Many people decide to exercise their rights or options to acquire new shares or units rather than sell them. In most cases, no CGT is payable at the time you exercise the rights or options.
The acquisition date of the shares or units is the date of exercise of the rights or options to acquire the shares or units.
If you exercise the rights or options on or after 20 September 1985, some special rules apply for calculating the cost base and reduced cost base of shares or units acquired as a result. Exercising the option or right may be subject to the foreign resident capital gains withholding, regardless of when the option or right was originally acquired. For more information, see What’s new.
The rules outlined below do not apply to rights or options to acquire shares under an employee share scheme.
Rights or options issued directly to you for no cost from a company or trust in which you are a shareholder or unit holder
The amount included in the cost base and reduced cost base of the shares or units you acquire on exercise of the rights or options depends on when you acquired your original shares or units. The following rules do not apply to rights or options to acquire units issued before 29 January 1988.
Original shares or units acquired before 20 September 1985
The first element of the cost base and reduced cost base for the shares or units you acquire on exercising your rights or options is:
- the market value of the rights or options at the time you exercised them, plus
- the amount you paid to exercise the rights or options, plus
- any amount that was included in your assessable income as a result of you exercising your rights or options on or after 1 July 2001.
Original shares or units acquired on or after 20 September 1985
The first element of the cost base and reduced cost base for the shares or units you acquire on exercising your rights or options is:
- the cost base of the rights or options at the time you exercised them, plus
- the amount you paid to exercise the rights or options (except to the extent that the amount is represented in the cost base of the rights or options at the time of exercise), plus
- any amount that was included in your assessable income as a result of you exercising your rights or options on or after 1 July 2001.
Flowchart 3.3 in appendix 3 summarises the rules relating to the treatment of such options and rights.
Rights or options you acquired from an individual or entity that received them as a shareholder in the company or as a unit holder in the trust
The amount included in the cost base and reduced cost base of the shares or units you acquire depends on when you acquired your rights or options. The following rules do not apply to rights or options to acquire units issued before 29 January 1988.
Rights or options acquired before 20 September 1985
If the rights or options were exercised on or after 20 September 1985, the first element of the cost base and reduced cost base for the shares is:
- the market value of the rights or options at the time you exercised them plus
- the amount you paid to exercise the rights or options plus
- any amount that was included in your assessable income as a result of you exercising your rights or options on or after 1 July 2001.
Rights or options acquired on or after 20 September 1985
The first element of the cost base and reduced cost base for the shares or units you acquire on exercising your rights or options is:
- the cost base for the rights or options (including any amount you paid for them) plus
- the amount you paid for the shares or units on exercising the rights or options (except to the extent that the amount is represented in the cost base of the rights or options at the time of exercise) plus
- any amount that was included in your assessable income as a result of you exercising your rights or options on or after 1 July 2001.
Flowchart 3.4 in appendix 3 summarises the rules relating to the treatment of such options and rights.
Rights or options you paid for that were issued directly to you from the company or trust or that you acquired from an individual or entity that was not a shareholder or unit holder
For rights or options to acquire units, these rules apply to rights or options exercised on or after 27 May 2005.
The amount included in the cost base and reduced cost base of the shares or units you acquire depends on when you acquired your rights or options.
Rights or options acquired before 20 September 1985
This includes rights or options last renewed or extended after that date if they were exercised before 27 May 2005.
If the rights or options were exercised on or after 20 September 1985 the first element of the cost base and reduced cost base for the shares or units is:
- the market value of the rights or options at the time you exercised them, plus
- the amount you paid for the shares or units on exercising the rights or options.
Rights or options acquired on or after 20 September 1985
This includes rights or options you acquired before 20 September 1985 which were last renewed or extended after that date and were exercised before 27 May 2005.
The first element of the cost base and reduced cost base for the shares or units you acquire on exercising your rights or options is:
- the amount you paid for the rights or options, plus
- the amount you paid for the shares or units on exercising the rights or options.
Flowchart 3.5 in appendix 3 summarises the rules relating to the treatment of such options and rights.
Example 39: Sale of rights
Shanti owns 2,000 shares in ZAC Ltd. She bought 1,000 shares on 1 June 1985 and 1,000 shares on 1 December 1996.
On 1 July 1998, ZAC Ltd granted each of its shareholders one right for each four shares owned to acquire shares in the company for $1.80 each. Shanti therefore received 500 rights in total. At that time, shares in ZAC Ltd were worth $2. Each right was therefore worth 20 cents.
