Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 11 - Concessions for capital gains by individuals and some other entities
Outline of Chapter
11. 1 Schedule 9 to this Bill amends the ITAA 1997 to provide a CGT discount to individuals, complying superannuation entities and trusts. This concession will allow individuals and trusts to exclude one-half of certain capital gains made on CGT assets from their assessable incomes. Complying superannuation entities will be able to exclude one third of those capital gains.
Context of Reform
11.2 These amendments to the ITAA 1997 will provide a broad form of CGT relief that has only a limited relationship to the period of holding of the asset. They will enable an individual, complying superannuation entity or trust to choose to include a set percentage of their capital gain, rather than claiming indexation of the cost base of the asset.
11.3 These amendments give effect to the Recommendations of the Review.
Summary of new law
11.4 After 11.45 am AEST on 21 September 1999 (the start time), an individual, complying superannuation entity or trust that acquires a CGT asset and makes a capital gain from a CGT event happening to that CGT asset will receive a discount on the capital gain, providing the CGT asset was owned by the taxpayer for at least 12 months.
11.5 For assets acquired at or before the start time, and disposed of after the start time, the taxpayer can choose whether to claim the CGT discount or to include an indexation adjustment in calculating the cost base of the asset.
11.6 Capital losses may be applied in the order chosen by the taxpayer. If the taxpayer chooses the CGT discount, capital losses will be applied against capital gains before applying the CGT discount. If the taxpayer chooses the indexation option, capital losses will be applied after calculating the capital gain using the indexed cost base of the CGT asset, with indexation frozen at 30 September 1999. Revenue losses will continue to be offset against net capital gains.
11.7 A beneficiary of a trust receiving a distribution from the trust that is attributable wholly or partly to a discount capital gain of the trust (because the trustee has claimed the CGT discount in calculating the net income of the trust) will need to gross up the distribution before applying any capital losses. The beneficiary will then apply the appropriate CGT discount (depending on whether the beneficiary is an individual, trust, or complying superannuation entity) to any remaining discount capital gains.
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Comparison of key features of new law and current law
11.8 The current law allows taxpayers to calculate capital gains on the happening of a CGT event to a CGT asset with an indexation component, based on the period of ownership of the asset.
11.9 The new law will remove that indexation component for CGT assets acquired after the start time, and replace it with the CGT discount. For a CGT asset acquired at or before the start time, the taxpayer may choose to claim the indexation component, frozen at 30 September 1999 in calculating a capital gain on a CGT event happening to the asset, or the taxpayer may choose to claim the CGT discount.
Detailed explanation of new law
11.10 If an individual makes a capital gain from a CGT event happening after the start time to a CGT asset acquired after that time, the individual will be taxed on one-half of the gain, without any indexation applying to the cost base. The CGT asset must have been acquired by the taxpayer at least 12 months before the CGT event that caused the capital gain. [Item 13, sections 115-5, 115-10, 115-15 and 115-20]
11.11 The gain before the CGT discount is applied is defined as the discount capital gain . The CGT discount is determined by the discount percentage. [Schedule 10, items 2 and 3, subsection 995-1(1)]
Sarah acquires listed public company shares in November 1999, for $15 each. She sells the shares in December 2000 for $27 each. She must include in assessable income a discounted gain of $6 for each share, being half of the realised nominal gain of $12.
11.12 If an individual makes a capital gain from a CGT event happening after the start time to a CGT asset acquired at or before that time and owned for at least 12 months, the individual may choose to include in his or her taxable capital gain:
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- one-half of the capital gain without any indexation of the cost base; or
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- the whole of the gain between the realised price of the asset and its cost base, including indexation frozen at 30September 1999.
