Capital Gains Tax in Australia
Capital gains tax refers to a type of tax levied on capital gains incurred by organizations or individuals. The capital gains refer to the profits that an organization or individual selling a capital asset obtains through selling an asset at a price higher than the original price. In many countries, the amount of capital gains tax takes into consideration the type of investment and the holding period of the asset. Australian capital gains tax takes a proportion of all achieved capital gains. Capital gains are not separate tax but part of the income tax on individuals and corporations upon disposing of capital assets. Australian capital gains tax exempts personal properties such as home, car, and furniture. Australian residents in any part of the world are subject to capital gains tax.
Issue 1. Moodly’s Conversion of her main residence.
Moodly being a childcare worker, wishes to convert part of her main residence for establishing a childcare centre. She acquired her main residence in 2005, so many years after the capital gains tax law passes in Australia. This means Moodly property was subject to capital gains tax during the time she acquired them. Special rules regarding taxation apply when an organization or individual is disposing properties in Australia (Pricewaterhouse Coopers, 2006). Moodly’s move to convert part of her main residence into a childcare subjects the property into capital gains taxation. This is because Moodly will make capital gains out of the property. According to OECD (2006), certain specific properties benefit from capital gains tax exemption. Otherwise, properties obtained after 1985 or properties that have undergone major changes and renovation are included in the capital gains tax bracket. It is from this fact that Moodly 25% conversion of the floor area of her main residence will face capital gains taxation. Under the ITAA 1997, (Paragraph 118-115 (1) (a)) the main residence is defined as a dwelling which a unit of accommodation that is a building of contained in a building. Capital gains tax laws in Australia exclude properties that worth less than $10,000. Moodly property worth more than the least amount that is not subject to tax and subject to capital gains taxation.
Personal use of a property does not attract capital gain tax, but using part of the property as a childcare center attracts capital gains taxation. According to subdivision 118-B of the ITAA 1997, once the conversion of a dwelling begins, the property is no longer considered to be a personal property for the purpose of the main residence. Australian capital gains tax law further limits the use of properties that cost less than $10,000 for personal use. If such properties fall under collectibles, the tax limit reduces to $500 unless an individual obtains them through bravery and valor. It is advisable for Moodly not to undertake the conversion of her main residence. 25% conversion of the floor area at $300,000 is uneconomical. Instead, Moodly should take advantage of the capital gains tax-free status she currently enjoys, sell the portion of the property and use the proceeds for a deposit in a new property. If the owner undertakes disposal of a part of the main residence, the individual will be entitled to a partial main residence tax exemption. Section (118-185 of the ITAA 1997) provides this. A new property that costs less or equal to $300,000 is economical than using the same amount for conversion of personal property. In order to continue to enjoy the capital gains tax-free main residence, Moodly should consider purchasing another property. OECD (2006) explains that, partial capital gains liability will arise if a taxpayer uses a property for business or other income-producing purposes. Future cash flow will not be enough to cater for tax deduction resulting from using part of her home for commercial services. Considering the implications from capital gains tax that will arise and the diminishing marginal value of the property, her transaction will not be sufficient to cover the costs for the extension.
Calculation layout: Cost of conversion $300,000
Selling a portion of the main residence: $500,000
Capital gains tax. 30% of $500,000= 150,000
50% discount by selling the property after 12 months. 50% of 150,000= 75,000.
Capital gains tax paid is 150,000-75,000= 75,000
Moodly capital gains. $500,000- 75,000= $425,000
Moodly makes capital gains in selling the portion of property rather than converting it at $300,000. Gains from selling compared to conversion is $425,000- $300,000= $125,000.
