• Capital assets and the 12 month rule

    Special rules apply to some short-term transactions if capital gains tax (CGT) and depreciating assets are acquired or disposed of, unless an election is made that these rules not apply. These special rules are an exception to the operation of the general rules that apply when foreign exchange (forex) realisation events 1 to 5 occur. Broadly, they provide that if these sort of assets are acquired or disposed of, and the time between the acquisition or disposal and the due date for payment is not more than 12 months, any forex realisation gains and losses realised in the course of acquiring or disposing of the relevant asset are integrated into the tax treatment of the underlying asset, instead of being treated as a separate revenue item.

    For depreciating assets, if the time between the asset beginning to be held and the due date for payment is not more than 12 months, forex realisation gains and losses on payments made not more than 12 months before or 12 months after the date the asset began to be held are integrated into the tax treatment of the depreciating asset.

    If you choose the Election out of the 12 month rule, this exception does not apply and the general rules will apply.

    If you make a forex realisation gain and the 12 month rule applies, the effects will most commonly be as follows:

    • If you dispose of a CGT asset (other than a depreciating asset), the forex gain is not assessable as revenue under the forex measures, but is assessed as a non-discountable capital gain.
    • If you have acquired a CGT asset (other than a depreciating asset), the forex gain is not generally assessable under these measures, but reduces the cost base or reduced cost base of the asset.
    • If you have acquired a depreciating asset, the forex gain is not assessable under these measures, but reduces the cost of the asset. If the asset has begun to depreciate under the capital allowance provisions, the gain will reduce the adjustable value of the asset, or the opening value of the pool in which the asset resides.

    In general, if the forex realisation gain on acquisition is more than the cost or opening adjustable value or the relevant opening pool balance, the excess is included in your assessable income under these measures.

    If you make a forex realisation loss and the 12 month rule applies, the effects will most commonly be as follows:

    • If you dispose of a CGT asset (other than a depreciating asset), the forex loss is not deductible under these measures, but is treated as a capital loss.
    • If you have acquired a CGT asset (other than a depreciating asset), the forex loss is not deductible under these measures, but increases the cost base of the asset.
    • If you have acquired a depreciating asset, the forex loss is not deductible under these measures, but will increase the cost of the asset. If the asset has begun to depreciate pursuant to the capital allowance provisions, the loss will increase the adjustable value of the asset, or the opening value of the pool in which the asset resides.

    The 12 month rule does not apply if you have disposed of a depreciating asset.

    See also:

    Forex acquisition of a CGT asset

    An investor acquires a capital gains tax (CGT) asset.

    Example

    On 1 August 2003, Art Ltd purchases a painting for US$500,000. The exchange rate on this date is A$1.00 = US$0.50.

    Art Ltd pays for the painting on 1 June 2004. The exchange rate at this time is A$1.00 = US$0.80.

    Art Ltd does not make an election out of the 12 month rule; therefore, the 12 month rule will apply.

    When will the foreign exchange realisation gain or loss arise?

    Art Ltd will make a foreign exchange (forex) realisation gain of A$375,000 when it pays for the painting on 1 June 2004.

    For the calculation of Art Ltd’s forex realisation gain, refer to Acquisition of a CGT asset (election out of 12 month rule).

    End of example

    How should the forex realisation gain or loss be assessed?

    As Art Ltd pays for the painting within 12 months of acquiring it, the forex realisation gain reduces the cost base of the painting by an amount equal to the gain.

    The 12 month rule generally requires that forex realisation gains and losses on the acquisition or disposal of capital assets be folded into the CGT treatment of the underlying assets, if the time between that acquisition or disposal and the due time for payment is not more than 12 months.

    Most taxpayers had a choice to elect out of the 12 month rule by 16 January 2004. The effect of such an election is that forex realisation gains will be included in assessable income and forex realisation losses will be allowable as a deduction.

    Art Ltd has not made an election out of the 12 month rule.

    If Art Ltd pays for the painting within 12 months of acquiring the painting, any forex realisation gain or loss is not treated as assessable income or an allowable deduction. Rather, it is effectively captured under the CGT provisions.

    Art Ltd acquires the painting on 1 August 2003. It pays for the painting on 1 June 2004. As the period between acquisition of the painting and payment is less than 12 months, the forex realisation gain of A$375,000 is not assessable income for Art Ltd.

    Instead, the cost base of the painting is reduced by this amount – subsection 775–70(1) Item 2. Any capital gain or loss on a subsequent disposal of the painting will then be calculated from this reduced cost base.

    Disposal price of CGT asset denominated in foreign currency

    An investor disposes of foreign shares.

    This example does not discuss the capital gains tax (CGT) consequences of the disposal of the shares.

    Example

    Eleanor acquired shares in January 2003. She disposes of her US shares for US$1,200 on 1 July 2005 when the exchange rate is A$1.00 = US$0.50.

    Eleanor receives payment on settlement on 1 August 2005 when the exchange rate is A$1.00 = US$0.60.

    Eleanor has not previously made an election out of the 12 month rule; therefore, the 12 month rule will apply.

    End of example

    When will the foreign exchange realisation gain or loss arise?

    Eleanor will make a forex realisation loss of A$400 when she receives payment on 1 August 2005.

    What are the consequences of any forex realisation gain or loss?

    As Eleanor receives payment within 12 months of disposal of the shares, the forex realisation loss will be a capital loss for the purposes of the CGT provisions.

    The 12 month rule, as it applies to the above facts, requires that any forex realisation gain or loss on the disposal of the capital assets be dealt with under the CGT provisions because the time between that disposal and the due time for payment is not more than 12 months.

    Most taxpayers had a choice to elect out of the 12 month rule by 16 January 2004. The effect of this election is that forex realisation gains will be included in assessable income and forex realisation losses will be allowable as a deduction. Eleanor has not previously made an election out of the 12 month rule.

    If the disposal proceeds became due for payment within 12 months of the disposal of the shares, any forex realisation gain or loss is not treated as assessable income or an allowable deduction. Rather, it is dealt with under the CGT provisions.

    Eleanor disposes of the shares on 1 July 2005. She receives the disposal proceeds on 1 August 2005. As the period between disposal of the shares and receipt of the payment is less than 12 months, the forex realisation loss of A$400 is not an allowable deduction. Rather, it is a capital loss – subsection 775-75(1) Item 1 and section 104-265 CGT event K11.

    Last modified: 01 Mar 2016QC 17062