Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello MP)Chapter 8 - CGT event G3
Outline of chapter
8.1 Schedule 8 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to extend the scope of CGT event G3 so that an administrator (in addition to a liquidator) of a company can declare shares and financial instruments in the company to be worthless for capital gains tax (CGT) purposes. The declaration permits taxpayers who hold those shares or financial instruments to choose to make a capital loss.
Context of amendments
8.2 Currently, section 104-145 of the ITAA 1997 specifies that CGT event G3 happens if a taxpayer owns a share in a company and its liquidator declares in writing that he or she has reasonable grounds to believe (at the time of the declaration) there is no likelihood that the shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution in the course of winding up the company. The declaration causes CGT event G3 to happen and permits shareholders to choose to make a capital loss in respect of their shares.
8.3 Financial instruments that are issued by a company, or that are created by or in relation to a company, that has appointed a liquidator may also be worthless. However, the liquidator cannot make a declaration in respect of financial instruments.
8.4 In addition, commercial factors may cause a company to appoint an administrator (rather than a liquidator) to conduct external administration proceedings. An administrator is unable to make a declaration that causes CGT event G3 to happen even though he or she may be in a similar position to a liquidator to make a judgement that shares or financial instruments in the company are worthless.
8.5 Therefore, the amendments will allow administrators to make a declaration that causes CGT event G3 to happen and allow the declaration to cover both shares and financial instruments. This will reduce compliance costs for affected taxpayers and allow them to more easily claim a capital loss in respect of their shares or financial instruments.
Summary of new law
8.6 These amendments will extend the scope of CGT event G3 so that administrators (in addition to liquidators) can make a declaration that shares or financial instruments are worthless for CGT purposes.
Comparison of key features of new law and current law
| New law | Current law |
|---|---|
| CGT event G3 can apply to taxpayers who own:
CGT event G3 will happen if a liquidator or administrator appointed by the company makes a declaration in writing that he or she has reasonable grounds to believe (as at the time of the declaration) that:
The declaration will cause CGT event G3 to happen at the time the declaration is made and permit affected taxpayers to choose to make a capital loss in respect of their shares or financial instruments. |
CGT event G3 happens if a taxpayer owns shares in a company and its liquidator declares in writing that he or she has reasonable grounds to believe (as at the time of the declaration) that there is no likelihood that the shareholders in the company, or shareholders of a relevant class of shares, will receive any further distribution in the course of winding up a company.
The declaration causes CGT event G3 to happen at the time the declaration is made and permits affected taxpayers to choose to make a capital loss in respect of their shares in the company. |
Detailed explanation of new law
When does CGT event G3 happen?
8.7 CGT event G3 can apply to taxpayers who own:
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- shares in a company; or
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- financial instruments that are issued by a company or that are created by or in relation to a company.
8.8 CGT event G3 will happen if a liquidator or administrator appointed by the company makes a declaration in writing that he or she has reasonable grounds to believe (as at the time of the declaration) that:
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- for shares - there is no likelihood that shareholders in the company, or shareholders of a relevant class of shares, will receive any further distribution for their shares; or
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- for financial instruments - the instruments, or a class of instruments that includes instruments of that kind, have no value or have only negligible value.
[Schedule 8, item 2, subsection 104-145(1)]
8.9 To ensure that a liquidator or administrator does not have to make a separate declaration for each type of share or financial instrument, the liquidator or administrator's declaration can refer to more than one type of share or financial instrument.
8.10 A liquidator is appointed under Chapter 5 of the Corporations Act 2001 to wind up a company.
8.11 An administrator is appointed under Part 5.3A of the Corporations Act 2001 to conduct external administration proceedings. An administrator of a company would require a comprehensive grasp of all of the company's affairs in order to have reasonable grounds to make a declaration for the purposes of CGT event G3. Generally only an administrator appointed in relation to a deed of company arrangement will be in a position to reasonably make this assessment.
What are financial instruments?
8.12 Examples of financial instruments are:
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- debentures, bonds or promissory notes issued by the company;
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- loans to the company; and
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- futures contracts, forward contracts or currency swap contracts relating to the company.
