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Tax Assessment Act : Indexation Mathod

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Question:

Discuss about Tax Assessment Act for Indexation Mathod.

 

Answer:

Capital gains are derived when a capital asset is liquidated and the resultant proceeds are higher than the underlying asset’s cost base.  With regards to capital gains, any gains on account of asset which are held for more than 12 months are termed as long term gains while capital gains made on assets with a holding period of less than 12 months amounts to short term gains (Barkoczy, 2014).

Part a)

Only assets that have been bought on or after September 20, 1985 fall within the CGT (Capital Gain Tax) ambit. In the case of assets which have been purchased before this, no CGT would be levied irrespective of the liquidation date and the capital gains derived (CCH, 2011).

The relevant information in this case suggests that the land was bought by Scott in the pre-CGT era and hence no CGT liability would arise on account of its liquidation. But the same cannot be said about the house whose construction was done in 1986 i.e, the period when CGT has come in enforcement and hence any gains on liquidation of house would levy CGT. As the property comprises of two assets with differential CGT treatments, hence both need to be accounted for separately (Coleman, 2011).

Land

The house asset was constructed only in 1986. At that time the land had a fair value of $ 90,000.

At the same time, fair value of the property = Fair value of land + Fair value of property = 90000 + 60000 = $ 150,000

Share of land = (90000/150000)*100 = 60%

These shares would continue to remain constant and therefore even in present 60% of the property value belongs to land and would be free from CGT burden.

Value of property exempted from CGT burden = 60% of 800000 = $ 480,000

House

Total value apportioned to the house = 40% of the property value or =  (40/100)*800,000 = $ 320,000

Only the above proceeds would be subject to CGT using the methods shown below,

Discount method

Capital gains arising from house sale = Value of house – Construction cost = 320000 -  60000 = $ 240,000

Since this method allows for a discount of 50%, hence the CGT would apply only on half the above amount or $ 120,000

 

Indexation Method

Construction cost incurred in 1986 = $ 60,000

Indexed construction cost adjusted for inflation using CPI = (68.72/43.2)*60000 = $ 95,400

Thus, gains that would be taxable under CGT regime = 320000 – 95400 = $ 224,600

Conclusion

Scott would choose the discount method for capital gains calculation as it would minimise the CGT payments. Hence, net capital gain from property sale is $ 120,000.

Part b)

The case states that Scott’s daughter has purchased the property for a total consideration of $ 200,000.

However, this transaction would not impact the net capital gains due to the application of Section 116-30 ITAA 1997. This states that the value to be used for calculation of capital gains should be one which is higher amongst the current market price and actual sale price obtained from the buyer (AustLii, nd). Applying this, $ 200,000 would be discarded and calculations would be done only on $800,000.  Thus, the capital gains on the property would now also be $ 120,000.

Part c)

This involves a change in ownership since instead of individual, now the owner is a company. This would impact the net capital gains since discount method can be availed by individual but not by a company (Coleman, 2011). Hence, the indexation method would be deployed and resultant capital gains as calculated in part (a) would be $ 224,600.

 

References

Austlii nd, INCOME TAX ASSESSMENT ACT 1997 - SECT 116.30, Austlii Website, Available online from https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s116.30.html (Accessed on August 26, 2016)

Barkoczy, S 2014,  Foundation of Taxation Law 2014, 6th eds., CCH Publications, North Ryde

CCH 2011, Australian Master Tax Guide 2011, 49th eds., Wolters Kluwer , Sydney

Coleman, C 2011, Australian Tax Analysis, 4th eds., Thomson Reuters (Professional) Australia, Sydney

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