
discovered or the destruction occurred: s 104-20(2).
Example 11.3: Event C1
Erin owns a factory that burns down. She has insurance that compensates
her for the loss. CGT event C1 happens when the factory is destroyed,
and the time of the event is when she receives the insurance payment.
CGT event C2, covering cancellation, surrender and similar endings, happens
where the taxpayer’s ownership of an intangible asset ends by the asset:
• being redeemed or cancelled; or
• being released, discharged or satisfied; or
• expiring; or
• being abandoned, surrendered or forfeited; or
• if the asset is an option –being exercised; or
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Example 11.4: Event C2
Tim has a contract with Acme Co to be the exclusive supplier of their
widgets for the next 10 years. Acme Co terminates the agreement with
Tim after five years. Tim is paid $5,000 as compensation for the early
termination of the contract.
CGT event C2 happens as Tim’s intangible asset, that is, his rights under
the agreement, have come to an end.
Later we will see that the capital gain will be the $5,000 less any costs
associated with the event (eg, legal fees).
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11: Capital gains tax [11.80] 339
CGT event C3, the end of an option to acquire shares, happens if an option that
a company or trustee of a unit trust granted to an entity to acquire a CGT asset,
which is shares in the company (or units in the unit trust or debentures in the
company or unit trust), ends because it is not exercised by the latest time for its
exercise, is cancelled, released or abandoned: s 104-30(1). Event C3 only deals
with company issued options. All other options are dealt with as a D2 event,
with the difference being the time of the event. The time of event C3 is when
the option ends: s 104-30(2).
Example 11.5: Event C3
On 1 January 2020, Gina pays Acme Co $100 for the right to acquire
10,000 shares in the company for $1 per share. The option to acquire
shares must be exercised within 12 months of entering into the option.
Gina decides not to exercise the option. As a result, the option expires
and CGT event C3 happens on 1 January 2021.
Acme Co makes a capital gain of $100 (less any associated expenses) on
1 January 2021.
events.
Example 11.6: Event D1
Bart sells his business to Lucy. As part of the agreement, Bart agrees not
to operate a similar business within a 5-km radius for the next two years.
Lucy pays $10,000 for Bart to agree to this restraint of trade. A contractual
right in favour of Lucy has been created. If Bart breaches the contract,
Lucy can enforce that right.
CGT event D1 happens when the contract for the restraint of trade is
entered into and Bart will have a capital gain. At the end of the two-year
period, CGT event C2 will happen and Lucy will have a capital loss.
Source: Adapted from s 104-35 of the ITAA 1997.
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340 [11.90] PRINCIPLES OF TAXATION LAW 2021
Example 11.7: Event D2
Ben pays Sara $5,000 for an option to purchase her business. The one-
month option is granted on 1 January 2021. Ben decides not to exercise
the option.
CGT event D2 happens on 1 January 2021 and Sara has a capital gain of
$5,000 less any associated expenses.
If Ben exercises the option, CGT event D2 is ignored and CGT event A1
happens: see [11.50].
Subdivision 104-E: Trusts
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[11.90] There are ten CGT events relating to trusts listed in subdiv 104-E of
the ITAA 1997:
• creating a trust over a CGT asset –CGT event E1;
• transferring a CGT asset to a trust –CGT event E2;
• converting a trust to a unit trust –CGT event E3;
• capital payment for trust interest –CGT event E4;
• beneficiary becoming entitled to a trust asset –CGT event E5;
• disposal to beneficiary to end income right –CGT event E6;
• disposal to beneficiary to end capital interest –CGT event E7;
• disposal by beneficiary of capital interest –CGT event E8;
• creating a trust over future property –CGT event E9;
• annual cost base reduction exceeds cost base of interest in AMIT –CGT
event E10.
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11: Capital gains tax [11.110] 341
Subdivision 104-F: Leases
[11.100] There are five CGT events relating to leases listed in subdiv 104-F of
the ITAA 1997:
• granting a lease –CGT event F1;
• granting a long-term lease –CGT event F2;
• lessor pays lessee to get lease changed –CGT event F3;
• lessee receives payment for changing lease –CGT event F4;
• lessor receives payment for changing lease –CGT event F5.
Example 11.8: Event F4
On 1 January 2021, Jake (the lessee) enters into a lease. On 1 May 2021,
Jake agrees to waive a term. Eastfield (the lessor) pays Jake $1,000 for
this. If Jake’s cost base at the time of the waiver is $2,500, it is reduced
from $2,500 to $1,500.
On 1 September 2021, Jake agrees to waive another term. Eastfield pays
Jake $2,000 for this. If Jake’s cost base at the time of the waiver is $1,500,
Jake makes a capital gain of $500 and the cost base is reduced to nil.
Source: Adapted from s 104-125 of the ITAA 1997.
Example 11.9: Event F5
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Eastfield owns a shopping centre. Con (the lessee of a shop in the centre)
pays Eastfield $10,000 for agreeing to change the terms of its lease.
Eastfield incurs expenses of $1,000 for a solicitor and $500 for a valuer.
Eastfield makes a capital gain of $8,500.
Source: Adapted from s 104-130 of the ITAA 1997.
Subdivision 104-G: Shares
[11.110] There are two CGT events relating to shares listed in subdiv 104-G
of the ITAA 1997.
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342 [11.120] PRINCIPLES OF TAXATION LAW 2021
Example 11.10: Event H1
Barry decides to sell land to Judy. A contract of sale for $120,000 is
entered into, and Judy pays Barry a 10% deposit. Judy fails to complete
the contract, and the deposit is forfeited. CGT event H1 happens, and
Barry has a capital gain of $12,000 less any costs associated with the
failed transaction.
Example 11.11: Event H2
Max owns land on which he intends to construct a manufacturing facility.
A business promotion organisation pays Max $50,000 as an inducement
to start work early. No contractual rights or obligations are created by the
arrangement.