[Schedule 8, item 2, paragraphs 104-145(3)(a) to (c)]
8.13 Rights or options to acquire financial instruments of the type referred to in paragraph 8.11 and rights or options to acquire shares in the company are also financial instruments. [Schedule 8, item 2, paragraphs 104-145(3)(d) and (e)]
What is the effect of a liquidator's or administrator's declaration?
Taxpayers can choose to make a capital loss
8.14 The liquidator's or administrator's declaration causes CGT event G3 to happen at the time the declaration is made and permits affected taxpayers to choose to make a capital loss in respect of any shares or financial instruments covered by the declaration. The amount of the capital loss is equal to the reduced cost base of the shares or financial instruments at the time the declaration is made. [Schedule 8, item 2, subsections 104-145(2) and (4)]
8.15 If a taxpayer chooses to make a capital loss in respect of any shares or financial instruments covered by the declaration, the cost base and reduced cost base of those shares or financial instruments are reduced to nil just after the declaration is made. Consequently, if a subsequent CGT event happens to the shares or financial instruments, the whole of the capital proceeds received will generally be a capital gain. [Schedule 8, item 2, subsection 104-145(5)]
Capital loss not available for pre-CGT assets
8.16 CGT is not generally imposed on assets acquired before 20 September 1985. Therefore, taxpayers cannot choose to make a capital loss if the shares or financial instruments were acquired before 20 September 1985. [Schedule 8, item 2, paragraph 104-145(6)(a)]
Capital loss not available for assets held on revenue account
8.17 Taxpayers cannot choose to make a capital loss if the share or financial instrument is a revenue asset at the time when the declaration is made. [Schedule 8, item 2, paragraph 104-145(6)(b)]
8.18 Section 977-50 defines a CGT asset to be a revenue asset if, broadly:
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- the profit or loss on disposal or other realisation of the asset would be taken into account in calculating the taxpayer's assessable income or tax loss, otherwise than as a capital gain or capital loss; and
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- the asset is neither trading stock nor a depreciating asset.
Capital loss not available for certain shares and financial instruments acquired under an employee share scheme
8.19 Division 13A of Income Tax Assessment 1936 (ITAA 1936), rather than the CGT provisions, applies to specify the taxation consequences of qualifying shares and rights acquired under an employee share scheme.
8.20 Consequently, a taxpayer cannot choose to make a capital loss in respect of a share if:
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- the share is a qualifying share under an employee share scheme;
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- the taxpayer has not made an election under section 139E of the ITAA 1936 for the income year in which the share is acquired; and
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- the declaration by the liquidator or administrator is made no later than 30 days after the cessation time of the share.
[Schedule 8, item 2, subsection 104-145(7)]
8.21 Similarly, a taxpayer cannot choose to make a capital loss in respect of a financial instrument if the financial instrument is:
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- a right acquired under an employee share scheme; or
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- a right that, apart from section 139DD of the ITAA 1936, would have been acquired under an employee share scheme.
[Schedule 8, item 2, subsection 104-145(8)]
Application and transitional provisions
8.22 The amendments apply to declarations made by liquidators or administrators after the date of Royal Assent of this bill. [Schedule 8, item 8]
Consequential amendments
8.23 The table in section 104-5 contains a summary of CGT events. The table will be amended to reflect the modifications to CGT event G3. [Schedule 8, item 1, section 104-5]
8.24 The table in section 112-45 sets out which element of the cost base or reduced cost base of a CGT asset is affected by various situations. The table will be amended to reflect the modifications to CGT event G3. [Schedule 8, item 3, section 112-45]
8.25 Generally, non-residents are subject to CGT if a CGT event happens to a CGT asset that has the necessary connection to Australia. The table in section 136-10 outlines the circumstances in which a CGT asset has the necessary connection to Australia. The table will be amended to reflect the modifications to CGT event G3. [Schedule 8, item 4, section 136-10]
8.26 Subdivision 165-CD requires adjustments to be made to the tax attributes of significant equity and debt interests that entities have in a company that has realised losses or unrealised losses if an alteration time occurs in respect of the loss company. The purpose of the adjustments is to prevent multiple recognition of the losses when the interests are realised. An alteration time happens if, among other things, CGT event G3 occurs. Therefore, amendments will be made to the relevant provisions in Subdivision 165-CD to reflect the modifications to CGT event G3. [Schedule 8, items 5 to 7, paragraph 165-115GB(1)(b), subsection 165-115H(2) and section 165-115N]
Regulation impact statement
Background
8.27 Currently, a liquidator of a company can declare shares in the company to be worthless for CGT purposes. The declaration causes CGT event G3 to happen and permits shareholders to choose to make a capital loss in respect of their shares.
