Explanatory Memorandum
(Circulated by authority of the Treasurer. the Hon. P.J. Keating, M.P.)MAIN FEATURES
The main features of the Bills are described below:
Income Tax Assessment Amendment (Capital Gains) Bill 1986
This Bill provides for the introduction, with effect from 20 September 1985, of a tax on capital gains which, basically, will apply to assets acquired on or after 20 September 1985.
The broad scheme is that capital gains made upon the realisation of assets will be included in assessable income and subject to income tax. In determining whether a gain has been made on the disposal of an asset that has been held for at least 12 months the asset's cost base will be adjusted for inflation by reference to the Consumer Price Index. Therefore, only gains in excess of the inflation rate on assets whose value increases at greater than the inflation rate will be subject to tax. If, upon its disposal, an asset has increased in value at a rate equal to or less than the inflation rate, there will be no taxable gain. Assets disposed of within 12 months of acquisition will be subject to the tax on capital gains if disposed of for more than the asset's unindexed cost base.
Residents of Australia will be liable for the tax on gains on the disposal of assets wherever situated, subject to relief from double taxation if the gain is taxed in the country where it is derived. Non-residents will be liable for tax on gains on the disposal of taxable "Australian assets", as defined in the Bill. Broadly, the term includes land or interests in land situated in Australia, assets used in an Australian business, shares in Australian private companies, partnerships and trusts, and share holdings of 10% or more in the issued capital of Australian public companies.
Capital losses (to be calculated without taking into account any indexation adjustments for inflation) realised in an income year will be available to be offset against capital gains realised in the same year or may be carried forward without time limit and offset against capital gains realised in subsequent years. However, losses on personal-use assets, i.e., assets that are used or kept primarily for the personal use and enjoyment of a taxpayer or a taxpayer's associates, except for specified kinds of personal-use assets, will not be so deductible. Losses on the specified classes of personal-use assets (referred to as "listed personal-use assets") will be deductible only against realised gains on other listed personal-use assets. Ordinary income tax deductible losses will also be able to be offset against realised capital gains. An exception is losses on negatively geared rental property investments for which special rules for the quarantining of deductions are to apply under measures contained in the Taxation Laws Amendment Bill 1986. Negative gearing losses will be allowed to be offset against any realised capital gains from the relevant rental properties.
Capital expenditures associated with the acquisition, improvement or disposal of an asset will generally be taken into account in calculating the cost base of the asset. However, income tax deductible expenses such as repairs of a revenue nature, and interest payments (whether for business or non-business purposes), will not form part of an asset's cost base. Costs of acquisition and disposal, such as legal fees, stamp duty, agent's commission and, in some cases, certain valuation costs, will form part of an asset's cost base to the extent that such costs are not deductible under another provision of the Income Tax Assessment Act 1936. However. capital expenditure on the acquisition of assets such as:
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- plant and equipment which attract depreciation allowances or other income tax deductions together with balancing adjustments on sale;
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- income-producing buildings which attract income tax deductions but no balancing adjustment on sale; and
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- shares in licensed management and investment companies,
For the purposes of calculating capital losses on such assets, losses allowed or allowable for income tax purposes will not also be taken into account for capital gains purposes. For example, losses on the sale of depreciable property, deductible as depreciation or balancing adjustments will not be allowed as capital losses.
The Bill contains rules to determine whether assets were acquired on or after 20 September 1985, and so within the scope of the tax, or were acquired before that date so as not to be within the proposed provisions. For example, where assets are acquired under a contract, the time of acquisition will be the time of the making of the contract. That is, if a person has acquired an asset under a legally binding contract entered into before 20 September 1985, the asset will not be within the scope of the tax even if possession is taken on or after that date. Where a person constructs an asset (otherwise than for another person), the date of acquisition will be taken to be when construction commenced.
Bodies which are currently exempt from tax on income will also be exempt from tax on capital gains. The tax on capital gains will also not apply on the disposal of certain assets even where those assets are acquired on or after 20 September 1985. These assets include:
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- a taxpayer's sole or principal residence (and reasonable curtilage);
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- proceeds from superannuation and life insurance policies, except where the taxpayer is not the original beneficial owner and acquired the right to the proceeds for an amount of money or other consideration;
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- gains on certain kinds of motor vehicles;
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- a personal-use asset (other than of a "listed" kind) whose disposal value is $5,000 or less; and
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- decorations awarded for valour or brave conduct where the taxpayer did not acquire the decoration for valuable consideration.
Other particular features forming the basis for the operation of the tax on capital gains are described below.