[Item 11, subsection 110-25(8), item 12, section 114-5, and Item 13, subsection 115-25(1)]
Sandra acquired shares in a listed public company in 1995 for $20 each, and sells these shares in May 2000 for $38 each. At the date of sale, the frozen indexation amount would increase the cost base to $22, based on indexation frozen at 30 September 1999. Sandra may choose to calculate the capital gain for each share in either of the following ways:
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- the excess of disposal proceeds ($38) over indexed cost base ($22), giving a capital gain of $16; or,
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- half of the realised nominal gain, being the excess of the capital proceeds ($38) over the cost base without any indexation ($20), the nominal gain being $18 and half of that gain being $9.
Given this outcome, Sandra chooses to claim the CGT discount.
Amy acquired listed public company shares in May 1999, for $11 each and sells these shares in April 2000 for $27 each. At the date of sale she has not owned the asset for at least 12 months and is therefore not able to choose either the CGT discount or the frozen indexation options. Amy must include in her assessable income a net capital gain based on $16 for each share.
John purchased 3,000 shares in Mineral Co. NL for $900 on 2February 1990. The par value of each share was 50 cents partly paid to 30 cents. On 15 April 2000, the company made a call of 20 cents per share. John paid the call, $600, on 22 April 2000.
John sold his shares in July 2000. Because he acquired the shares prior to the start time he has the choice of using either the frozen indexation option or the CGT discount option in calculating the capital gain. If John chose the frozen indexation option, only the $900 is indexed. The cost base would include this indexed amount plus the $600.
John cannot choose the frozen indexation option for part of his cost base and the CGT discount option for another part of his cost base.
Application to complying superannuation entities
11.13 If a complying superannuation entity makes a capital gain from a CGT event happening after the start time to a CGT asset acquired after that time, the complying superannuation entity will be taxed on two-thirds of the gain, without any indexation applying to the cost base. The CGT asset must have been acquired by the complying superannuation entity at least 12 months before the CGT event that caused the capital gain. [Item 13, sections 115-5, 115-10, 115-15 and 115-20]
11.14 After the start time, if a complying superannuation entity makes a capital gain from a CGT event happening to a CGT asset it acquired at or before that time and owned for at least 12 months, it may choose to include in its assessable income:
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- two-thirds of the capital gain calculated without any indexation of the cost base; or
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- the whole of the capital gain calculated with the indexed cost base as frozen at 30 September 1999.
[Item 11, subsection 110-25(8), item 12, section 114-5, and item 13, subsection 115-25(1)]
11.15 A complying superannuation entity is a:
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- complying superannuation fund;
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- complying approved deposit fund; or
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- pooled superannuation trust.
[Schedule 10, item 1, subsection 995-1(1)]
11.16 If a trust makes a capital gain from a CGT event happening after the start time to a CGT asset acquired after that time, the net income of the trust will include one-half of the gain, without any indexation applying to the cost base. The CGT asset must have been acquired by the trust at least 12 months before the CGT event that caused the capital gain. [Item 13, sections 115-5, 115-10, 115-15 and 115-20]
11.17 If a trust makes a capital gain from a CGT event happening to a CGT asset it acquired at or before that time and it has owned the asset for at least 12 months, the trustee of the trust may choose the CGT discount or frozen indexation option. [Item 11, subsection 110-25(8), Item 12, section 114-5, and Item 13, subsection 115-25(1)]
11.18 The net income of the trust will include the discounted capital gain or indexation gain depending on the trustees choice. The beneficiary will need to know what proportion of their entitlement to the net income of the trust is attributable to capital gains, and what proportion of that capital gain amount is attributable to a discounted capital gain. [Item 13, Subdivision 115-C]
11.19 The beneficiary of a trust must gross up that part of their share of the net income of the trust that is attributable to a discounted capital gain by applying a gross up factor of 100%. This amount is treated as a capital gain of the beneficiary for the purposes of calculating the net capital gain for the year. This gross up factor allows the beneficiary to appropriately apply any capital losses against the trust capital gain before applying the CGT discount that is appropriate for that beneficiary. [Item 13, sections 115-210 and 115-215]
11.20 No discount is allowed for a trustee assessed under subsection 98(3) or section 99A of the ITAA 1936. [Item 13, sections 115-220 and 115-225]
11.21 That part of the beneficiarys share of the net income of the trust that is treated as a capital gain is deducted from their assessable income for the income year. This ensures that the capital gains component is not taxed twice. [Item 13, subsection 115-215(5), item 31]
A fixed trust makes a capital gain of $1,000 as a result of an A1 event happening to a CGT asset that the trustee has owned for more than 12months. In calculating the net income under section 95 of the ITAA 1936 the trustee chooses to claim the CGT discount, resulting in a net income for the trust of $2,500, including the discounted capital gain of $500. There is one beneficiary, a company, that is presently entitled to the net income of the trust. The company will gross up the discounted capital gain component to $1,000. The company is not eligible to apply the CGT discount to that grossed up capital gain. This means that the company will include in its assessable income for the year the net trust distribution of $2,000, and the capital gain amount of $1,000.