The payment is made because of an event (the inducement to start
construction early) in relation to Max’s land, so a CGT event H2 happens
and Max has a capital gain of $50,000 (less any costs associated with
starting early).
Source: Adapted from s 104-155 of the ITAA 1997.
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11: Capital gains tax [11.150] 343
CGT event I2 happens if a trust stops being a resident trust for CGT purposes:
s 104-170(1).
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344 [11.160] PRINCIPLES OF TAXATION LAW 2021
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11: Capital gains tax [11.180] 345
• options;
• debts owed to you;
• a right to enforce a contractual obligation; and
• foreign currency.
While the definition of “CGT asset” is very broad, there are certain things that
are not considered CGT assets. Generally, a right that is not property must be
enforceable by legal or equitable proceedings. For example, general freedoms,
such as the right to work, are not CGT assets nor are the right of a landlord
to enter into a lease and the right to a refund. Although, the Commissioner of
Taxation has recently expressed the view that bitcoin is a CGT asset.
Collectables
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It is important to remember that there are two limbs to this definition. First, the item
must be one of the kind listed. For example, the Commissioner considers that an
antique is an “object of artistic or historical significance that is of an age exceeding
100 years”: Determination TD 1999/40. Second, the asset must be used or kept
mainly for personal use or enjoyment. This means that artwork that is purchased
as an investment rather than to enjoy will not be considered a collectable.
Where an item is defined as a collectable, there are four specific rules that apply:
1. Capital gains and capital losses made from collectables are disregarded
where the first element of the asset’s cost base is $500 or less.
2. When working out the cost base of a collectable, disregard the third
element (non-capital costs of ownership).
3. Capital losses from collectables can only be used to reduce capital
gains from collectables. This is known as a quarantining rule. Any
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346 [11.190] PRINCIPLES OF TAXATION LAW 2021
losses not used in the current tax year can be carried forward to be
offset against gains from collectables in future years. Note, however,
that the quarantining rule only applies one way –that is, you are able
to offset losses from the sale of ordinary CGT assets against gains from
collectables.
4. If you own collectables that are part of a set, then that set of collectables
is treated as a single collectable.
Example 11.14: Sets
Lily buys a set of three books for $900. If the books are of equal value, she
has acquired the books for $300 each. However, the books are taken to
be a single collectable. Lily will not get the exemption in s 118-10 because
she acquired the set for more than $500.
Source: Adapted from s 108-15 of the ITAA 1997.
Personal use assets
[11.190] “Personal use asset” is defined in s 108-20(2) of the ITAA 1997 as a
CGT asset (other than a collectable) that is used or kept mainly for personal use
or enjoyment.
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11: Capital gains tax [11.200] 347
Where an item is defined as a “personal use asset”, there are four specific rules
that apply:
1. Capital gains made from personal use assets are disregarded where
the first element of the asset’s cost base is $10,000 or less.
2. When working out the cost base of a personal use asset, disregard the
third element (non-capital costs of ownership).
3. A capital loss made from a personal use asset is disregarded.
4. If you own personal use assets that are part of a set, then that set of
personal use assets is treated as a single personal use asset.
Examples of personal use assets include:
• a television at home;
• mobile telephone for private use;
• a bicycle; or
• a yacht owned for personal use and enjoyment.
Section 108-20(3) provides that a personal use asset does not include a land or
a building. Further, if an asset is considered a collectable, it will not be treated
as a personal use asset.
Given that a gain made from a personal use asset acquired for $10,000 or less
is disregarded, it is difficult to think of many personal use assets that would
be subject to tax on any gains. Examples commonly cited are yachts and
racehorses.
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Separate CGT assets
[11.200] Subdivision 108- D of the ITAA 1997 provides special rules for
separate CGT assets. In particular, it provides an exception to the common law
principle that what is attached to the land is part of the land, special rules about
buildings and adjacent land, and rules about when a capital improvement to a
CGT asset is treated as a separate asset.
Example 11.15: Separate CGT assets
Mills Pty Ltd constructs a timber mill on land it already owns. The building
is subject to a balancing adjustment on disposal, loss or destruction. The
timber mill is considered a separate CGT asset.
Source: Adapted from s 108-55(1) of the ITAA 1997.
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348 [11.200] PRINCIPLES OF TAXATION LAW 2021
Example 11.16: Separate CGT assets
Acme Co purchases a block of land with a building on it on 1 January
1980. On 1 January 2010, Acme Co enters a contract to have another
building erected on the land. The second building is taken to be a separate
CGT asset.
Source: Adapted from s 108-55(2) of the ITAA 1997.
Example 11.17: Separate CGT assets
Acme Co carries on a business of producing widgets from its factory.
It installs new bathrooms for the employees. The plumbing fixtures
and fittings are depreciable assets. They are separate CGT assets to
the factory. The factory will be subject to the CGT provisions, but the
depreciable assets will be disregarded for CGT purposes.
Source: Adapted from s 108-60 of the ITAA 1997.
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Example 11.18: Separate CGT assets
In 1980, David purchased a block of land. In 1990, David purchased
the adjacent block of land and amalgamated the two titles into one. The
second block is a separate CGT asset. A capital gain will be made on the
second block when the land is disposed of.
Source: Adapted from s 108-65 of the ITAA 1997.
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11: Capital gains tax [11.210] 349
relevant income year and more than 5% of the capital proceeds from
the event; or
• the total cost base of related capital improvements to an asset acquired
before 20 September 1985 is more than the improvement threshold
for the relevant income year and more than 5% of the capital proceeds
from the event.
The improvement threshold is $50,000 indexed from 1985. For the year ended
30 June 2019, it is $150,386 (TD 2018/8): for the year ended 30 June 2020, it is
$153,093 and for the year ended 30 June 2021 it is $155,849.