Shanti decided that she did not wish to buy any more shares in ZAC Ltd, so she sold all her rights for 20 cents each, a total amount of $100. Only those rights issued for the shares she bought on 1 December 1996 are subject to CGT. As Shanti did not pay anything for the rights, she has made a $50 taxable capital gain on their sale.
The $50 Shanti received on the sale of her rights for the shares she bought on 1 June 1985 is not subject to CGT, as those rights are taken to have been acquired at the same time as the shares, that is, before 20 September 1985.
End of example
Example 40: Rights exercised
Assume that, in example 39, Shanti wished to acquire more shares in ZAC Ltd. She therefore exercised all 500 rights on 1 August 1998 when they were still worth 20 cents each.
There are no CGT consequences arising from the exercise of the rights.
However, the 500 shares Shanti acquired on 1 August 1998 when she exercised the rights are subject to CGT and are acquired at the time of the exercise.
- When Shanti exercised the rights issued for the shares she bought on 1 December 1996, the cost base of the 250 shares she acquired is the amount she paid to exercise each right ($1.80 for each share).
- When Shanti exercised the rights for the shares she bought before 20 September 1985, Shanti’s cost base for each of the 250 shares she acquired includes not only the exercise price of the right ($1.80) but also the market value of the right at that time (20 cents). The cost base of each share is therefore $2.
CGT discount on shares or units acquired from exercise of rights or options
You can only use the discount method to calculate your capital gain from an asset if you own it for at least 12 months. In calculating any capital gain on shares or units you acquire from the exercise of a right or option, the 12-month period applies from the date you acquire the shares or units (not the date you acquired the right or option).
Retail premiums
Some or all of a payment may be a retail premium if you receive it because:
- you did not exercise some or all of your right or entitlement, either by choice or otherwise
- you were not eligible to exercise some or all of your right or entitlement
- you did not receive some or all of your right or entitlement.
You receive a retail premium if:
- a company you own shares in offers shareholders a right or entitlement to subscribe for additional shares in proportion to their existing shareholding at a set amount, often called 'the offer price'.
- you do not participate; that is, one of the following applies
- you choose not to take up some or all of your right or entitlement
- you are ineligible to receive some or all of a right or entitlement
- you are not permitted to take up some or all of your right or entitlement.
- the company that issued the right or entitlement arranges to issue a number of shares, equivalent to those which would have been issued to you had you exercised the right or entitlement for which you did not participate, to other subscribers such as institutional investors. The amount offered by the subscribers for the equivalent shares is often called 'the clearing price'.
- the clearing price is the basis of a payment to you, generally because it is more than the offer price.
The retail premium will be the amount paid to you, generally worked out on a pro rata basis by the company because you are a shareholder or unit holder and you do not participate. The retail premium the company pays will generally be a share of all or part of the difference between the clearing price of the shares and the offer price.
Retail premiums are unfranked dividends, or alternatively ordinary income, and should not be treated as capital gains. Shareholders who receive the premiums are not eligible to claim the CGT discount.
For more information, see Taxing retail premiums.
Convertible notes
A convertible note (which is one type of convertible interest) is another type of investment you can make in a company or unit trust. A convertible note earns interest on the amount you pay to acquire the note until the note’s expiry date. On expiry of the note, you can either ask for the return of the money paid or convert the note to new shares or units.
Convertible notes you acquired after 10 May 1989 will generally not be subject to CGT if you sold or disposed of them before they were converted into shares. Instead, you include any gain you make on your tax return as ordinary income and any loss you make is included as a deduction.
If the TOFA rules apply to you, gains and losses from your convertible notes may be brought to account under those TOFA rules. For more information about the TOFA rules, see Guide to the taxation of financial arrangements (TOFA).
For more information, see You and your shares 2017.
If you have sold or disposed of a convertible note that you acquired before 11 May 1989, phone us on 13 28 66. When you phone, have the date you acquired the convertible note as this may affect the tax treatment.
Conversion of notes to shares
The tax treatment that applies when your convertible notes are converted to shares depends on when you acquired the convertible notes, the type of convertible note, when the conversion occurred and when the convertible note was issued.
Shares acquired by the conversion of convertible notes on or after 20 September 1985 will be subject to CGT when they are sold or disposed of as the shares are taken to be acquired when the conversion happens.
You may have acquired the convertible notes on or after 20 September 1985 and, as a traditional security or qualifying security, you have already included the gain you made on the conversion of the notes on your tax return as income (or as a deduction if you made a loss). The way you calculate the cost base of the shares varies depending on whether the notes converted to shares before 1 July 2001 or on or after that date. Table 4 provides a summary.