11.22 The CGT discount is not available to a company.
11.23 If a company acquires an asset after the start time indexation of its cost base is not available.
11.24 If a company acquired an asset at or before the start time indexation of its cost base, frozen at 30 September 1999 is used to calculate a capital gain, providing the asset was owned for at least 12months at the time the CGT event happens.
The 12 month holding requirement
11.25 To qualify for the CGT discount, a CGT asset must have been owned by the taxpayer for at least 12 months at the time of the CGT event happening. [Item 13, subsection 115-25(1) and (2)]
11.26 In some cases, a taxpayer who acquires an asset within 12 months of the CGT event happening to that asset will be eligible for the CGT discount for any capital gain arising from the CGT event. Certain assets acquired under the same asset or replacement asset roll-over provisions (e.g. Divisions 122, 123 and 124) or under the rules applying to deceased persons (Division 128) will be treated as having been owned by the taxpayer for at least 12 months if the collective period of ownership is at least 12 months. This effective ownership rule is only for the purposes of claiming the CGT discount. [Item 13, section 115-30]
11.27 Certain CGT events do not qualify for the CGT discount. If a capital gain is made from a CGT event that creates a new asset, the 12month ownership rule cannot be satisfied and the taxpayer is not eligible for the CGT discount. [Item 13, subsection 115-25(3)]
11.28 Table 11.2 sets out those CGT events that do not qualify for the CGT discount.
| D1 | Creating contractual or other rights the CGT event happens upon the creation of the right. |
| D2 | Granting an option the CGT event happens upon granting, renewal or extension of the option. |
| D3 | Granting a right to mining income the CGT event happens upon granting the right to mining income. |
| E9 | Creating a trust over future property the CGT event happens at the time of the agreement to hold future trust property. |
| F1 | Granting a lease the CGT event happens upon the grant, renewal or extension of the lease by the lessor. |
| F2 | Granting a long-term lease the CGT event happens upon the grant, renewal or extension of a long-term lease by the lessor. |
| F5 | Lessor receives payment for changing lease the CGT event happens on the varying or waiver of the terms of the lease. |
| H2 | Receipt for event relating to a CGT asset the CGT event happens at the time of the act, transaction or event. |
| K1 | Partial realisation of intellectual property right the CGT event happens on realisation or on entering into a contract for realisation. |
11.29 If a taxpayer makes a capital gain from a CGT event happening to a CGT asset acquired by the taxpayer more than 12 months before the CGT event, under an agreement entered into witin that 12 month period, the capital gain does not qualify for the CGT discount [item 13, section 115-40] . This rule will prevent taxpayers inappropriately taking advantage of the CGT discount by seeking to extend artificially the period of ownership of the asset that produces the capital gain.