The death of an asset's owner will generally not be treated as a disposal of the asset. Tax on capital gains will not be determined following the death of a taxpayer until the relevant assets are disposed of by the legal personal representative or the beneficiary, as the case may be. When that occurs the legal personal representative or beneficiary will be taken to have acquired the asset at the date of death.
Thus, where the deceased died before 2O September 1985, the legal personal representative or beneficiary will be taken to have acquired the assets of the deceased before 20 September 1985, including situations where the estate is finalised after that date. A subsequent disposal of such assets by the representative or beneficiary will not give rise to a tax on any capital gains.
Where the asset owner died on or after 20 September 1985 and the asset was acquired by the asset owner before that date, the asset will be deemed to be acquired by the legal personal representative or beneficiary at the asset's market value at the date of death. In this way no tax will be payable on any gain accrued up to the date of death. Where the asset was acquired by the deceased on or after 20 September 1985, the legal personal representative or beneficiary will be taken to have acquired the asset on the date of death at the asset's relevant cost base and no capital gain or loss may be taken into account until the asset is subsequently disposed of by the personal representative or the beneficiary.
The existing income tax law distinguishes between assessable and non-assessable bonus shares. For capital gains purposes, all bonus shares will be deemed to have been acquired on the date of acquisition of the shares to which the bonus shares relate. This will mean that the capital gains provisions will not apply to bonus shares issued in respect of shares acquired by the recipient before 20 September 1985. The acquisition cost of bonus shares will be calculated as they are for purposes of the existing income tax provisions.
For share rights and share options acquired for no consideration as a result of an existing shareholding, the date of acquisition for capital gains purposes will be taken as the acquisition date of the primary shares. Where such rights or options are exercised by the shareholder the date of acquisition of the resulting new shares will be the date of exercise. Where the rights or options were, or were deemed to have been, acquired before 20 September 1985, the cost of the new shares will be taken to be the market value of the right or option at the time of exercise plus any amount paid on exercise.
Where the rights or options were acquired on or after 20 September 1985 the deemed acquisition cost of the shares will be the amount paid on exercise. For share rights or share options that are purchased, similar rules to the above will apply, but for shares acquired by the exercise of rights or options that are purchased on or after 20 September 1985, the acquisition cost will include the amount paid for the right or option.
In the case of convertible notes acquired before 20 September 1985 and converted to shares on or after that date without payment of additional consideration, the shares will also be treated as acquired before 20 September 1985. Consequently, the tax on capital gains will not apply upon a subsequent disposal of those shares. On the other hand, if a convertible note was acquired before 20 September 1985 and consideration was paid for the conversion on or after that date or the note was acquired on or after 20 September 1985, the shares will be deemed to have been acquired at the time of conversion.
The act of converting a note will not be the occasion for determining any tax liability on any gain on the convertible note. The cost of acquisition of shares received on conversion of a note acquired before 20 September 1985, is to be the sum of the market value of the note at conversion and any amount paid on conversion. The cost to be attributed to shares from a convertible note acquired on or after 20 September 1985 is the cost of the note and the amount paid (if any) in respect of the conversion.
Land and buildings, improvements, etc.
Where a taxpayer acquired land before 20 September 1985 and on or after that date a building is constructed on that land, the building will be treated as a separate asset from the land. Accordingly, where the land and building are subsequently disposed of, a capital gain may accrue or a capital loss may be incurred in respect of the disposal of the building. No capital gain or loss will arise in respect of the land.
In addition, where major capital improvements are made on or after 20 September 1985 to a building or other asset acquired before 20 September 1985, a capital gain or loss attributable to the improvements may arise in respect of a subsequent disposal of the asset. Major capital improvements in relation to an asset will be where the indexed values of the improvements in the year of disposal exceed a specified value ($50,000 for the year of income ending 30 June 1986), and also exceed five per cent of the consideration that is obtained on disposal of the asset. Where these conditions are met the capital improvements will be treated as an asset acquired on or after 20 September 1985 separate from the pre 20 September 1985 asset to which the improvements were made. A taxable capital gain or deductible capital loss, calculated by reference to the part of the proceeds attributable to the improvements, may thus arise in respect of the disposal.
Where an "original" business (i.e., one where there is no goodwill in the initial asset base) is sold by a taxpayer and the net value of the business interests of the taxpayer is less than $1 million, twenty per cent of any otherwise taxable capital gain on the goodwill component of the sale proceeds will be exempt from the tax on capital gains.
