Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
Chapter 2.1 - Structure of the CGT provisions
Overview
This segment describes the structure of proposed Parts 3-1 and 3-3 (capital gains and losses) of the Income Tax Assessment Act 1997.
Part A discusses why it was necessary to take a fresh approach to the rewriting of the capital gains and losses provisions and explains the underlying rationale for it.
Part B provides a brief outline of each of the Divisions that comprise the new parts 3-1 and 3-3. Fuller explanations follow in later segments of this Chapter.
Part C identifies provisions of the 1936 Act that are to be rewritten later.
A. The new approach
The aim of capital gains tax can be simply stated: to tax, as income, gains made on the disposal of assets and on the receipt of certain capital amounts. Theimplementation of that simple aim has previously been compromised by an unnecessarily complex approach to the presentation and expression of the law.
CGT applies to many events that do not, in fact, involve the disposal of an asset. However, the present law insists on treating each of those events as a disposal. Thisdeeming of something to be what it is not obscures the true scope of the tax and leads to a complex and highly artificial set of consequential deemings that can frustrate and mislead even experienced users of the law.
The rewritten provisions more clearly explain the operation of the law by applying CGT to these other events on the basis of their true nature. This will assist taxpayers to determine whether or not there is a liability to tax in particular circumstances.
For each event the provisions:
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- describe how a capital gain or loss can arise;
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- identify when the gain or loss arises;
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- specify how to calculate the amount of the gain or loss; and
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- identify specific exceptions that might apply.
Currently, all of this information is scattered throughout the law. In contrast, the rewritten CGT provisions bring it together in a logical and coherent way. As a result, the legislative intention is more simply and directly expressed.
The CGT provisions have been structured to try to make them as useful as possible to readers in identifying the rules that are relevant to their particular circumstances.
The new CGT structure is more accessible. Readers will find it easier to:
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- understand what the law requires;
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- identify the general principles of the law; and
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- follow a path to the provisions they need to know.
The new structure will be flexible enough to accommodate any future changes.
B. Outline of the Divisions in Parts 3-1 and 3-3
The rewritten CGT provisions are structured in two layers, ie. general topics that apply quite widely and special topics covering less frequently encountered situations. This streamlines the law and means that readers will not have to work their way through specialised provisions only to find that they do not apply to them. TheDivisions, and the provisions within them, are arranged so that readers are assisted to locate the rules that apply to their circumstances.
This layer has the general provisions which establish the scope of the CGT regime and cover a broad range of commonly found situations.
Part 3-1 begins with Division 100 - a Guide to capital gains and losses. Itgives an aerial view of the CGT provisions as an introduction.
Tells taxpayers how to work out whether they have a net capital gain or a net capital loss for the income year and if they do, what the consequences for them are. A net capital gainis included in assessable income under section 6-10 (statutory income). Division 102 thereby links the CGT provisions to the core provisions of the 1997 Act. Capital losses differ from other deductible amounts in that they can only be offset against current year or later capital gains.
Has those rules that apply generally across the CGT structure. These rules are concerned with such things as constructive receipts and payments, the translation of foreign currency and the making of choices permitted by the CGT provisions.
Describes each kind of event that call for consideration whether a capital gain or loss has arisen.
The CGT events are presented as a straightforward and comprehensive expression of actual events which may result in a capital gain or loss. The CGT event provisions describe what each kind of relevant event is, identify when it occurs and explain how to work out whether a capital gain or loss has been made.
All CGT events are presented in a consistent pattern to help regular readers become familiar with them.
The discipline of analysing the relevant elements of CGT events has helped to reveal grey areas in the 1936 Act and where possible the rewrite has addressed these. The clarifications and changes are identified in Chapter 2.4.
Sets out the cases where a capital gain or loss is made by someone other than the entity to which a CGT event happens. Entities affected by these rules include partnerships, bankruptcy trustees, company liquidators, trustees of certain categories of trusts, and holders of assets as security.
Deals with the three broad groups of assets relevant to working out capital gains and capital losses ie.:
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- CGT assets;
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- collectables (previously known as listed personal-use assets); and
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- personal use assets (previously known as non-listed personal-use assets).
It shows how capital losses from collectables and personal use assets are to be accounted for in working out whether there is a net capital gain or net capital loss.
This Division also sets out when land, buildings and property improvements are to be dealt with as separate CGT assets.
Contains rules about how and when a CGT asset is acquired.
Has the general rules for calculating the cost base and reduced cost base of a CGT asset. The cost base of a CGT asset is used to help determine whether a capital gain has been made when a CGT event has occurred. Thereduced cost base (reduced because it excludes all deductible expenditure or costs) is relevant when a capital loss is made.