11.30 The CGT discount is not available for capital gains arising from certain CGT events happening to equity interests in a company or trust if more than half of the assets of the underlying company or trust were acquired within the 12 month period before the sale of the equity interests in the company or trust. This measure will compare the sum of the cost bases of assets acquired by the company or trust within 12 months of the CGT event happening to the equity interest, to the total of the cost bases of the company or trust at the time of the CGT event. [Item 13, section 115-45]
11.31 The rule outlined in paragraph 11.29 will not apply to capital gains from CGT events happening to:
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- shares in a company with at least 300 members; or
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- interests in a fixed trust with at least 300 beneficiaries,
unless the concentrated ownership rules apply (refer to paragraph 11.26). [Item 13, subsections 115-50(1) and (2), Schedule 10, item 4]
11.32 In determining whether the company or trust satisfies these requirements, any concentrated ownership is taken into account. Concentrated ownership occurs if:
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- one or up to 20 individuals own, directly or indirectly, shares with fixed entitlements to at least 75% of the income or capital, or at least 75% of the voting rights in the company; or
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- one or up to 20 individuals own, directly or indirectly, interests in the trust with fixed entitlements to at least 75% of the income or capital, or at least 75% of the voting rights in the trust (if any).
[Item 13, subsections 115-50(3) and (4)]
11.33 For the purposes of these tests, one individual together with associates, and any nominees of the individual or their associates will be counted as one individual. [Item 13, subsections 115-50(5)]
11.34 The tests also consider whether there is any potential for rights attaching to the shares or interests in the trust to be varied or abrogated. It does not matter whether or not the rights attaching to any of the shares or interests are actually varied or abrogated. [Item 13, subsection 115-50(6) to (8)]
11.35 Certain CGT events require a taxpayer to disregard a capital gain or loss (e.g. if the CGT event happens to a CGT asset acquired by the taxpayer before 20 September 1985). In other cases certain exemption provisions apply to reduce or disregard the capital gain or loss arising from a CGT event. In calculating the capital gain that is subject to discount, the taxpayer takes these general exemption provisions into account before applying any available capital losses, and before applying any discount. [Item 3, subsection 102-5(1), step 1, note 2)
Lauren purchased a beach front house in 1990 for $140,000. After renting the house out as a holiday home for 3 years, Lauren moved into the house in 1993 and it became her principal place of residence for the next 7 years until she sells it in 2000 for capital proceeds of $260,000. Lauren has prior year net capital losses of $4,000 and current year capital losses of $6,000 and she chooses to apply the CGT discount to the capital gain. In calculating the net capital gain made on the house, Lauren will apply the partial main residence exemption first to reduce the capital gain received on disposal of the holiday house. $120,000 * 7/10 (partial main residence exemption) = $36,000
| Capital proceeds | - | Cost base | = | Capital gain |
| ($260,000) | ($140,000) | ($120,000) |
$120,000 * 7/10(partial main residence exemption) = $36,000
Lauren will then apply her capital losses to this amount.
| Current year losses | Prior year net capital losses | |||||
| $36,000 | - | ($6000) | - | ($4000) | = | $26,000 |
Lauren can then apply her CGT discount to calculate her net capital gain.
$26,000 * 1/2 = $13,000
11. 36 A taxpayer may choose to apply capital losses against capital gains in any order [item 3, subsection 102-5(1), step 1). In most cases the best outcome will be achieved if capital losses are applied against capital gains in the following order:
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- to capital gains that have received neither indexation of the cost base nor the CGT discount (i.e. assets owned for less than 12months) and to capital gains calculated with the assets indexed cost base; and
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- to capital gains which have received the CGT discount.
