CGT Newsletter 2008/09 Issue 3
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» CGT small business reliefs
Significant amendments to the CGT small business reliefs are being made by the Tax Laws Amendment (2009 Measures No 2) Bill 2009 which was introduced into Parliament on 19 March 2009. The main amendments will (broadly) increase access to the CGT small business reliefs via the small business entity test with effect from the 2007-08 income year.
The amending Bill also contains important proposed amendments to other areas of the CGT small business reliefs, including the CGT event within two years of death rule, the maximum net asset value test, the retirement exemption and the definition of active asset.
Some aspects of the proposed amendments are briefly noted below.
Increased access via small business entity test
The introduction of the small business entity test by the Tax Laws Amendment (Small Business) Act 2007 as an alternative to the maximum net asset value test resulted in a difference between how the two tests treat businesses with passive asset structures (that is, where one entity owns a CGT asset and an affiliate of, or an entity connected with, the asset-owning entity uses the asset in its business).
Under the law as presently enacted, owners of such passively held CGT assets can access the CGT small business reliefs via the maximum net asset value test in some circumstances. However, the small business entity test is not available because the asset-owning entity typically does not meet the requirement of carrying on a business. Amendments in the Tax Laws Amendment (2009 Measures No 2) Bill 2009 address this deficiency and, in doing so, in fact extend the circumstances in which a passive asset may qualify as an active asset and also potentially expand the entities that will be taken into account for the purposes of applying the maximum net asset value test.
Partner's asset used in partnership business
As the law is presently enacted, a partner can access the CGT small business reliefs via the small business entity test only if the partnership is a small business entity and the relevant CGT asset is an "asset of the partnership". An asset of a partnership is an asset that is owned by the partners in accordance with their fractional interests in the partnership or in accordance with their respective interests as specified in the partnership agreement.
In some circumstances, an individual partner (or partners) owns an asset directly and makes the asset available for general use in the partnership. Under the law as currently enacted, because this asset is not an asset of the partnership (as the partner owns the asset), the partner is not able to access the CGT small business reliefs for the asset via the small business entity test but may be able to access the concessions via the maximum net asset value test. Amendments in the Tax Laws Amendment (2009 Measures No 2) Bill 2009 address this issue.
Other amendments
Other amendments being made by the Tax Laws Amendment (2009 Measures No 2) Bill 2009 include the following:
- in calculating the net value of the CGT assets of an entity, liabilities in relation to shares, units or other interests (except debt) in another connected entity will be taken into account;
- the definition of active asset is being amended to ensure that all of the uses of an asset (apart from the personal use of an asset by the taxpayer or an individual who is the taxpayer's affiliate) are considered in determining whether it is an active asset for the purposes of the CGT small business reliefs;
- the CGT event within two years of death rule (which was enacted by the Tax Laws Amendment (2006 Measures No 7) Act 2007) is being extended to apply where the CGT event happens for the trustee of a testamentary trust or the CGT asset is owned by joint tenants and there is a passing of an interest in the asset by survivorship on the death of one of the joint tenants;
- to correct an unintended effect on the operation of the retirement exemption made by the Superannuation Legislation Amendment (Simplification) Act 2007:
- a rule to apply the retirement exemption to capital proceeds received in instalments by individuals is being reinserted; and
- a duplicate provision for receipt of capital proceeds in instalments by companies and trusts is being removed;
- if a capital gain arises from CGT event J5 or J6 it will not be necessary to satisfy the CGT small business relief basic conditions for the retirement exemption to be available;
- a company or trust will be able to make a retirement exemption payment indirectly through one or more interposed entities to a CGT concession stakeholder;
- a partner in a partnership cannot qualify as a small business entity in their capacity as a partner; and
- small business retirement exemption payments (made under sec 152-325 ITAA 1997) will be excluded from the operation of the deemed dividend provisions of sec 109 and Div 7A ITAA 1936.
These proposed amendments have various application dates.
» Tax benefits and CGT
The Tax Laws Amendment (2009 Measures No 2) Bill 2009 is also amending the ITAA 1997 to provide a general exemption from CGT for capital gains arising from a right or entitlement to a tax offset, deduction or similar benefit. This measure applies to CGT events happening in the 2009-10 and later income years.
