Determining Net Capital Gain And Capital Gains Tax (CGT) Consequences In An Essay.

Scenario and Information Provided

You are working as a tax consultant in Mayfield, NSW. 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:

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 $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.

b. Antique bed. On 12 November of the current tax year your client 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.

c. Painting. Your client acquired a painting by a well-known Australian 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 for $125,000 at an art auction on 3 April of the current tax year.

d. Shares. Your client has a substantial share portfolio which she has acquired over many years. She sold the following shares in the relevant year of income:

Key Aspects for Computing CGT Consequences

i. 1,000 Common Bank Ltd shares acquired in 2001 for $15 per share and sold on 4 July of the current tax year for $47 per share. She incurred $550 in brokerage fees on the sale and $750 in stamp duty costs on purchase.

ii. 2,500 shares in PHB Iron Ore Ltd. These shares were also acquired in 2001 for $12 per share and sold on 14 February of the current tax year for $25 per share. She incurred $1,000 in brokerage fees on the sale and $1,500 in stamp duty costs on purchase

iii. 1,200 shares in Young Kids Learning Ltd. These shares were acquired in 2005 for $5 per share and sold on 14 February of the current tax year for $0.50 per share. She incurred $100 in brokerage fees on the sale and $500 in stamp duty costs on purchase.

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 neighbor 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 which she sold in April of the previous year.

Required:

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.

2. Rapid-Heat Pty Ltd (Rapid-Heat) is an Electric Heaters manufacturer which sells Electric Heaters directly to the public. On 1 May 2017, Rapid-Heat provided one of its employees; Jasmine, with a car as Jasmine does a lot of travelling for work purposes. However, Jasmine's usage of the car is not restricted to work only. Rapid-Heat purchased the car on that date for $33,000 (including GST).

For the period 1 May 2017 to 31 March 2018, Jasmine travelled 10,000 km in the car and incurred expenses of $550 (including GST) on minor repairs that have been reimbursed by Rapid-Heat. The car was not used for 10 days when Jasmine was interstate and the car was parked at the airport and for another five days when the car was scheduled for annual repairs.

On 1 September 2017, Rapid-Heat provided Jasmine with a loan of $500,000 at an interest rate of 4.25%. Jasmine used $450,000 of the loan to purchase a holiday home and lent the remaining $50,000 to her husband (interest free) to purchase shares in Telstra. Interest on a loan to purchase private assets is not deductible while interest on a loan to purchase income-producing assets is deductible.

During the year, Jasmine purchased an Electric Heaters manufactured by Rapid-Heat for $1,300. The Electric Heaters only cost Rapid-Heat $700 to manufacture and is sold to the general public for $2,600.

Required:

a. Advise Rapid-Heat of its FBT consequences arising out of the above information, including calculation of any FBT liability, for the year ending 31 March 2018. You may assume that Rapid-Heat would be entitled to input tax credits in relation to any GST- inclusive acquisitions.

b. How would your answer to (a) differ if Jasmine used the $50,000 to purchase the shares herself, instead of lending it to her husband?

Scenario and Information Provided

The scenario that has been presented provides detail of a client who is primarily an investor along with being a collector. In 2017/2018, a series of transactions have been entered into by the client, which involved sale of selected assets. Two scenarios can emerge based on the given information. Under one scenario, the client may have a business whereby these assets are regularly bought and sold and thereby treated as trading stock. The resultant income would be assessable income as per s. 6-5 ITAA 1997 in this scenario. However, this is not feasible as the provided information makes it apparent that this scenario is not true considering that it is given that the client does not conduct business dealing with these assets. In such situation, only one possible explanation remains whereby these are investment assets and have been liquidated to yield capital proceeds. While these proceeds are immune from any taxation, any difference from the capital base would lead to capital gains/loss implications which need to be dealt with under the aegis of Capital Gains Tax (CGT).

Some key aspects which are pivotal with regards to computation of CGT consequences are indicated below.

Before moving ahead, for every asset the first criterion to be applied is whether the given asset is a pre-CGT asset is not. This is imperative to apply as s. 149-10 ITAA 1997 exempts such assets from any CGT being levied on capital gains or losses  (Austlii, 2018 a). The rule to determine if a given asset belongs to this class or not is to consider the date of purchase which must be before 20^th September 1985 in order to asset be classified as pre-CGT asset (Hodgson,Mortimer and Butler, 2016).

The computation of capital gains/ losses is started with the taking place of a CGT event (Barkoczy, 2017). Subsection 104-5 ITAA 1997 lists down the summary of various possible CGT events along with the precise approach to determine the gains and losses (Krever, 2017). With regards to the given scenario, only one event has special relevance as all the transactions tend to fall within the ambit of the same event which is A1 event. The precise manner of capital gains/losses computation is contingent on two factors namely the proceeds that the sale generates and the asset cost base associated with respective asset.

The above section clearly underlines the need to define the cost base for which the relevant section is 110-25 (Barkoczy, 2017). While the most obvious element to be included in the cost base is the price at which the asset purchase is done but there are other elements also as indicated follows (Hodgson, Mortimer and Butler, 2016).