11.37 If the taxpayer chooses to claim the frozen indexation option, capital losses will be applied against the capital gain arising after deducting the cost base, including any indexed elements, from the capital proceeds. If the taxpayer does not choose the indexation option, or it is not available, the capital gain is calculated by deducting the cost base, excluding indexation, from the capital proceeds for the CGT event. Capital losses will be applied against the capital gain before it is reduced by the CGT discount. [Item 3, subsection 102-5(1), step 1]
11.38 Net capital losses from previous income years must be applied in the order in which they were made. Subject to this rule, the taxpayer can choose to apply any prior year net capital losses against capital gains for the income year in any order. Any prior year net capital losses will be applied against the current year capital gains before applying the CGT discount. [Item 3, subsection 102-5(1), step 2)
11.39 If a capital gain remains after applying all available capital losses, the remaining capital gain is either:
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- fully included in assessable income as a net capital gain without further reduction (if the taxpayer has claimed the frozen indexation option, or if the CGT discount is not available for the CGT asset); or
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- reduced by the appropriate CGT discount and included as a net capital gain (if the taxpayer chose the CGT discount).
Sharon acquires shares in a listed public company in June 1992, and units in a listed unit trust in May 1996. She has a net capital loss of $12,000 in the 1998-1999 income year, and incurs a further capital loss of $6,000 in August 1999.
Sharon sells the shares in July 1999 and makes a capital gain of $4,000 (Sharon chooses to calculate this capital gain using her indexed cost base). She also sells the units during February 2000, and makes a capital gain of $22,000 (Sharon chooses to calculate this capital gain using the CGT discount).
Sharon may choose to apply her capital losses in any order, but she must apply the losses against discount gains prior to reduction. Sharon chooses to apply the $6,000 current year capital loss firstly against the $4,000 gain realised in July 1999, leaving a current year capital loss balance of $2,000. Sharon will then apply the remaining $2,000 current year capital loss and the prior year net capital loss of $12,000 against the discount gain of $22,000. This results in a nominal gain after losses of $8,000.
This nominal gain is then reduced by the CGT discount of one-half applicable to individuals, leaving a net capital gain of $4,000 for the 1999-2000 income year.
11. 40 A beneficiary of a trust may apply capital losses to both personal capital gains and trust capital gains. That part of the beneficarys share of the net income of the trust that is attributable to discounted capital gains (capital gains calculated by the trustee using the CGT discount of one-half) will be grossed up prior to applying the capital losses of the beneficiary. The balance of discount capital gains (if any) will then be reduced according to the appropriate CGT discount for that beneficiary. [Item 13, subsections 115-215)
A fixed trust makes a capital gain of $1,000 following the disposal of a CGT asset owned for at least 12 months. In calculating the capital gain the trustee of the trust chooses the CGT discount, leaving a net income in terms of section 95 of the ITAA 1936 of $500. There is a single beneficiary who is an individual and who is presently entitled to the net income of the trust. The beneficiary also has personal current year capital losses available of $400. In calculating his net capital gain for the year, the beneficary must gross up the trust gain to $1,000 before applying his personal capital losses of $400, leaving a discount capital gain of $600, with a net capital gain of $300 after the CGT discount has been applied.
A fixed trust makes a capital gain of $900 following a CGT event A1, and a separate capital gain of $1,000 (after claiming indexation) from a CGT event C1. The trustee of the trust chooses the CGT discount for the A1 gain of $900 leaving a net income in terms of section 95 of the ITAA 1936 of $450, and chooses the frozen indexation option for the C1 gain.
There is a single beneficiary who is a complying superannuation fund and who is presently entitled to the net income of the trust. This fund has prior year capital losses of $700 available. The fund grosses up the part of the net income of $450 that is attributable to the discount gain (no gross up of the part of the net income that is attributable to the $1,000 indexed gain is necessary). The fund has a choice of applying its capital losses firstly to either the $900 grossed up discount gain or to the $1,000 indexed gain. The fund chooses to apply its capital losses to the $1,000 indexed gain, leaving a capital gain of $300. The discount capital gain of $900 is then reduced by one-third, resulting in a discounted capital gain of $600. The fund then adds together the $300 indexed gain and the $600 discounted gain to get a net capital gain of $900 which it includes in its assessable income for the year.
11. 41 Consistent with the current law, revenue losses will continue to be applied against net capital gains.