Example 11.19: Improvements to CGT assets
In 1980, William purchased a boat. In 1991, he installed a new mast for
$30,000. He sold the boat in 2020–2021 for $150,000. Assuming the cost
base of the improvement in the year of sale is $41,000, the improvement
will not be considered a separate CGT asset as it is below the $155,849
threshold. Therefore, the capital gain or loss on the boat will be fully
exempt.
Source: Adapted from s 108-70 of the ITAA 1997.
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350 [11.220] PRINCIPLES OF TAXATION LAW 2021
The most common exception that we saw in Div 104 applies to CGT events
where the CGT asset was acquired before 20 September 1985. Where this is
the case, the capital gain or loss is generally disregarded. In this section of the
chapter, we are going to consider some of the other common exemptions.
Exemptions can be divided into four broad categories:
• exempt gains and losses on certain assets: see [11.230];
• exempt or loss denying transactions: see [11.280];
• anti-overlap provisions: see [11.310]; and
• small business relief: see [11.320].
for valour or brave conduct, is disregarded in terms of CGT: s 118-5 of the ITAA
1997. “Car” is defined in s 995-1 to mean a motor vehicle designed to carry a
load of less than one tonne and fewer than nine passengers. Any capital gain
made on the disposal of a decoration awarded for valour or brave conduct is
ignored provided the taxpayer did not pay any money or give property for it.
[11.240] Collectables and personal use assets. A capital gain or capital loss
made from a collectable is disregarded if the first element of its cost base is
$500 or less: s 118-10(1). Where a capital loss is made from a collectable with
a cost base of more than $500, it can only be used to reduce capital gains from
collectables: s 108-10(1). A capital gain from a personal use asset is disregarded
if the first element of its cost base is $10,000 or less (s 118-10(3)), while a capital
loss from a personal use asset is always disregarded: s 108-20(1).
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11: Capital gains tax [11.310] 351
[11.270] Depreciating assets. A capital gain or capital loss made from a CGT
event that involves the disposal of a depreciating asset is disregarded provided
the event is also a balancing adjustment event where the asset was used wholly
for a taxable purpose and the decline in value was worked out under Div 40:
s 118-24(1). If the asset was not used wholly for a taxable purpose, any disposal
of it may give rise to both a capital gain or loss and a balancing adjustment.
[11.275] Trading stock. A capital gain or capital loss made from a CGT asset
is disregarded if the asset is trading stock: s 118-25 of the ITAA 1997. This is
because the treatment of trading stock is dealt with in Div 70 of the ITAA 1997.
Anti-overlap provisions
[11.310] The most important anti-overlap provision is s 118-20 of the ITAA
1997, which provides that any capital gain made from a CGT event is reduced
if, because of the event, a provision of the Act includes an amount in the
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352 [11.320] PRINCIPLES OF TAXATION LAW 2021
Small business relief
[11.320] As a measure to help small business, provided the basic conditions
for relief are satisfied, any capital gains arising from the disposal of the business
can be reduced by various concessions in Div 152 of the ITAA 1997. The four
available small business concessions are as follows:
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[11.330] Basic conditions for relief. For a taxpayer to be able to access the
CGT small business relief, certain conditions must be met. The three basic
conditions, contained in subdiv 152-A of the ITAA 1997, are as follows:
• The entity must be a small business entity or a partner in a partnership
that is a small business entity, or the net value of assets that the entity
and related entities own must not exceed $6 million. A taxpayer will
also be a small business entity if it is an individual, partner, partnership,
company or trust that is carrying on a business and has an aggregated
turnover of less than $2 million in the previous or current year (either
as an estimate or an actual turnover). From 1 July 2016, the aggregate
turnover test for a small business has increased to $10 million. However,
this new threshold does not apply to CGT concessions.
• The CGT asset must be an active asset. An active asset may be a
tangible asset or an intangible asset. The asset will be an active asset if
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11: Capital gains tax [11.350] 353
it is used or held ready for use in the course of carrying on the business
or, if an intangible asset, it is inherently connected with the business –
for example, goodwill.
• If the asset is a share or interest in a trust, there must be a CGT concession
stakeholder (a significant individual or spouse of a significant individual)
just before the CGT event, and the entity claiming the concession must
be a CGT concession stakeholder in the company or trust, or CGT
concession stakeholders in the company or trust must have a small
business participation percentage in the entity of at least 90%.
Example 11.21: 15-year exemption
Jo is 60 years old. He has owned the local news agency that he purchased
in 1986 for $50,000. Jo decides to retire as he wants to travel the world.
In March 2021, Jo sells the business for $250,000, making a capital gain
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of $200,000.
Assuming Jo meets the three basic conditions to qualify for the small
business exemptions, he will qualify for the 15-year exemption as he is
over 55 years and has owned the business for more than 15 years. As this
will exempt all capital gains made from the sale of the business, Jo will
not need to consider any other exemptions or concessions nor will he
need to consider indexation.
Example 11.22: 50% reduction
Zara, who operates a small manufacturing business, disposes of a CGT
asset. She owned the CGT asset for three years. It was used as an active
asset of the business.
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354 [11.360] PRINCIPLES OF TAXATION LAW 2021
Zara qualifies for the CGT general discount and for the small business
50% reduction. From the CGT event, she makes a capital gain of $20,000,
and she sells another asset, which gives her an additional capital loss of
$5,000 in the income year.
Zara calculates her net capital gain for the year as follows:
$20,000 − $5,000 = $15,000
$15,000 − (50% × $15,000) = $7,500
$7,500 − (50% × $7,500) = $3,750
If the taxpayer is under 55 years, the proceeds must be paid into a complying
superannuation fund, approved deposit fund or retirement savings account. If
a taxpayer is over 55 years, the concession is available automatically, and it is
not necessary to rollover the capital gain to a complying superannuation fund.