Issue 2. Property inheritance
The law requires that an individual dispose an inherited property 12 months from the time of acquiring it. According to the Australian government taxation office, disposal of inherited assets is subject to the normal rules and any capital gains an inheritor makes on disposal is subject to capital gains taxation. The law assumes that Moodly acquired the property on the day that her sister died. Section 128-15 (2) of the ITAA 1997 requires that the legal personal delegate or the beneficiary of a property is considered to have attained the property on the day the deceased dies. Moodly acquires the block land in March 1997. The law requires that property inherited after 1985 are subject to capital gains taxation. According to section 110-25 of the ITAA 1997 the payment of inheritance tax cannot be included as part of the cost base because it does not fall within any element of the cost base. In this regard, the first element of Moodly’s cost base and reduced cost base is taken to be her deceased sister’s cost base and reduced cost base of the asset on the day she died. Because Moodly’s sister died before 21 Septemeber 1999, the tax law requires that Moodly use the indexation method to work out the capital gains when disposing the block land. The indexation method requires indexing the first element of the cost base from the date Moodly’s sister acquired the block land. Special rules under section 118-195 ITAA 1997 requires that an inheritor to a property regardless of whether it is the main residence or not need to hold the property for 12 months from the date the deceased died. Abiding to these rules will enable an inheritor to obtain the 50% general CGT discount. According to Howarth (2009), gains on assets held for less than 12 months are not in the increased cost base or the 50% discount. Special rules for calculating the cost base are applicable in this case because Moodly inherited the block land after 20 August 1996. Determination of the acquisition cost that is the market value at the date of death is necessary.
The block land does not face diminishing returns and increases its value as time moves on. This implies that the inheritor will make capital gains upon disposing of the asset. Disposing the asset immediately after 12 months, results in a low incidental cost. At the same time, disposing it immediately means foregoing higher capital gains resulting from land appreciation over time. Section 118-195 (3) ITAA 1997 states that, any capital gains or capital loss the legal personal representative or inheritor makes when the asset passes to them, the law will disregard. Moodly as the beneficiary can include in the cost base of the land any expenditure that the legal personal representative to her deceased sister would have been able to include at the time the asset passes to her. Moodly can include the expenditure on the day the legal personal representative incurred it. In this case, Moodly sister died on 20 March 1997, this means that on 20 April 1997, legal personal representative pays $500 council rates for the land. A month later, the legal personal representative transfers it to Moodly whom the law will assume has acquired the property on 20 March 1997 (ITAA Act 1997 Section 128-15 (5)).
If moodly proceeds with the sale of the land in 14 June 2013, it will attract another incidental cost. The council rates for the land cater for incidental cost. Upon disposing of the property, Moodly will be subject to capital gains taxation. The capital gains implication of the property results from the gains the beneficiary will make when disposing the property at a higher at a price higher than the original cost. Incidental cost charges take place when a property changes ownership. Apart from capital gains tax, Moodly will incur the incidental charge when handing over ownership of the block land in the estate to a new owner.
Calculation layout: Initial cost of land $14,000
At the point of death Cost of land $32,000
32,000-14000= 18,000
Appreciation per year. 18,000/5 = $3,600
At the point of sale. Cost of land $450,000.
Appreciation per year. 450,000- 32,000= 418,000
418,000/16= $26,125
The land appreciates at a higher rate than before the death of her sister. Selling the land at $450,000 enables Moodly to make capital gains.
Issue 3. Disposing an inherited gift painting.
Inheriting the painting from a friend gives capital gains to Moodly. When Moodly wants to sell off the painting at a higher cost than the original cost, she makes capital gains. The painting is as a lifetime gift and the idea to sell it is a disposal in the open market for capital gains (ITAA 1997, section 116-30). According to the Australian tax system, the gift provides capital gains to the inheritor upon disposing it. It is subject to capital gains taxation when Moodly decides to sell it off to the art collector before midnight 29 June 2013. Personal gifts such as the painting are non-taxable since they are on a personal basis and not from a taxable source. According to Ault and Arnold (2010), the Australian laws treat gifts and bequest of appreciated properties differently. The taxation law treats gifts as realization events whereas transfer of property at death results in the carryover of tax costs. A gain in the sale of such gifts will be taxable. The law specifies a number of gifts that benefit from capital gains tax deductions. Properties that cost more than $5,000 and those that bought during the 12 months before a gift is made are eligible for tax deduction. Tax laws further provide a specific characteristic that a property must portray to qualify as a gift. Division 30 of the ITAA1997 provides these characteristics such as there must be a transfer of beneficial interest in property. For a property to be a gift, these transfers must also be voluntarily and arises by way of benefaction.