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- Subsection 104-145(1) of the ITAA 1997 specifies that CGT event G3 happens if a taxpayer owns a share in a company and its liquidator declares in writing that he or she has reasonable grounds to believe (at the time of the declaration) there is no likelihood that the shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution in the course of winding up the company.
8.28 Where a company appoints an external administrator, other than a liquidator, shareholders can only cause a CGT event (CGT event E1) to happen by creating a trust over the shares.
Policy objective
8.29 The objective is to allow taxpayers to more easily claim a capital loss on their worthless shares or financial instruments.
Implementation options
8.30 Given the framework for CGT event G3 and the nature of the representations from taxpayers, only one broad implementation approach was considered. That is, to amend section 104-145 to allow a wider range of insolvency practitioners to be able to make the relevant declaration in relation to shares or financial instruments.
8.31 However, insolvency practitioners other than administrators and liquidators are often appointed for a short period of time or for a specific purpose and are not usually in a position to make a declaration. As a result, it was considered that it would not be viable for practitioners other than administrators and liquidators to make the declaration, so only the option of allowing administrators and liquidators to be able to make the relevant declaration has been considered further.
8.32 These amendments will apply to declarations made by liquidators or administrators after the date of Royal Assent of this bill.
Assessment of impacts
8.33 These amendments are expected to impact on taxpayers that are shareholders and holders of financial instruments in companies under external administration. The class of taxpayers potentially affected include individuals, superannuation funds, trusts and companies.
8.34 According to statistics provided by the Australian Securities and Investments Commission, in the 2000-2001 to 2002-2003 income years:
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- an average of approximately 2,575 companies per annum appointed a voluntary administrator; and
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- an average of approximately 717 companies per annum entered into a deed of company arrangement.
8.35 The average voluntary administration lasts for 28 days (as required by the Corporations Act 2001) before the company either moves into liquidation, enters a deed of company arrangement or resumes trading. A deed of company arrangement can last for many years.
8.36 There will be an unquantifiable cost to revenue which is not expected to be significant.
8.37 As a result of these amendments, liquidators and administrators will incur additional costs in determining whether there are reasonable grounds to declare shares or financial instruments to be worthless and in making the appropriate declarations. The level and extent of these costs is uncertain. However, as some administrators made representations seeking the change, the additional costs involved are not expected to be significant.
8.38 The Australian Taxation Office (ATO) may incur some additional administration costs to implement the amendments. For example, the ATO will need to ensure that call centre staff and provision of advice staff are aware of the changes. In addition, the ATO website, CGT publications, an ATO fact sheet and a tax determination may need to be updated. These costs are not expected to be significant.
8.39 The implementation option will allow a liquidator or administrator to be able to declare shares or financial instruments in a company worthless for CGT purposes. The declaration will enable taxpayers who hold relevant shares and financial instruments to claim a capital loss without having to incur the cost of establishing a trust. This will reduce compliance costs for affected taxpayers. In this regard, commercial organisations who assist taxpayers to establish a trust over worthless shares typically charge an administration fee of between $70 and $150 per transaction.
Consultation
8.40 Representations were made to the Government seeking a modification to the current law to allow administrators to make a declaration that shares and financial instruments are worthless for CGT purposes. The representations were made by individuals who hold shares in companies that have had an administrator appointed, Members of Parliament on behalf of those individuals, media representatives, accountants and administrators.
8.41 Draft legislation to implement the measure was released on a confidential basis to CPA Australia, the Institute of Chartered Accountants in Australia, the National Tax and Accountants' Association, Deloitte Touche Tohmatsu and Ferrier Hodgson.
8.42 Stakeholders generally supported the proposed measure. Some stakeholders suggested that a wider range of insolvency practitioners should be able to make a declaration, but this was not considered to be practical for the reasons indicated earlier.
Conclusion and recommended option
8.43 This measure will reduce net compliance costs for affected taxpayers at little cost to the revenue and therefore is supported.
8.44 The Department of the Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system, on an ongoing basis.