Example 11.23: Retirement concession
Jack acquired a farm in 2013. In December 2020, at the age of 60 years,
he retires and transfers the farm to his son for no consideration. The
market value of the farm was $1 million, so the market value substitution
rule applies. It deems that the capital proceeds equal the market value of
the farm.
The cost base of the farm was $600,000, so, assuming the other retirement
exemption conditions are satisfied, Jack made a capital gain of $400,000.
Jack reduces his capital gain twice: first, by the 50% CGT general
discount to $200,000 and then further, by the 50% active asset reduction,
to $100,000. Although he received no capital proceeds, and assuming
the other retirement exemption conditions are satisfied, Jack may choose
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11: Capital gains tax [11.380] 355
to apply the retirement exemption for the full amount of the remaining
$100,000 capital gain.
Source: Adapted from ATO, Advanced Guide to Capital Gains Tax
Concessions for Small Business available at https://www.ato.gov.au/
uploadedFiles/Content/MEI/downloads/39821n33590614.pdf.
[11.370] Rollover relief. If a taxpayer chooses a rollover, all or part of the capital
gain is not included in the taxpayer’s assessable income until circumstances
change. A taxpayer may defer paying tax on a capital gain made from a CGT
event in relation to a small business if the taxpayer acquires a replacement
active asset and elects to obtain a rollover. The rollover relief may be applied
after the CGT general discount and active asset reduction.
Example 11.24: Partial rollover relief
Jude’s small business has an original capital gain of $100,000. After Jude
applies the CGT general discount and 50% active asset reduction, his
original capital gain is reduced to $25,000.
If we assume the first and second elements of the cost base of the business’
replacement asset total $20,000, this amount can be disregarded under
the rollover, leaving Jude with a final capital gain of $5,000.
Source: Adapted from ATO, Advanced Guide to Capital Gains Tax
Concessions for Small Business available at https://www.ato.gov.au/
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The full exemption on gains or losses on a main residence is known as the base
case. However, this full exemption, or base case, will only apply where the
residence was the main residence during the whole of the ownership period
and it was not used for the purposes of producing assessable income. There
are some specific rules that may extend the exemption and other specific rules
that may limit the exemption. Section 118-105 contains a map of subdiv 118-B
as reproduced in Figure 11.3.
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11: Capital gains tax [11.400] 357
The basic case applies where the taxpayer lives in the property for the whole
of the ownership period. Where this is the case and the taxpayer sells the
property, the capital gain or loss will be disregarded. There are instances
where the taxpayer does not live in the property for the whole of the ownership
period but can still disregard the capital gain or loss on disposal. These rules
extend the exemption. Where a taxpayer is able to extend the exemption, it is
not necessary to consider the partial exemption rules.
[11.400] Rules that may extend the exemption. The following rules may
extend the main residence exemption:
• The main residence exemption extends to cover the period from the
time of acquisition to the time when it is first practicable for the taxpayer
to move into the dwelling: s 118-135 of the ITAA 1997.
• A taxpayer who acquires a new dwelling that is intended to be a
main residence, but still holds an existing main residence, may treat
both dwellings as a main residence for the six-month period before
the disposal of the old dwelling or the period between the acquisition
of the new dwelling and disposal of the old dwelling, whichever
is the shorter: s 118-140(1). The extension only applies, however, if
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the original main residence was the taxpayer’s main residence for a
continuous period of at least three months in the 12 months before it is
disposed of and it was not used to produce income during any part of
that 12-month period: s 118-140(2).
• A taxpayer may be entitled to treat a dwelling as his or her main residence
during a period of absence provided no other dwelling is treated as a
main residence during the period of absence. If a dwelling that was
the taxpayer’s main residence ceases to be the main residence, and
the taxpayer uses the dwelling for the purposes of producing income,
the taxpayer may choose to continue to treat the dwelling as his or her
main residence for a maximum period of six years: s 118-145(2). If the
dwelling is not used for the purposes of producing income, a taxpayer
may treat the dwelling as a main residence indefinitely: s 118-145(3).
• Where a taxpayer builds, repairs or renovates a dwelling, provided no
other dwelling is treated as a main residence, a taxpayer may choose
to treat the dwelling as his or her main residence from the time of
acquisition, provided it becomes the taxpayer’s main residence as
soon as practicable after the work has finished: s 118- 150(2). This
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358 [11.410] PRINCIPLES OF TAXATION LAW 2021
extension can only operate for the shorter of four years before the
dwelling becomes the taxpayer’s main residence or the period between
the date of acquisition of the land the dwelling becoming the main
residence: s 118-150(4). TD 2017/13 deals with the situation where you
build a dwelling on land acquired pre-CGT and wish to claim the main
residence exemption before it becomes your main residence. In that
case, a choice needs to be made under s 118-150(2).
• Where a dwelling that is a taxpayer’s main residence is accidentally
destroyed and a CGT event happens in relation to the land, provided
there is no other main residence, the taxpayer may choose to apply
the exemption to the period after destruction until the land is sold:
s 118-160.
[11.410] Rules that may limit the exemption. The following rules may limit
the main residence exemption:
• The main residence exemption does not apply to a CGT event that
happens in relation to land, or a garage, storeroom or other structure,
to which the exemption can extend if the event does not also happen
in relation to the dwelling: s 118-165 of the ITAA 1997.
• A taxpayer and his or her spouse will generally have the same main
residence. Where the taxpayer and spouse have different main
residences, the parties must choose one of the dwellings as the
main residence of both or nominate the different dwellings as the main
residences: s 118-170(1). If the parties nominate different residences,
the entitlement to the main residence exemption is split between the
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two dwellings in accordance with s 118- 170(3) and (4). Where the
taxpayer’s interest in his or her main residence is not more than half,
the dwelling is taken to be the main residence during the period.