The Bill also provides for a deferral of tax liability on capital gains in certain circumstances. These include gains on:
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- transfers of assets to a company where the sole consideration consists of shares or securities of the same company and where, after the transfer, the transferor holds beneficially all of the share capital of the company;
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- transfers of assets between companies in the same group, provided the companies share 100 per cent common ownership;
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- share substitutions where, as part of a reorganisation of the capital of a company, a shareholder surrenders all of his or her shares of a particular class to the company in exchange for other shares of the same company;
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- the transfer of assets between spouses upon the breakdown of their marriage. An automatic rollover will apply to such asset transfers where they are effected pursuant to an order of, or a maintenance agreement approved by, a court under the Family Law Act; and
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- an asset disposed of as a result of its compulsory acquisition by a Government, State or Territory, or where property is stolen or destroyed, provided specified replacement assets are acquired within a stipulated period. For compulsory acquisitions the period commences one year before the disposal and ends one year after the end of the taxation year in which the compulsory acquisition occurs. For other involuntary disposals the stipulated period will start on the date of the disposal and end one year after the end of the taxation year in which the disposal occurs.
In cases where an asset that was acquired prior to 20 September 1985 is transferred in circumstances where it would have qualified for a rollover of tax liability if the asset had been acquired after 19 September 1985, the asset in the hands of the transferee or the replacement asset in the case of involuntary disposals will also be taken to have been acquired before 20 September 1985 so as to be outside the scope of the tax.
The Bill will amend section 25A of the Income Tax Assessment Act 1936, which provides for the inclusion in assessable income of profits from the sale of assets acquired for the purpose of profit-making by sale, so that assets acquired on or after 20 September 1985 will be subject to the new provisions and not to section 25A. Section 26AAA will continue to apply so as to include in assessable income profits on the sale of assets within 12 months of the date of acquisition.
Employee share acquisition schemes
The Bill also proposes, as a consequence of the introduction of the tax on capital gains, amendments to section 26AAC of the Income Tax Assessment Act 1936. Broadly, that section includes in a taxpayer's assessable income the value of a benefit attributable to the acquisition of shares in a company, or of rights to acquire shares, where the derivation of the benefit stems from services rendered by the taxpayer as an employee of the company or in a similar capacity.
In relation to such shares, the value of the benefit is included in assessable income of the employee, etc., in the year of acquisition of the shares and represents the excess of their value at the date of acquisition over any consideration paid for them. Where the shares are subject for a time to conditions or restrictions on sale, the date of acquisition is taken to be the date on which those conditions or restrictions cease. In relation to share rights given to employees and subsequently sold, the value of the benefit is determined and included in assessable income in the year of sale. The assessable amount is the excess of the sale price over any consideration paid for the rights. Where a share is acquired by the exercise of a right, the consideration paid for the right is taken into account, together with any consideration paid on exercise of the right in calculating any assessable benefit to the employee associated with the acquisition of that share.
The amendments proposed by the Bill will give taxpayers a right of election under section 26AAC in respect of rights or shares in an employer company that are subject to conditions or restrictions on sale. The effect of the election, available in respect of rights and shares issued after 19 September 1985, will be to include the value of the benefit (measured as the excess of the value of the share or right at the time of issue over the consideration paid for the share or right) in the assessable income of the year of issue instead of the year in which, in the case of a share, the conditions or restrictions cease to exist or, in the case of a right, the right is sold or exercised.
The value of the share or right at the time of issue will be taken as the cost base for capital gains purposes in the event that the share or right is subsequently sold. Similarly, where a share acquired as a result of the exercise of a right is subsequently sold, the value of the right at the time when the right was obtained will be included in the cost base of the share for capital gains purposes.
The Bill will also make several other consequential amendments to other provisions of the Principal Act as a result of the introduction of the tax on capital gains.
Income Tax (Rates) Amendment (Capital Gains) Bill 1986
This Bill will amend the Income Tax (Rates) Act 1982 to allow for the calculation of rates of tax where the taxable income of a taxpayer includes a capital gain. While, basically, the rates of tax otherwise payable by a taxpayer will apply to any capital gains included in his or her taxable income, a form of averaging will apply, under which one-fifth of a taxpayer's capital gain will be added to taxable income other than capital gains in the year of the disposal of the asset. The tax attributable to the inclusion of that amount will then be multiplied by five in order to determine the tax payable on the whole of the capital gain. This basic approach will be modified in the case of taxpayers subject to the primary producer averaging provisions or taxpayers in receipt of other forms of income to which notional assessment measures apply. In these circumstances one-fifth of the capital gain will be added to the taxpayer's average or notional income, as the case may be. The average or notional income will be calculated without reference to the capital gain.
More detailed explanations of each of the provisions of the Bills are contained in the notes that follow.