Capital Gains Tax

Capital gains tax (“CGT”) has been a part of the tax landscape for over 30 years now and despite its long history still presents challenging issues.

Often, those issues present themselves not on the question whether a CGT event has occurred on which tax may be payable, but on the question of whether concessions to reduce that tax are available.

Within the CGT rules, there are a multitude of rollovers and concessions which, if the circumstances so permit, can be used to minimise or defer until a later date tax payable on an event. Some of those concessions can be used to remove the tax altogether.

Perhaps the most commonly sought concessions are the general discount rule and the small business concessions.

Access to the general discount rule is relatively straightforward; if a CGT asset owned for more than 12 months is disposed of, the gain may be reduced by a discount factor of 50%. Companies are not entitled to use the discount, but resident individuals and trusts can. Superannuation funds can also use the discount rule, but the rate of discount is 33.3%.

Of course, there are a multitude of rules that apply in relation to the discount concession, but the broad outcome is that the discount amount is free from tax.

Individuals and trusts may also be able to access the small business concessions which can operate to further reduce a capital gain subject to tax. Should these concessions be available, it can sometimes be possible to reduce the taxable gain to nil. Companies may also be able to access the small business concessions to reduce the amount of a taxable gain.

Because of the exceptionally tax favourable nature of the small business concessions, the Taxation Office understandably questions the proper application of the complex rules to a high degree. Most commonly, enquiries by the Taxation Office are targeted at two threshold, but very important, issues; they are, firstly, whether the asset disposed of is an “active” (and not “passive”) asset, and secondly whether the “net values” of the seller’s (and relevant associated entities’) assets does not exceed $6 million.

 

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Working out which, and whose, assets have to be counted as part of the “net value” test is often a challenge, as is determining the market value of those assets.

And sometimes the question might be, does the asset exist at all?

Such a question arose in a recent Federal Court decision in relation to a loan which had been made some years ago to the taxpayer, a beneficiary of a trust. In this case, the taxpayer argued that because the trust’s loan was made so long ago, the loan was statute-barred under relevant state law and therefore had no value. It could not, therefore, be included in the $6 million net asset test.

Unfortunately for the taxpayer, he lost the argument on technical grounds as to how the state law applied. What the case does highlight, however, is that because each state has different statute of limitations laws, the CGT outcome may differ depending on the relevant jurisdiction.

Also, the case highlights that certain actions on the part of the lender or borrower may, and some may not, operate to “refresh” an old loan so that it could not be regarded as having no value.

CGT, and its concessional rules is a complex area of twists and turns, even more so when state law has a relevant bearing on the question. No wonder the Taxation Office scrutinises its operation with such a high degree of attention.

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