Key Aspects for Computing CGT Consequences

The capital gains derived from the methodology highlighted in A1 CGT event are not subject to CGT. Instead, these are applied certain concessions and only the remainder capital gains after concession would be levied CGT. There are two key approaches namely the indexation method and discount method (Nethercott, Richardson and Devos, 2016). However, discussion would be limited to the second method as it is the one more relevant for the given transactions where the capital gains are significant. The discount method has been explained in s. 115-25 which opines that a flat discount to the tune of 50% would be levied provided the underlying capital gains from asset sale are long term (Austlii, 2018 b). The necessary condition for this to happen is that the underlying asset needs to be held in excess of one year (Sadiq, et.al., 2015).

As per s. 102-5, any capital losses that are generated need to be adjusted against the capital gains that would have been generated in the same year (Deutsch, et.al., 2015). However, if this is not possible due to absence of capital gains, then the capital losses are taken into next year for combining with capital gains. The shifting of capital losses would continue till the time capital gains are encountered. Under no circumstance can these be levelled against the taxable income to reduce tax liability (Krever, 2017).

Using the concepts outlined above, the transactions enacted need to be analysed so as to highlight the taxable capital gains.

The purchase date for the land asset can be traced to 2001 implying that it cannot be placed in the category of pre-CGT asset. Thus, CGT exemption cannot be availed for this asset. Further, the sale of land has triggered CGT event A1 and hence it is imperative to compute the underlying gains or losses. The first step in this direction is the determination of the cost base of land asset in accordance with the discussion carried out above. This has been carried out below.

Also, an interesting aspect in the transaction is that the contract for sale in case of land has already been enacted but the sales proceeds will not be collected till the next tax year. In this situation, it becomes pivotal to determine as to whether the CGT would be applicable on the capital gains in 2017/2018 or 2018/2019. Appropriate solution to this issue has been indicated in TR 94/29 which clearly endorses the computation of capital gains in the year when execution of sale contract takes place (ATO, 1994). Thereby, the CGT consequences for the capital gains realised would be levied in the current year only. Further consideration would be given to the longer than one year holding period of land by client which entitles to 50% rebate in line with the discount method highlighted in s. 115-25.

CGT Events and Method of Computation

The purchase date for the antique bed can be traced to 1986 implying that it cannot be placed in the category of pre-CGT asset. Thus, CGT exemption cannot be availed for this asset. Further, the stealing of antique bed has triggered CGT event A1 and hence it is imperative to compute the underlying gains or losses. The first step in this direction is the determination of the cost base of antique bed asset in accordance with the discussion carried out above. This has been carried out below.

In relation to collectables as per s. 118-10, CGT consequences would not arise if the purchase price does not $ 500 and thus condition is satisfied in the given case of antique bed which was purchased for $ 3,500. With regards to disposal of antique bed, it has been stolen and therefore the proceeds obtained from insurance would be taken as the sale proceed and used to determine the capital gains. Further consideration would be given to the longer than one year holding period of antique bed by client which entitles to 50% rebate in line with the discount method highlighted in s. 115-25.

It is evident that the painting has been purchased in May 1985 which clearly precedes the application of CGT on September 20, 1985. Since the given asset has been bought in a pre-CGT era, hence it fall within the ambit of a pre-CGT era. Thereby, s. 149-10 would apply and hence  full exemption from CGT would apply for this asset (Nethercott, Richardson and Devos, 2016).

The purchase date for the shares asset can be traced to 2001 implying that it cannot be placed in the category of pre-CGT asset (Nethercott, Richardson and Devos, 2016). Thus, CGT exemption cannot be availed for this asset. Further, the sale of shares has triggered CGT event A1 and hence it is imperative to compute the underlying gains or losses. Further, consideration needs to be given to the holding period of shares which would determine whether the underlying gains are long term or not and decide on the applicability of discount as per s. 115-25 ITAA 1997.

In wake of the computation carried out below, the discount method would be applied whereby 50% discount would be available for all but one share. The three shares are eligible for 50% concession in capital gains owing to the underlying gains being long term which is not true for the shares of Built Ltd.  The capital gains that would be levied CGT are exhibited below.

Cost Base for CGT

A key question that arises in relation to the given asset is whether this is a collectable or a personal asset. This question has relevance owing to the differential CGT rules that are applicable for the two assets. A key difference is represented in the form of s. 108-20(1) which is applicable only for personal use assets and demands that CGT must be levied only on those assets which have a purchase price exceeding $ 10,000 (Deutsch, et.al., 2015). The corresponding limit for collectables is $ 500 as exhibited by s. 118-10.

The asset in question would be a personal use asset considering the regular use by the client for personal entertainment. Thus, it is not a collectable item but rather an asset which is of regular use by the client. Further, the purchase price of the violin in question does not exceed $ 10,000 as it is only $ 6,500. Owing to this, the violin sale would not produce any CGT liability on the client.

The cumulative taxable capital gains for the client are summarised below for the year 2017/2018.