Tabulates modifications to the cost base and reduced cost base. The modifications depend on the type of asset or the circumstances of the CGT event. The table allows taxpayers to readily identify whether a modification applies to them and provides signposts to the detailed rules about each kind of modification.
Has rules for working out what amounts of expenditure in the cost base of a CGT asset are indexed for inflation and when to index them. Generally, the cost base amounts are indexed only if the taxpayer had owned the asset for at least 12 months. Rules on how to index the cost base are set out in Subdivision 960-M.
Has rules for determining the capital proceeds (previously known as disposal consideration) from a CGT event. You need to know this to work out whether there is a capital gain or loss, by comparing the capital proceeds with the cost base or reduced cost base.
Sets out various exemptions and exceptions. Some allow taxpayers to disregard or reduce a capital gain. Others prevent a capital loss.
Sets out what records must be kept for CGT purposes and for how long they must be retained.
Part 3-3 and 3-5 - special topics
The second layer of the structure has rules of narrower application, such as those to do with deceased estates and non residents. Provisions specific to companies, such as those relating to intra-group dealings and share value shifting are also in Part 3-3.
This layer also has the provisions that deal with roll-overs which can allow the taxing point to be postponed. It also has specific rules for transactions in particular types of assets such as leases, options and other investments.
Provides the roll-over rules for the transfer of an asset to, or the creation of an asset (eg. by giving an option) in a company that is wholly-owned by the transferor or creator. The rewritten rules in this Division also deal explicitly with the transfer of all of the assets of a business to a company, as occurs when incorporating an existing business. A roll-over can be available to an individual or trustee, or to all the members of a partnership. There are same-asset roll-overs for assets transferred to a company and replacement-asset roll-overs for exchanges of assets for shares in a company.
Defines the circumstances in which most replacement asset roll-overs apply (the others are in Division 122) and sets out the tax consequences. Replacement asset rollovers defer the making of a capital gain or loss when, in specified circumstances, ownership of a CGT asset ends and a replacement asset is acquired.
Provides for a roll-over when ownership of a CGT asset changes or a CGT asset is created:
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- in circumstances of marriage breakdown; and
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- within a wholly owned group of companies.
It allows the capital gain or loss that would otherwise arise to be disregarded for the time being, and for certain CGT attributes of the asset to be transferred to the new owner.
The Division also allows a reduction in the capital gain or capital loss a company makes when shares in its wholly owned subsidiary are cancelled on liquidation.
Sets out the CGT consequences for assets that pass on death.
Has specific rules for investments such as bonus shares and units, rights and options, convertible notes and shares acquired under employee share schemes.
Has specific rules to do with leases.
Has specific rules about options that are not covered in Division 130.
Applies the CGT provisions to non-residents and limits their application to assets which have a necessary connection with Australia (previously known as taxable Australian assets). This Division also contains rules for the treatments of assets of non-residents who become Australian residents.
Has rules guarding against arrangements known as share value shifting that have the effect of reducing or deferring CGT on shares.
Explains how majority changes in underlying ownership of companies or trusts can require a pre-CGT asset to be treated as a post-CGT asset.
Rules dealing with the losses of companies, presently included in Part IIIA of the 1936 Act, have been relocated to parts of the 1997 Act that already contain rules with common elements.
Provisions in Parts 3-1 and 3-3 also draw on the general concept of indexation in Subdivision 960-M and on defined terms listed in the Dictionary [Division 995] .
Subdivisions 165-CA, 165-CB, 170-B, 175-CA and 175-CB (Part 3-5)
Provide the rules for company net capital losses, including the rules for transferring net capital losses between companies that are members of the same wholly-owned group. These Subdivisions also contain the rules for working out a companys net capital gain for a year in which there is a change in majority ownership or control and the company does not satisfy the same business test; and anti-avoidance provisions relating to capital losses of a company.
C. Provisions of the old law that have not been rewritten
This Bill does not contain rewrites of provisions dealing with small business roll-overs and the small business retirement exemption. Provisions dealing with these areas of CGT were enacted by Taxation Laws Amendment Act (No. 1) 1997 and Taxation Laws Amendment Act (No. 3) 1997 . Extension of the roll-over is proposed by Taxation Laws Amendment Bill (No. 5) 1997.
The Bill also does not contain a rewrite of provisions dealing with value shifts between companies under common ownership.
These areas of the law are to be further reviewed by the JCPAA and will be included in the 1997 Act at a later date.