Otherwise the dwelling is taken to be the taxpayer’s main residence for
half of the period. The same principle applies to the main residence of
the taxpayer’s spouse.
• A taxpayer and his or her dependent child or children will generally have
the same main residence. If another dwelling is the main residence of
a dependent child under 18 years, the taxpayer must choose one main
residence for both themselves and the dependant: s 118-175.
• The main residence exemption will be limited where the dwelling
is acquired by a taxpayer under the marriage breakdown rollover
provisions. In these circumstances, the taxpayer’s exemption will be
apportioned according to how the dwelling was used both before and
after the rollover: s 118-178.
[11.420] Partial exemption rules. In addition to the rules that extend or limit
the main residence exemption, there are two situations where a taxpayer may
be entitled to a partial exemption only.
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11: Capital gains tax [11.420] 359
A taxpayer will only be entitled to a partial exemption for a CGT event that
happens in relation to a main residence if the dwelling was the taxpayer’s
main residence for part only of the ownership period. Where only a partial
exemption is allowed, the capital gain is apportioned according to the days
the dwelling was the taxpayer’s main residence: s 118-185 of the ITAA 1997.
Where a taxpayer is only entitled to a partial exemption because the property is
used for income-producing purposes and that income-producing purpose first
occurred after 20 August 1996, the partial exemption is calculated by reference
to s 118-192. This section deems the taxpayer to have acquired the property at
market value at the date it first produces income.
Example 11.25: Partial exemption
Rebecca bought a house in March 2010 for $200,000 and moved in
immediately. In March 2013, she purchased another property, which she
immediately began to treat as her main residence. She moved out of
the first property and began to rent it out. At that time, it was valued at
$350,000. She sold it in March 2021 for $360,000.
The capital gain or capital loss will be calculated using s 118-192 to value
the property. Rebecca will have made a capital gain of $10,000.
366
$10,000 × = $1,431
2,557
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360 [11.425] PRINCIPLES OF TAXATION LAW 2021
A taxpayer will only be entitled to a partial exemption for a CGT event that
happens in relation to a main residence if the dwelling was used for the
purpose of producing assessable income during all or part of the period of
ownership: s 118-190. The test to determine whether the property was used
to earn assessable income is based on whether the interest is or would be
deductible if incurred: s 118-190.
Example 11.27: Partial exemption
Sandra’s house purchase contract was settled on 1 January 2017, and the
house was her main residence for the entire four years she owned it, until
she sold it under a contract entered into on 1 November 2020 and settled
on 31 December 2020. From the time Sandra bought it until 31 December
2018 (75% of the ownership period), she used 25% of her house to run
her photographic business. The rooms were modified for that purpose so
were no longer suitable for private and domestic use.
Sandra made a capital gain of $10,000 when she sold the house and used
the following formula to calculate the taxable portion:
Capital gain × % of floor area not used as main residence × % of
period of ownership that that part of the home was not used as main
residence = taxable portion
$10,000 × 25% × 75% = $1,875
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Death
[11.425] Division 128 of the ITAA 1997 sets out what happens when a taxpayer
dies and a CGT asset devolves to a legal personal representative or a beneficiary
of the estate. The capital gain or capital loss made by the deceased from the
CGT event is disregarded: s 128-10. There are, however, consequences for
the beneficiary. The beneficiary will have acquired either a pre- CGT asset
or a post-CGT asset. Where the beneficiary acquires a pre-CGT asset, he or
she is deemed to have acquired the asset for the market value on the date of
death: s 128-15(4). Where the beneficiary acquired a post-CGT asset, he or she
is deemed to have acquired the asset for the deceased person’s cost base as at
date of death: s 128-15(4). For the purposes of applying the discount, the asset
is taken to be acquired when the deceased person acquired them if they are
post-CGT assets: s 115-30. If, however, the CGT asset was the deceased’s main
residence, the beneficiary is deemed to have acquired the asset for market
value at the date of death: s 128-15(4).
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11: Capital gains tax [11.430] 361
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362 [11.440] PRINCIPLES OF TAXATION LAW 2021
All same asset rollovers are listed in a table in s 112-150. However, some
common examples of sale asset rollovers are as follows:
• transfer of a CGT asset from one spouse to another because of a
marriage breakdown;
• transfer of a CGT asset to a wholly owned company; and
• transfer of an asset between related companies.
From 1 July 2016, optional rollover relief is available where a small business
undertakes a genuine restructure, but the ultimate legal ownership of the asset
remains unchanged. This rollover extends beyond CGT assets to apply to gains
and losses on trading stock, revenue assets and depreciating assets as well.
Columns 3 and 4 of the table contained in s 104-5 of the ITAA 1997 provide
a useful summary of when a capital gain or a capital loss arises for each
CGT event.
CGT event A1, the disposal of a CGT asset, is the most common event. Section
104-10(4) of the ITAA 1997 specifically provides:
You make a capital gain if the capital proceeds from the disposal are more than the
asset’s cost base. You make a capital loss if those capital proceeds are less than the
asset’s reduced cost base.
If you re-examine the other CGT events, you will find a similar section for
each. In each provision is the use of various terms that have specific legislative
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364 [11.470] PRINCIPLES OF TAXATION LAW 2021
Capital proceeds
[11.470] For most CGT events, the capital amounts that the taxpayer receives
or is entitled to receive are the capital proceeds. Section 116-20 of the ITAA
1997 defines the capital proceeds from an event as the total amount of money
the taxpayer has received or is entitled to receive in relation to a CGT event
happening and the market value of any other property the taxpayer has
received or is entitled to receive in respect of the event happening. The Full
Federal Court has held that an entitlement to receive money is not affected
even if the money is received from a third party: Quality Publications Australia
Pty Ltd v FC of T [2012] FCA 256. For the purposes of determining the proceeds
of a CGT event, any GST on the supply is disregarded: s 116-20(5).