In Example 11.9, if the fund had a prior year revenue loss of $500, that loss would be claimed as a deduction for the 1999-2000 income year. If the $900 net capital gain were the only amount of assessable income, the taxable income of the fund would be $400.
Distribution by a trustee of excluded gain amounts
11.42 A distribution by the trustee of the amount of capital gain that is excluded from the net income of the trust because the trustee claimed the CGT discount may be a non-assessable amount for the purposes of section 104-70 of the ITAA 1997. If the non-assessable amount is distributed to an individual beneficiary who has received the benefit of the CGT discount (in calculating the capital gain that he includes in his net capital gain), section 104-70 will reduce the cost base of the individual beneficiarys interest in the trust. Once the cost base of the beneficiarys interest in the trust is reduced to nil a capital gain may arise (CGT event E4). This capital gain may also qualify for the CGT discount.
11.43 In order to prevent an element of double taxation of a beneficiary of a trust who receives such a non-assessable amount, and who is a company or a complying superannuation entity, there will be no cost base adjustment under section 104-70 for that part of the trust capital gain which is excluded from the calculation of the net income of the trust because the trustee claimed the CGT discount. [Item 5, and item 6, subsection 104-70(7A)]
In Example 11.5, the company included in its assessable income a net capital gain of $1,000 being the grossed up amount of the share of the net income of the trust that was attributable to the discounted gain. The net income of the trust does not include that part of the capital gain that represents the CGT discount. If the trustee later decides to distribute that excluded amount to the company beneficiary, there will be no adjustment under section 104-70 of the cost base of the companys interest in the trust.
11.44 On distribution of the excluded gain amount by the trustee, there will also be no cost base adjustments under section 104-70 to the extent to which the beneficiary of the trust has applied personal capital losses against the grossed up trust capital gain. The beneficiary will need to identify which capital gains he has chosen to apply against his capital losses, particularly if the excluded gain amount is distributed in a later year of income than that in which the grossed up trust gain was assessed.
In Example 11.8, the beneficiary applied personal capital losses of $400 against the grossed up trust discounted capital gain of $1000 (twice that part of the net income of the trust that was attributable to a discounted capital gain). On distribution by the trustee to that beneficiary of the excluded gain amount, $200 of the distribution of $500 has effectively been offset against capital losses. No cost base adjustment under section 104-70 will apply to that part of the distribution. The remaining $300 will be applied to reduce the cost base of the beneficiarys interest in the fixed trust.
Application and transitional provisions
11.45 The amendments to Divisions 100, 102, 104, 109 and new 115 of the ITAA 1997, apply to assessments for the income year including 21September 1999 and later years. The amendments to the cost base and indexation provisions apply to the calculation of the cost base of a CGT asset for a CGT event happening after the start time. [Item 14]
11.46 The amendment of section 6AD of the ITAA 1936 applies for income years commencing on or after 1 July 2000. [Item 21]
11.47 The consequential amendments to the ITAA 1997 apply to assessments for the income year including 21 September 1999 and later years [item 30] . The additional signposting for section 12-5 of the ITAA 1997 applies to assessments for the income year including 21 September 1999 and later years [item 32] .
Consequential amendments
11.48 Minor changes are made to the Guide to capital gains and losses in Division 100 of the ITAA 1997 to reflect these changes, and to introduce an outline of the CGT discount in Division 102. [Item 1 and 2]
11.49 The changes to the method statement in subsection 102-5(1) to give effect to the choice of CGT discount require consequential changes to paragraph 6AD(4)(e) of the ITAA 1936 to ensure that that provision continues to apply to capital gains and losses from a CGT event. [Item 15]
11.50 Further consequential changes have been made to insert notes referring to the application of Subdivision 115-C at the end of a number of provisions in Division 6 of Part III of the ITAA 1936 [items 16 to 20] . The introduction of the concept of complying superannuation entity has also required consequential changes to a number of provisions in Parts 3-1 and 3-3 of the ITAA 1997 to ensure consistency of terminology [items 22 to 29] .
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