Convertible notes issued after 14 May 2002
If your convertible notes are traditional securities and were issued by a company after 14 May 2002:
- any gains you make when these notes are converted or exchanged for ordinary shares in a company will not be ordinary income at the time of conversion or exchange, and any losses you make will not be deductible
- instead, any gains or losses you make on the later sale or disposal of the shares (incorporating any gain or loss that would have been made on the conversion or exchange of the notes) will be:
- subject to CGT if you are an ordinary investor, or
- ordinary income (or deductible, in the case of a loss) if you are in the business of trading in shares and other securities.
If you are an individual who is an ordinary investor, this means you will be able to get the benefit of the CGT discount if you own the shares for more than 12 months.
Table 4 sets out how you calculate the cost base.
Convertible note |
Converted before 1 July 2001 |
Converted on or after 1 July 2001 |
|---|---|---|
The note is a traditional security* that was issued before 15 May 2002. |
You include gain on conversion as income (or loss on conversion is deducted). Cost base of shares includes their market value at the date the convertible notes were converted. |
You include gain on conversion as income (or loss on conversion is deducted). Cost base of shares includes cost base of the convertible note, any amount paid on conversion and any amount included in your assessable income on conversion. |
The note is a traditional security* that was issued after 14 May 2002. |
Not applicable |
You disregard gain (or loss) on conversion. Cost base of shares includes cost base of the convertible note and any amount paid on conversion. |
The note is a qualifying security** |
You include accrued gains as income and include any gain on conversion as income (or deduct any loss on conversion). Cost base of shares includes amounts paid to acquire the note and any amount paid on conversion. |
You include accrued gains as income and include any gain on conversion as income (or deduct any loss on conversion). Cost base of shares includes cost base of the convertible note, any amount paid on conversion and any amount included in your assessable income on conversion. |
*A traditional security is one that is not issued at a discount of more than 1.5%, does not bear deferred interest and is not capital indexed. It may be, for example, a bond, a deposit with a financial institution, or a secured or unsecured loan.
**A qualifying security is one that has a deferred income element, that is, it is issued under terms such that the investor’s return on investment (other than periodic interest) will be greater than 1.5% per annum.
Conversion of notes to units
Convertible notes, converted before 1 July 2001
If your convertible notes are traditional securities, the first element of the cost base and reduced cost base of the units is their market value at the time of conversion. You disregard any capital gain or capital loss made on their conversion to units in the unit trust.
If your convertible notes are not traditional securities and were issued by the unit trust after 28 January 1988, the first element of the cost base and reduced cost base of the units includes both the cost of the convertible notes and any further amount payable on their conversion. You disregard any capital gain or capital loss made on their conversion to units in the unit trust.
Convertible notes, converted after 1 July 2001
If your convertible notes are traditional securities the first element of the cost base and reduced cost base of the units includes:
- the cost base of the convertible notes, plus
- any amount paid on conversion, plus
- any amount included in your assessable income on conversion.
You disregard any capital gain or capital loss made on their conversion to units in the unit trust.
Similarly, if the convertible notes are not traditional securities and were issued by the unit trust after 28 January 1988, the first element of the cost base and reduced cost base of the units includes:
- the cost base of the convertible notes, plus
- any amount paid on conversion, plus
- any amount included in your assessable income on conversion.
You disregard any capital gain or capital loss made on their conversion to units in the unit trust.
Example 41: Converting notes to shares
David bought 1,000 convertible notes in DCS Ltd on 1 July 1997 (that is, notes that were issued before 15 May 2002). The notes cost $5 each. Each convertible note is convertible into one DCS Ltd share. On expiry of the notes on 1 July 2000, shares in the company were worth $7 each. David converted the notes to shares, which are subject to CGT. No further amount was payable on conversion of the notes. David sold the shares on 4 December 2016 for $10 each.
The $2 ($7 − $5) gain David made on the conversion of each of the notes to shares was assessable to David as ordinary income at the time of conversion, that is, in the 2000–01 income year. As such, David has no capital gain in that year.
The $3 ($10 − $7) gain David made on the sale of each of the shares is subject to CGT. The $7 cost base is the market value per share on the date the notes converted to shares. Because he sold the shares after 11.45am (by legal time in the ACT) on 21 September 1999 and owned them for at least 12 months, David can claim the CGT discount. David calculates his capital gain as follows:
$3 per share × 1,000 shares = $3,000
less CGT discount of 50% = $1,500
Net capital gain = $1,500
David includes the capital gain on his 2017 tax return.
End of example