» Transformation of water rights
In a media release of 27 February 2009, the Assistant Treasurer announced that the Government will provide CGT roll-over relief for irrigators who transform their entitlement to water under an irrigation right held against an irrigation infrastructure operator into an individual water entitlement.
The Assistant Treasurer explained that the roll over will facilitate transformation arrangements allowed under the new water market rules that will be made under the Water Act 2007 by deferring the CGT consequences of the transformation for irrigators until they subsequently deal with their individually held water entitlement. The roll-over is to apply to CGT events that happen on and after 1 July 2008. The roll over will not be available where the entitlement to water under an irrigation right against an irrigation infrastructure operator is transformed into the hands of a third party (rather than the irrigator).
The Government will also allow termination and exit fees to be recognised when calculating a capital gain or loss on an asset by including these costs in the asset’s cost base. This change (which is to also apply to CGT events that happen on and after 1 July 2008) will be available for all assets and not just those relating to the irrigation industry.
A consultation paper providing further information about the roll-over has been released.
» Optional loss roll-over: complying super funds
The Minister for Superannuation and Corporate Law announced on 23 December 2008 that, with effect from 24 December 2008, an optional CGT roll over is to be available for capital losses arising from CGT events happening under a complying superannuation fund’s merger with an APRA regulated superannuation fund with at least five members before 1 July 2010.
Typically, the transfer of assets from one super fund to another, as part of a merger of the funds, triggers the realisation of capital gains or losses for the transferring fund. If the transferring super fund is in a net capital loss position, its winding up following these transfers will lead to these losses being extinguished. The proposed roll-over is intended to preserve the value of these capital losses in the receiving super fund – allowing them to be offset against capital gains in the future.
Any capital gains that may be realised under such a merger would continue to be taxable. However, as capital gains and losses are calculated on an asset-by-asset basis, providing an optional roll over will allow the transferring fund to choose not to disregard capital losses realised under the merger to offset against any realised capital gains.
A Treasury discussion paper on the proposed roll-over has been released.
» "Trust cloning" abolished
The Assistant Treasurer announced on 31 October 2008 that the Government will remove the CGT trust cloning exception to CGT events E1 and E2, with effect for CGT events that happen after that date.
The Assistant Treasurer said that removing the trust cloning exception was consistent with the policy principle of taxing capital gains that arise where there is a change in ownership of an asset as typically occurs on the creation of a trust over a CGT asset (CGT event E1) and on transferring a CGT asset to an existing trust (CGT event E2).
The other current exception to CGT events E1 and E2, where the taxpayer is the sole beneficiary of the relevant trust that is not a unit trust and the taxpayer is absolutely entitled to the asset as against the trustee, is to be retained and a mere change of trustee of a single trust will continue not to trigger a CGT taxing point.
The Assistant Treasurer noted that the amendment would remove the possibility of using the trust cloning exception to eliminate tax liabilities on accrued capital gains which would help ensure equity and the integrity of the tax system.
Legislation to give effect to this measure is to be introduced as soon as practicable, after consultation has taken place.
» Losses and CGT Sub-committee minutes
The minutes of the NTLG Losses and Capital Gains Tax Sub-committee meeting of 19 November 2008 were released on 16 April 2009. Issues covered include:
- the ATO’s position on PS LA 2005/1 (GA) (taxation of capital gains of a trust);
- distribution by a trust of a CGT event J5 capital gain to a beneficiary with carried forward losses;
- CGT event D2 (granting an option) and the CGT small business reliefs;
- CGT small business roll-over relief and trading stock; and
- the CGT discount capital gain concession and replacement asset rollovers.
» Cost base of shares
The Federal Court (Middleton J) has held that a capital contribution made by the taxpayer did not form part of the cost base or reduced cost base of shares held by the taxpayer in the company under the former CGT cost base rules (National Mutual Life Association of Australia Ltd v FC of T [2008] FCA 1871).
Under the former cost base and reduced cost base rules, the capital contribution could only qualify as an element in of the cost base and reduced cost base of the shares to the extent to which it was incurred for the purpose of enhancing the value of the shares and was reflected in the state or nature of the shares at the time of their disposal.