The definition in s 116-20 is known as the general rule about capital proceeds.
In addition to this general rule, there are six modifications that may be relevant:
1. The first modification rule is the market value substitution rule, which
is relevant if a taxpayer receives no capital proceeds from a CGT event
or some or all of the capital proceeds cannot be valued, or the taxpayer
did not deal at arm’s length with another entity in connection with
the event: s 116-30. In other words, there is a connection between
the parties; for example, they are related or good friends. The capital
proceeds are deemed to be the market value determined at the time
of the CGT event. “Market value” is determined by reference to its
ordinary meaning and is generally understood to mean the price that
a willing purchaser at that date would have had to pay: Spencer v
Commonwealth (1907) 5 CLR 418 at 441 per Isaacs J.
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11: Capital gains tax [11.470] 365
Example 11.29: Apportionment rule
Betty sells a block of land and a boat for a total of $100,000. This transaction
involves two CGT events.
The $100,000 must be divided among the two events. The capital proceeds
from the disposal of the land are so much of the $100,000 as is reasonably
attributable to it. The rest relates to the boat.
Source: Adapted from s 116-40 of the ITAA 1997.
Example 11.30: Non-receipt rule
Lyn sells a painting to Mat for $5,000 (the capital proceeds). Lyn agrees to
accept monthly instalments of $100.
Lyn receives $2,000, but then Mat stops making payments. It becomes
clear that Lyn is not likely to receive the remaining $3,000. The capital
proceeds are reduced to $2,000.
Source: Adapted from s 116-45 of the ITAA 1997.
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Example 11.31: Repaid rule
Simon sells a block of land for $50,000 (the capital proceeds). Siobhan
(the purchaser) later finds out that Simon misrepresented a term in the
contract. Siobhan sues Simon, and the court orders him to pay $10,000
in damages to Siobhan.
The capital proceeds are reduced by $10,000, to $40,000.
Source: Adapted from s 116-50 of the ITAA 1997.
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366 [11.480] PRINCIPLES OF TAXATION LAW 2021
Example 11.32: Assumption of liability rule
Olivia sells land for $150,000. She receives $50,000 (the capital proceeds),
and Angus (the buyer) becomes responsible for a $100,000 liability under
an outstanding mortgage.
The capital proceeds are increased by $100,000, to $150,000.
Source: Adapted from s 116-55 of the ITAA 1997.
Cost base
[11.480] For most CGT assets, the cost base is the total of the costs associated
with the CGT asset. The cost base is used for the purpose of working out a
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capital gain. Where the taxpayer is registered for GST, the cost base will be
net of any GST credits available. If, however, the taxpayer is not registered for
GST, any GST paid will be included in the cost base of the asset.
Subdivision 110-A of the ITAA 1997 sets out the rules for determining the cost
base of a CGT asset. The cost base of a CGT asset has five elements:
• Element 1: The money paid by the taxpayer, or required to be paid,
in respect of acquiring the asset and the market value of any other
property given or required to be given in respect of acquiring the
asset: s 110-25(2).
• Element 2: The incidental costs incurred by the taxpayer. There are
a number of incidental costs that a taxpayer may have incurred.
The following nine categories of costs, the first eight of which must
occur in relation to the acquisition or event, are listed in s 110-35 as
incidental costs:
– remuneration for the services of a surveyor, valuer, auctioneer,
accountant, broker, agent, consultant or legal adviser;
– cost of transfer;
– stamp duty;
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11: Capital gains tax [11.480] 367
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368 [11.490] PRINCIPLES OF TAXATION LAW 2021
[11.490] In addition to the basic rules about cost base, there are cost base
modification rules that need to be considered:
• The first modification rule is the market value substitution rule. The
first element of the cost base will be replaced with the market value if
the taxpayer did not incur any expenditure to acquire the asset, some
or all of the expenditure cannot be valued or the taxpayer did not deal
at arm’s length in relation to the acquisition: s 112-20(1). Where it is
the case that the parties did not deal at arm’s length with each other
and the acquisition resulted from another entity doing something
that did not constitute a CGT event happening, the market value will
only be substituted where the taxpayer paid more than market value:
s 112-20(2). However, there are circumstances where the market value
substitution rule will not apply –for example, where CGT event D1
happens and the taxpayer did not pay anything for it.
• The second modification rule deals with split, changed or merged
assets. If a CGT asset is split into two or more assets or a CGT asset
changes into an asset of a different nature, the splitting or change is
not a new CGT asset. However, the cost base needs to be worked
out for the new assets. The cost base of each asset is a reasonable
apportionment of the cost base of the original asset. If two or more
assets are merged, the cost base of the new asset is the sum of the
elements of each original asset: s 112-25.
• The third modification rule deals with the apportionment of expenditure
where the expenditure relates in part only to the CGT asset. The
expenditure allocated to the CGT asset is that which is reasonably
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11: Capital gains tax [11.495] 369
base of a CGT asset acquired at least 12 months before the CGT event. Where
a taxpayer acquires an asset before 21 September, they will have a choice to
use either indexation or the CGT general discount discussed below in Step 3
and may use whichever gives them the best result. Subdivision 960-M of the
ITAA 1997 shows how to apply indexation and calculate the indexation factor.
The calculation involves multiplying the separate elements of the cost base by
the indexation factor. The indexation factor is determined by dividing the index
number for the quarter in which the CGT event occurred (or September 1999 if
the CGT event occurred after that date) by the index number of the quarter in
which the expenditure was incurred. Note that the indexation factor is always
rounded to three decimal places. See [11.580] for a table of indexation figures.
