Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 6 Discount capital gains: integrity measures
6.1 A capital gains tax (CGT) discount is available to an individual, complying superannuation entity and trust if the entity has made a discount capital gain. Schedule 6 to this Bill amends the CGT provisions in the Income Tax Assessment Act 1997 (ITAA 1997) to correct certain aspects of the CGT discount provisions.
6.2 Under the current law the CGT discount is not available:
- for a capital gain arising from a CGT event happening to an equity interest in a company or trust if more than half of the assets of the company or trust were acquired within 12 months before the sale of the equity interest; or
- if the capital gain is worked out using a cost base that includes indexation.
6.3 In certain situations these rules produce an inappropriate result. Schedule 6 modifies these rules, ensuring taxpayers can obtain the benefit of the CGT discount in appropriate circumstances.
6.4 Section 115-45 of the ITAA 1997 is an integrity measure that ensures that the 12 month ownership test under the CGT discount rules is not undermined if a capital gain is made from a CGT event happening to an equity interest in a company or trust.
6.5 Amendments to section 115-45 will remove unintended applications of this integrity measure and allow the CGT discount where the 12 month ownership test is effectively satisfied.
6.6 In certain circumstances amendments to section 115-20 will allow a taxpayer to recalculate the cost base of an asset to exclude indexation in order to treat a capital gain as a discount capital gain.
|New law||Current law|
|Two additional conditions now apply before a capital gain on an equity interest is
a discount capital gain. That is:
If any of the 3 conditions is not met, the gain is a discount capital gain.
|Section 115-45 contains only one condition in determining whether a capital gain on an equity interest is
a discount capital gain. That is:
|Section 115-45 does not preclude a capital gain made because of CGT event E4 from being a discount capital gain, if the gain was a discount capital gain for the trustee.||It is possible that section 115-45 may preclude a capital gain, made because CGT event E4 happens, from being a discount capital gain.|
|A taxpayer who is deemed to have a cost base element that includes indexation can recalculate their cost base to exclude the indexation in order for the capital gain to be a discount capital gain.||A capital gain may not be a discount capital gain if the cost base used to calculate the gain included an indexation component as a result of the application of a provision which deemed an element of the cost base to include an indexation amount.|
6.7 Section 115-45 operates to deny a CGT discount for a CGT event happening to a share in a company or an interest in a trust, if the CGT discount would not have been allowed if the taxpayer owned the underlying assets of the company or trust and a CGT event had happened to those assets.
6.8 The current test denies the discount if the total of the cost bases of CGT assets acquired by a non-widely held company or trust less than 12 months before the disposal of the membership interest is more than half the total of the cost bases of the CGT assets of the company or trust at that time. The test applies only to an entity with less than 300 equity holders.
6.9 Inappropriate tax consequences have been identified in applying the current test, denying the CGT discount for a capital gain from a CGT event happening to an equity interest in situations such as:
- the disposal of an interest in a trading business with significant internally generated goodwill may fail the section 115-45 test as the goodwill has a negligible cost base while assets such as trading stock, cash and receivables, more likely to have been acquired in the previous 12 months, may have relatively higher cost bases;
- the test may capture an asset acquired and disposed of in the 12 months before the CGT event; and
- if an asset with a relatively high cost base has been purchased within the previous 12 months, a taxpayer may fail the test even though the unrealised gain on that asset may represent a negligible portion of the total unrealised gains on all the assets held by the entity.
6.10 Schedule 6 replaces section 115-45 and adds 2 further conditions to the existing cost base condition [Schedule 6, item 3, subsection 115-45(4)] to correct these inappropriate consequences. These conditions, which must be met before a capital gain is denied access to the CGT discount, are:
- a de minimus condition requiring the taxpayer to have at least 10% of the equity in the entity before the CGT event (including any interests of associates); and
- a notional capital gain condition, requiring the notional net capital gain made on assets held by the company or trust just before the CGT event, and acquired less than 12 months before, to be greater than 50% of the notional net capital gain on all assets held by the company or trust at that time.
[Schedule 6, item 3, subsections 115-45(3) and (5) to (7)]
6.11 The notional capital gain condition allows for CGT concessions to be taken into account when calculating the notional net capital gain for assets acquired less than 12 months before the CGT event and the notional net capital gain for assets held just before that CGT event. In calculating the latter notional net capital gain, capital gains and losses that would normally be disregarded, are included in the calculation. This treatment avoids the possibility of the condition being met because the company or trust owned pre-CGT assets with significant 'notional' capital gains and ensures that pre-CGT assets are not adversely affected.
6.12 It may not be necessary to apply all 3 conditions in section 115-45. If any one of the conditions is not met , the capital gain is a discount capital gain.