Benefaction in gifts relates to the essence that the receiver obtains an advantage in a material sense to the extent that the property extends to them. It also considers the fact that there are no countervailing detriments that arises from the terms of the transfer. Moodly painting from her friend qualifies to be a gift, and it costs more than $5,000 as the law specifies. Selling off the painting to an art collector attracts capital gains taxation. In the same notion, the property is subject to a tax deduction because it qualifies for the tax deduction provisions. The rate of appreciation of the painting is higher than on the death of her friend. The gift is chargeable to inheritance tax (IHT). This is because the donor within seven years from the time of the donation of the gift. According to (section 3 IHTA, 1984) the donor is charged on a transfer of value and the transfer of value is analyzed as the loss to the donor’s estate. The deceased friend’s state reduces by an amount equivalent to the capital gains and the value of the gift. On rare occasions, the receiver pays the capital gains instead of the donor. If it happens that, the receiver pays the capital gains, the law provides for deductions of capital gains from the value transferred for the purposes of determining the loss to the donor’s estate. Section 165 (1) IHTA 1984 gives two provisions relating to the capital gains charged on gifts. The whole or part of the capital gain from a gift is a chargeable gain and part or the whole of the income tax chargeable on the gain is bone by the receiver. It is beneficial for Moodly to sell the property to the art collector before 29 June 2013 midnight.
Calculation layout;
Initial cost of the painting: $13,200
Cost of the painting at death. $23,000
Rate of appreciation of the painting. 23,000- 13200= 9,800
9,800/10 = 980 per year
Current cost of the painting. $54,000.
Appreciation rate. 54,000- 23,000= 31,000
31,000/2= $15,500 per year.
Moodly will make capital gains from the sale of the painting because the painting has a high market value. It is also subject to capital gains taxation
Section 4. Selling of shares
Selling of shares at a price higher than the initial market price attracts capital gains taxation. According to the Australian government tax office, consideration on the date of acquisition and disposal of shares, the cost of shares, brokerage cost, and the cost of shares are important. Capital gains or losses from disposing shares are not in this bracket since the testamentary gift of possessions would be deductible to the dead as explained under section 30-15 of the ITAA 1997. Transferring of shares from her aunt triggers capital gains taxation. The laws require capital gains tax is payable on capital gains on disposal of shares obtained after 1985. According to section 115-45 of the ITAA1997 there are no capital gains on sells of shares held for a period of less than 12 months. For a discount capital gain to take place, it must meet the requirements of (section 115-5 of the ITAA1997). One of the requirements is that the capital gain must arise from a capital gain tax event obtained 12 months before the capital gain tax event. Disposal of the inherited shares at a higher market price results in capital gains. The capital gains are subject to capital gains transaction. Section 115-5 of the ITAA 1997 also requires that if acquiring of shares is because of asset replacement, there are special rules, which treat it as being acquired at the time the original shares were acquired. Based on subsection 115-45 (6) of the ITAA 1997, capital gains on disposal of shares takes place if the notional capital gain of a company is more than half the notional net capital gains which is specified under subsection 115-45 (7) of the ITAA 1997 (subsection 115-45 (5) of the ITAA 1997). To calculate the capital gains tax for individuals requires the use of any of the four methods available. A method chosen will have the implication of affecting the handling of capital losses. A suitable method involves calculation of the cost base for each part of the assets, which is the cost of the shares and brokerage fee. In relation to the above provisions and specifications, that the tax laws provide, Moodly sell of the shares will result in capital gains taxation and brokerage fee of $350. Moodly receives the shares prior to 21 September 1999. The implication of this is that, the calculation of the capital gains requires an application of the indexation method, which provides a 50% discount. The method works out better and results in less tax payment.