68.7
= 1.517
45.3
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The indexed first element of Peter’s cost base is:
1.517 × $250,000 = $379,250
Assuming Peter has no other costs associated with the property, his
capital gain under the indexation method would be:
$500,000 − $379,250 = $120,750
Peter’s capital gain using the CGT general discount would be:
$500,000 − $250,000 = $250,000
less 50% discount = $125,000
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370 [11.500] PRINCIPLES OF TAXATION LAW 2021
Reduced cost base
[11.500] For most CGT events, the reduced cost base is the total of the
costs associated with the CGT event. The reduced cost base is used for the
purpose of working out a capital loss. The reduced cost base also consists of
five elements. All the elements are the same as the cost base (see [11.480])
except for the third element. The third element of the reduced cost base is
an amount included in the taxpayer’s assessable income because of certain
balancing adjustments. Further, the elements of the reduced cost base cannot
be indexed.
The reduced cost base does not include any of the costs the taxpayer has
previously claimed or can claim in the current year as a deduction. For example,
the cost base must be reduced by any capital works deductions claimed for
capital expenditure.
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372 [11.530] PRINCIPLES OF TAXATION LAW 2021
losses from personal use assets are disregarded and losses from collectables
are quarantined to be used only against gains from collectables.
Generally, a taxpayer will apply any losses against gains that cannot utilise the
50% general discount or indexation. It will then normally be a case of applying
losses against indexed capital gains and, finally, against gains that attract the
50% CGT general discount.
Calculation 2
[11.530] If a taxpayer still has capital gains after deducting the current year
capital losses, he or she can then reduce those capital gains in the order he or
she chooses by any losses of previous years. The losses, however, are applied
in the order in which they were incurred.
Calculation 3
[11.540] Calculation 3 allows some taxpayers to reduce any discount capital
gain by the discount percentage. Discount capital gains are dealt with in Div
115 of the ITAA 1997.
In certain circumstances, the cost base of a CGT asset may be indexed to take
into account inflation: see [11.490] and Example 11.33. As of 21 September
1999, indexation was abolished and replaced with a CGT general discount.
Individuals and trusts receive a 50% general discount on the capital gain from
certain CGT events, while complying superannuation funds receive a one-third
general discount. A taxpayer may apply the general discount where a CGT
event occurs on or after 11.45 am on 21 September 1999 and he or she has
held the asset for more than 12 months. A further 10% discount specifically
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11: Capital gains tax [11.560] 373
available for investors disposing of property used for affordable housing was
introduced with effect from 1 January 2020: see s 115-125 of the ITAA 1997.
Where a CGT asset is acquired before 21 September 1999 and the CGT event
occurs after that date, the taxpayer may elect to use indexation or apply the
general discount. Taxpayers cannot use both.
There are also certain CGT events that do not attract the CGT general discount,
generally because the 12-month rule is not satisfied. For example, the CGT
general discount does not apply to any of the D category events. In certain
circumstances, a discount capital gain may be recalculated without reference
to indexation.
Calculation 4
[11.550] Once any losses are taken into account, as well as any CGT general
discount available, a taxpayer who is entitled to any of the small business
concessions may apply them at this stage: see [11.320].
Calculation 5
[11.560] Calculation 5 requires a taxpayer to add up any remaining capital
gains that are not discount capital gains and any remaining discount capital
gains to determine the net capital gain to be included in assessable income.
A net capital gain is included in a taxpayer’s assessable income as statutory
income.
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374 [11.570] PRINCIPLES OF TAXATION LAW 2021
Capital losses
[11.570] A net capital loss is determined via similar steps to determine a net
capital gain. However, a taxpayer cannot deduct from his or her assessable
income a net capital loss for any income: s 102- 10(2) of the ITAA 1997.
Therefore, there is only a three-step process to follow to determine a taxpayer’s
net capital loss. To the extent that a net capital loss cannot be applied in an
income year, it can be carried forward to a later income year: s 102-15(1).
Indexation figures
Current index reference base
[11.580]
Quarter ending
Year 31 March 30 June 30 September 31 December
1985 37.9 38.8 39.7 40.5
1986 41.4 42.1 43.2 44.4
1987 45.3 46.0 46.8 47.6
1988 48.4 49.3 50.2 51.2
1989 51.7 53.0 54.2 55.2
1990 56.2 57.1 57.5 59.0
1991 58.9 59.0 59.3 59.9
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Questions
[11.590]
11.1 Anita is a client of yours. To fund her career as an artist, Anita sold
some of her art collection by other artists. It consisted of:
(a) An antique ceramic bowl purchased in February 1985 for $4,000.
She sold the bowl on 1 December of the current tax year for $12,000.
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11: Capital gains tax [11.590] 375
(b) A sculpture purchased in December 1993 for $5,500. She sold the
sculpture on 1 January of the current tax year for $6,000.
(c) A bronze figure purchased in October 1987 for $14,000. She sold
the bronze figure on 20 March of the current tax year for $13,000.
(d) A painting purchased in March 1987 for $470. She sold the painting
on 1 July of the current tax year for $5,000.
Consider the CGT consequences of the above transactions.
11.2 Other than the examples provided in this chapter, provide an example
for each of CGT events A1, B1, C1, C2, D1 and D2.
11.3 Are the following CGT assets collectables or personal use assets:
(a) An engagement ring that cost $5,000?
(b) A second-hand car purchased for $2,000?
(c) Shares in BHP?
(d) Your home?
(e) A painting hung in the foyer of your accounting firm?
(f) A holiday house at Byron Bay?
11.4 List five things that you own that are considered personal use assets.
Can you think of any collectables that you may own?
11.5 What CGT events apply to the following transactions:
(a) You sell shares in BHP for $5,000.
(b) You receive $100,000 in return for signing a three-year contract to
play AFL with the Brisbane Lions.
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(c) You sell your holiday home at Byron Bay for $750,000.
(d) You sell your hairdressing salon for $200,000 and receive an
additional $20,000 for agreeing not to open another salon within a
10-km radius for the next three years.