2. The key issue in the situation presented is to highlight the liability on account of Fringe Benefit Tax (FBT) that would be payable by Rapid Heat due to the benefits that have been availed by Jasmine (the employee)..

The necessary condition in relation to car fringe benefit is that private use of the employer’s car by the employee. Section 7 requires that employee should have the right to use the car for his/her personal use which would then constitute car fringe benefit. In the given case, explicit permission by the employer has been given to Jasmine for using car for her own personal purpose (ATO, 2018).  Section 9 provides guidance in the form of statutory formula which is used for calculating the extent of fringe benefit given. A key input in this quest is the number of days during the underlying tax year for which private car usage is permitted. In this context, any visit to the garage for minor repairs would not yield in deductions in time available but the same would be applicable for major repairs. Besides, the inability of the taxpayer to use the car despite being available would not result in any time deduction (Barkoczy, 2017). Hence, in the given case, no deduction would be considered for the time spent in garage since minor repairs and also the days at car parking since the car availability was intact and only Jasmine was not available to use the car.

Discount Method in CGT

For ascertaining the car fringe benefit taxable value, the key inputs are as follows.

Gross up factor (2017/2018 Type 1 Good) = 2.0802

FBT rate (2017/2018) = 47%

Days of allowed private usage in 2017/2018 = 335

For the doling out of loan fringe benefit to employee, a key condition is that the interest rate charged must be lower than the benchmark interest rate for the given year under consideration. The benchmark interest rate is revised on an annual basis by the RBA (Reserve Bank of Australia) (ATO, 2018). Providing of loan lesser than this rate implies that the employee would have lower interest expense and hence would be benefitted.

The case details highlight extension of loan to Jasmine at an interest cost of 4.25% p.a. This is clearly 100 basis points lower than the applicable benchmark rate of 5.25% p.a. for the year under consideration. Hence, there is extension of loan fringe benefits which would result in FBT liability to apply on Rapid Heat (the employer).

For ascertaining the loan fringe benefit taxable value, the key inputs are as follows.

Gross up factor (2017/2018 Type 2 Good) = 1.8868

FBT rate (2017/2018) = 47% (ATO, 2017) 

Days of loan usage in 2017/2018 (September 1, 2017 to March 31, 2018) = 212

Also, deduction is also permitted for the employer as per s. 18, FBTAA. However, a necessary condition is that the loan must be used for generation of income by the employee. Further, deduction is not available if the loan money is used by any associate of employee irrespective of income being produced.  In the given case, 90% of the loan amount i.e. $450,000 is used by Jasmine while the remainder 10% is being used by her husband.  A holiday home has been purchased by Jasmine which is quite likely to produce income as rent since it would not be used as a main residence. As a result, possible deductions may be claimed by employer based on income generation by the holiday home.

The expenses of personal nature must be borne by the employees themselves. However, some employers help the employees in meeting these expenses by paying for these and such acts result in expense fringe benefit as outlined in s. 20, FBTAA 1986 (Barkoczy, 2017). For the given circumstance, Rapid Heat is a manufacturer of electric heaters. Jasmine wants to purchase an electric heater manufactured by Rapid Heat for her personal use. The price at which these heaters are sold in the market by Rapid Heat is $ 2,600 per piece. Hence, the same amount should be paid by jasmine. However, the employer shoulders this personal expense burden and hence pays half of the amount, thus leaving Jasmine to pay the balance amount of $ 1,300.

For ascertaining the expense fringe benefit taxable value, the key inputs are as follows.

Gross up factor (2017/2018 Type 1 Good) = 2.0802

FBT rate (2017/2018) = 47%

Personal savings realised = $1,300

(b)  It is known that Jasmine now utilises the complete amount of $ 500,000. The addition is of $ 50,000 which she is investing in Telstra shares in a manner similar to her husband before. Clearly, dividend income would be generated which is assessable income in accordance with s. 6(5) ITAA 1997. As a result, s. 20 FBTAA would apply and additional deduction to the extent of $ 500 would be available on the FBT liability imposed on the employer as explained below.

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: 28 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: 28 September 2018)

ATO, (2018) Fringe Benefits Tax- A Guide For Employers. https://law.ato.gov.au/atolaw/view.htm?DocID=SAV%2FFBTGEMP%2F00010 (Accessed: 28 September 2018)

Austlii, (2018 a) Income Tax Assessment Act 1997- SECT 149.10 [Online]. Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s149.10.html (Accessed: 28 September 2018)

Austlii, (2018 b) Income Tax Assessment Act 1997- SECT 115.25 [Online]. Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s115.25.html (Accessed: 28 September 2018)

Barkoczy, S. (2017) Core Tax Legislation and Study Guide 2017. 2nd ed.   Sydney: Oxford University Press Australia.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., and Snape, T. (2015) Australian tax handbook.  8th ed. Pymont: Thomson Reuters.

Hodgson, H., Mortimer, C. and Butler, J. (2016) Tax Questions and Answers 2016. 6th ed. Sydney: Thomson Reuters.

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

Nethercott, L., Richardson, G., & Devos, K. (2016)  Australian Taxation Study Manual 2016. 8th 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.