Example 6.1 Kate sold her 8% shareholding in Autumn Leaves Ltd (a non-widely held entity) making a capital gain of $10,000. Kate had owned the shares for 3 years.The de minimus condition in subsection 115-45(3) precludes section 115-45 from applying (Kate owned less than 10% of the equity in Autumn Leaves Ltd). This means that Kate has access to the CGT discount.
Fred sold his 20% shareholding in Prestige Property Rentals Ltd (a non-widely held entity) making a capital gain of $25,000. Fred had owned the shares for 4 years. At the time of the sale Prestige Property Rentals Ltd owned the following assets:
Example 6.3 John was one of 3 shareholders in Top Gain Investments Ltd (a non-widely held entity) that was wound up on 1 June 2000. John had owned the shares for 5 years. On 30 March 2000 the liquidator sold 3 of the company's assets for $26,000 making a capital gain of $2,000. The remaining asset that had been owned for a number of years had a cost base of $8,000 and a market value of $13,000 at 1 June 2000. The company also held $26,000 cash from the sale of the assets at that time.On 1 June 2000 when the company was wound up John was paid $13,000 by the liquidator. John had a CGT event C2 in respect of his shares in the company and made a capital gain of $11,000.Applying the 3 conditions in section 115-45 produced the following results:De minimus condition - John owned 331/3% of the shares in Top Gain Investments Ltd (condition met).Cost base condition - $26,000 (cost base of less than 12 months assets) is greater than 50% of $34,000 (cost base of all assets) (condition met).Notional capital gain condition - nil (notional capital gain of less than 12 month assets) is not greater than 50% of $5,000 (notional capital gain of all assets) (condition not met).Section 115-45 does not apply to deny John access to the CGT discount.
6.13 In applying the conditions in section 115-45 it is appropriate that acquisition dates be preserved in situations where the assets of the company or trust are acquired under a same asset or replacement asset roll-over or through a deceased estate. The acquisition rules in section 115-30, providing the time when a company or trust is taken to have acquired such assets for the purposes of applying the CGT discount provisions, are extended to section 115-45. [Schedule 6, item 2, subsection 115-30(1)]
6.14 Currently, section 115-45 may prevent a capital gain made under CGT event E4 from being a discount capital gain, if the trust paying the non-assessable amount (the CGT discount allowed in the trust), fails the threshold tests in section 115-45. This is also an unintended consequence as any CGT event E4 gain arising from the payment of the CGT discount should be able to be a discount capital gain.
6.15 The CGT discount integrity rules are amended to ensure that, to the extent that the distribution is from a discount capital gain, section 115-45 will not prevent a capital gain arising on the happening of CGT event E4 to the interest holder from being a discount capital gain. [Schedule 6, item 4, section 115-60]
6.16 A capital gain cannot be a discount capital gain if any element of the cost base is indexed. If, for example, a person acquired an asset under a replacement asset roll-over, the cost base for that person becomes the first element of their cost base for the replacement asset. The original cost base may have included an indexation amount.
6.17 Currently, when a subsequent CGT event happens to this asset, a discount capital gain cannot be made, as the entity could not recalculate the cost base to exclude indexation.
6.18 The proposed amendment ensures that the cost base in these circumstances can be recalculated to exclude indexation if the application of another provision in the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 included indexation in the cost base. This will enable the entity to make a discount capital gain if the other tests are met. [Schedule 6, item 1, section 115-20]
Example 6.4 In 1995 Katherine acquired shares in Stinger Ltd under the roll-over provisions in section 160ZZN of the ITAA 1936. At that time Katherine was deemed to have acquired the shares for $5,600 being the indexed cost base of the assets she transferred to Stinger Ltd. The cost base of the assets at the time was $4,000. In April 2000 Katherine sold the shares for $15,000. Assuming the integrity measure in section 115-45 does not apply, Katherine's discount capital gain is $11,000 (capital proceeds $15,000 less cost base $4,000).
6.19 The general rule that a capital gain can only be made if a CGT event happens is modified if a beneficiary is taken to have made an extra capital gain under subsection 115-215(3) of the ITAA 1997. [Schedule 6, item 5, subsection 115-215(4)]
6.20 This subsection effectively excludes the capital gain amount from the share of the net income to which a beneficiary is presently entitled. The beneficiary is taken to have made an extra capital gain, which is a capital gain not made as a result of a CGT event happening to the beneficiary. After offsetting any capital losses against this gain and then applying the appropriate CGT concessions, the balance is included in the beneficiary's net capital gain for the year.
6.21 The amendments to Division 115 of the ITAA 1997 made by Schedule 6 apply to assessments for the income year including 21 September 1999 and all later years, in relation to CGT events happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999. [Schedule 6, item 6]