(e) You pay Shelby $50,000 for the option to purchase her hairdressing
salon in three years time.
(f) In three years time, you exercise the option to purchase Shelby’s
salon for $300,000.
(g) You sell a diamond ring for $20,000. You paid $12,000 for the ring
in 1984.
11.6 Dave Solomon is 59 years of age and is planning for his retirement.
Following a visit to his financial adviser in March of the current tax
year, Dave wants to contribute funds to his personal superannuation
fund before 30 June of the current tax year. He has decided to sell
the majority of his assets to raise the $1,000,000. He then intends to
rent a city apartment and withdraw tax-free amounts from his personal
superannuation account once he turns 60 years in August of the next
year. Dave has provided you with the following details of the assets he
has sold:
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376 [11.590] PRINCIPLES OF TAXATION LAW 2021
assessable income.
Dave has also indicated that his taxation return for the year ended
30 June of the previous year shows a net capital loss of $10,000
from the sale of shares. These shares were the only assets he sold
in that year.
(a) Based on the information above, determine Dave Solomon’s net
capital gain or net capital loss for the year ended 30 June of the
current tax year.
(b) If Dave has a net capital gain, what does he do with this amount?
(c) If Dave has a net capital loss, what does he do with this amount?
11.7 Your client is an investor and antique collector. You have ascertained
that she is not carrying on a business. Your client provides the following
information of sales of various assets during the current tax year.
Based on this information, determine your client’s net capital gain or
net capital loss for the year ended 30 June of the current tax year.
(a) Block of vacant land. On 3 June of the current tax year, your
client signed a contract to sell a block of vacant land for $320,000.
She acquired this land in January 2001 for $100,000 and incurred
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11: Capital gains tax [11.590] 377
$20,000 in local council, water and sewerage rates and land taxes
during her period of ownership of the land. The contract of sale
stipulates that a deposit of $20,000 is payable to her when the
contract of sale is signed and the balance is payable on 3 January
of the next tax year, when the change of ownership will be
registered.
Antique bed. On 12 November of the current tax year, your client
(b)
had an antique four-poster Louis XIV bed stolen from her house.
She recently had the bed valued for insurance purposes and the
market value at 31 October of the current tax year was $25,000.
She purchased the bed for $3,500 on 21 July 1986. Although the
furniture was in very good condition, the bed needed alterations
to allow for the installation of an innerspring mattress. These
alterations significantly increased the value of the bed, and cost
$1,500. She paid for the alterations on 29 October 1986. On 13
November of the current tax year, she lodged a claim with her
insurance company seeking to recover her loss. On 16 January of
the current tax year, her insurance company advised her that the
antique bed had not been a specified item on her insurance policy.
Therefore, the maximum amount she would be paid under her
household contents policy was $11,000. This amount was paid to
her on 21 January of the current tax year.
Painting. Your client acquired a painting by a well-known Australian
(c)
artist on 2 May 1985 for $2,000. The painting had significantly
risen in value due to the death of the artist. She sold the painting
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378 [11.590] PRINCIPLES OF TAXATION LAW 2021
(iv) 10,000 shares in Share Build Ltd. These shares were acquired
on 5 July of the current tax year for $1 per share and sold on
22 January of the current tax year for $2.50 per share. She
incurred $900 in brokerage fees on the sale and $1,100 in
stamp duty costs on purchase.
(e) Violin. Your client also has an interest in collecting musical
instruments. She plays the violin very well and has several violins
in her collection, all of which she plays on a regular basis. On 1 May
of the current tax year, she sold one of these violins for $12,000
to neighbour who is in the Queensland Symphony Orchestra. The
violin cost her $5,500 when she acquired it on 1 June 1999.
Your client also has a total of $8,500 in capital losses carried forward
from the previous tax year, $1,500 of which are attributable to a
loss on the sale of a piece of sculpture that she sold in April of the
previous year.
11.8 Scott is an accountant who purchased a vacant block of land in
Brisbane on 1 October 1980. On 1 September 1986, Scott built a house
on the land. At the time, the land was valued at $90,000 and the cost
of construction was $60,000. The property has been rented out since
construction was completed. On 1 March of the current tax year, Scott
sold the property at auction for $800,000.
(a) Based on the information above, determine Scott’s net capital
gain or net capital loss for the year ended 30 June of the current
tax year.
(b) How would your answer to (a) differ if Scott sold the property to
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11: Capital gains tax [11.590] 379
relation to the sale and paid sales commission to the real estate agent
of $48,000.
The four offices in the block had been rented out to tenants for the
period of ownership.
Sophia wants to know whether she is better off using the indexation
method for calculating her capital gain or the discount method. Based
on your calculations, advise her.
11.10 Discuss the CGT consequences of the following in relation to the main
residence exemption:
(a) Your client purchases a property to live in and does so for four
months. They are then sent overseas by their employer for
12 months during which time the residence is rented out.
(b) Your client purchases a new home and moves in immediately.
Four months later, their previous main residence is sold.
(c) Your client purchases a new home and moves in immediately.
Nine months later, their previous main residence is sold.
(d) Your client decides to make extra income by renting out their
spare bedroom in their main residence on Airbnb.
11.11 Martin purchased a home in Brisbane on 7 April 2011 and moved into
it once the contract was settled. Martin lived there until he moved into
a retirement facility on 18 September 2016. At that stage, he rented the
house to long-term tenants.
On 20 January 2020, Martin passed away. Martin’s daughter, Millie,
was the beneficiary of the estate and inherited the house. Millie then
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Sadiq, E. A. (2020). Principles of taxation law 2021. ProQuest Ebook Central <a
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Copyright © 2020. Thomson Reuters (Professional) Australia Pty Limited. All rights reserved.
Sadiq, E. A. (2020). Principles of taxation law 2021. ProQuest Ebook Central <a
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