Middleton J said that, looking at the context in which the concept "state or nature" was used in former sec 160ZH(3)(c) ITAA 1936 referable to a share, he did not consider the concept included a share's value. The relevant provision clearly distinguished the concept of "value" with "state" or "nature". Moreover, even by just considering the words "state" or "nature" themselves, his Honour was of the view that it could not be said in relation to a share as an item of property, which may be bought and sold, that "value" forms any part of the nature or state of that form of asset. The "nature" of a share refers to the bundle of rights (and obligations) attaching to a share, being the inherent qualities of a share. Those rights exist, and may be exercised, irrespective of their value. The "state" of a share does not refer to its "value", but refers to other matters, such as whether a share is fully paid up or not. The value of a share does not affect the "state" of a share, if one focuses on the particular condition of a share as an item of property.
The taxpayer has lodged an appeal to the Full Federal Court from the decision of Middleton J.
It should be noted that the effect of amendments made by the Taxation Laws Amendment (2006 Measures No 1) Act 2006 is that it is no longer necessary, for expenditure to qualify as part of the fourth element of the cost base of a CGT asset, that the expenditure be reflected in the state or nature of the asset; it is sufficient if the purpose or the expected effect of the capital expenditure is to increase or preserve the asset’s value (see sec 110-25(5) ITAA 1997).
» Payment by vendor to cancel contract
An interpretative decision to the effect that an amount paid by a vendor of a CGT asset to the purchaser to obtain the purchaser’s agreement to terminate the contract was included in the fifth element of the asset’s cost base and reduced cost base (ID 2008/147).
The fifth element of the cost base is capital expenditure that the taxpayer incurred to establish, preserve or defend the taxpayer's title to the asset or a right over the asset (sec 110-25(6) ITAA 1997). The Macquarie Dictionary defines "preserve" to include "4. to keep possession of; retain".
The expenditure was incurred so that the taxpayer could retain title to the CGT asset. It was the amount paid so that the potential purchaser would agree to termination of the contract, as opposed to enforcing the taxpayer's performance of the contract. The effect of termination was that the title to the CGT asset remained that of the taxpayer. Accordingly, the expenditure was included in the fifth element of the cost base and reduced cost base of the CGT asset.
Compulsory acquisition of part of residence
The Assistant Treasurer announced on 19 March 2009 that the CGT main residence exemption will be extended for compulsory acquisitions (and certain other involuntary events) relating to part of a taxpayer's main residence.
This will ensure that taxpayers do not pay CGT on compulsory acquisitions of part of their main residence and that taxpayers are not worse off as a result of a compulsory acquisition, compared to if the compulsory event had not occurred.
The changes are to apply to CGT events that happen after the date of Royal Assent. However, taxpayers will also have the option to apply the changes from the 2004-05 income year to the date of Royal Assent.
A Treasury consultation paper providing further information about the proposal has been released.
First home owner grant
An interpretative decision has been released which is to the effect that the first home owner grant is a recoupment for the purposes of the CGT cost base and reduced cost base provisions and, therefore, reduces the amount of the relevant element of the cost base or reduced cost base (ID 2008/157). Recoupment is defined to include a grant in respect of a loss or outgoing (sec 20-25 ITAA 1997).
No identity of ownership interest
In an AAT decision the trustee of a deceased estate was denied the CGT main residence exemption because the ownership interest disposed of by the trustee (a one-half interest in the dwelling) was not the same ownership interest of the deceased (a licence to occupy the dwelling owned by a company of which the deceased and his spouse were the sole shareholders) (Estate of Cawthen v FCT [2008] AATA 1168; 2008 ATC ¶10-069).
» Foreign residents - staggered sell down arrangements
A taxpayer alert has been issued in relation to certain "staggered sell down" arrangements designed to result in disregarded CGT where there is an indirect disposal of Australian real property under Div 855 ITAA 1997 (TA 2008/19).
The alert applies to arrangements having the following features:
- A foreign resident vendor will typically have an existing membership interest of 10% or greater in a resident entity whose assets consist principally of Australian real property.
- The foreign resident vendor enters into an arrangement to dispose of part of its interest, retaining just less than 10% of that interest under a sale agreement.
- The foreign resident vendor concurrently enters into an option agreement to dispose of the remaining interest at a later time.
- This is intended to ensure that the foreign resident vendor can argue that they do not maintain a 10% or more membership interest at both:
- the time of the second disposal, and
- throughout a 12 month period that began no earlier than 24 months before that time and ends no later than that time.
- Such structural planning may result in some CGT being circumvented despite the fact that overall, a greater than 10% interest was held and eventually disposed of by the foreign resident vendor.