Calculation layout: Initial cost of the shares. $1.20 each. 20,000 shares equals $24,000
At the point of her aunt’s death. Cost of shares. $2.35 each. 20,000 shares equals $47,000
Gains per year. 47,000- 24,000= 23,000
23,000/8= $2,875
Current cost of the shares. $3.35 each. 20,000 shares equals $67,000
Market gains at the current point of sale. 67,000- 47,000= $20,000
Gains per year. $20,000/15= $1,333.33.
The market gains for the shares have reduced. If moodly decides to sell the shares in 2013, she will make a loss because of low capital gains. Although the cost of shares is high in 2013, there a low gains compared to 1997.
Conclusion
The Australian tax system is systematic and provides specific clauses for different subjects that require taxation. The tax system enables the government to obtain revenues through capital gains on the sale or transfer of ownership of various properties. The tax system prevents individuals and organizations from escaping to pay taxes or benefiting from a misfortune such as the death of a family member. Taxes help reduce consumption of harmful products and help to increase consumption of certain products that benefit the Australian society and state. According to Cocks (1999), the Australian system works to permit a zero tax on necessities and a high tax on luxuries, products that are highly polluting and goods endangering public health. The tax system can also work to encourage or discourage investment in certain sectors of the economy. The authority can easily do this by increasing taxation in the selling of shares that generate capital for such investment. According to a study conducted by Dollery, Crase & Ohnson (2006) the taxes help local authorities raise funds to cater for local level development. The per head taxation also help to cover the cost of provision of a given public good.
References
OECD Tax policy studies. 2006. Taxation of Capital Gains of Individuals: Policy
Considerations and Approaches. No.14. Paris: OECD Publishing.
Pricewaterhouse Coopers. 2006. Mergers and acquisition: A global Tax Guide. New Jersey:
John Wiley and Sons Inc.
Income Statement Assessment Act 1997 (NSW) s 118-195
Howarth, C. (2009). International Mater Tax Guide. 6th edition. Australia: MC Pherson’s
Printing Group.
Effect on the Legal personal Representative or Beneficiary 1997 (CCA) s 128-15 (2)
Income Statement Assessment 1997 (NSW) s116-30
Effect on the Legal personal representative or Beneficiary 1997 (CCA) s 128-15 (5)
Income Tax Statement Assessment Act 1997 (NSW) s 30 (13).
Inheritance tax Act 1984 ( IHTA 1984) s (3A).
Inheritance tax Act 1984 (IHTA 1984) s 165 (1).
Income Tax Assessment Act 1997 (NSW) s 115-45 (7)
Income Tax Assessment Act 1997 (NSW) s 115-45 (5)
Income Tax Assessment Act 1997 (NSW) s 110-25
Income Statement Assessment Act 1997 (NSW) 115-25 (1)
Income Tax Assessment Act 1997 (NSW) s 115-45
Income Tax Assessment Act 1997 (NSW) s 115-5.
Income Tax Assessment Act 1997 (NSW) s 115-45 (6)
Income Tax Assessment Act 1997 (NSW) paragraph 118-115 (1) (a)
Income Tax Assessment Act 1997 (NSW) s 118-B
Income Tax Assessment Act 1997 (NSW) s 118-145
Income Tax Assessment 1997 (NSW) s 118-185
Income Tax Assessment 1997 (NSW) s 30-15
Cocks, D.K. 1999. Future makers, Future Takers: Life in Australia, 2050. Sydney: University of New South Wales.
Ault, J.H & Arnold, J.B. (2010). Comparative Income taxation: A structural Analysis. New York: Kluwer law International.
Dollery, B., Crase, L & Ohnson, A. (2006). Australian Local Government Economics. Sydney:
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