Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Preventing a deduction and a capital loss arising from a single economic loss
Outline of Chapter
4.1 Schedule 4 to this Bill inserts new subsections 110-55(9) and 110-60(7) into the ITAA 1997. These subsections will ensure that a taxpayer cannot claim a deduction and a capital loss for the same economic loss if a CGT event happens to a CGT asset (including an interest in a CGT asset of a partnership).
Context of Reform
4.2 Under the existing law, it is unclear whether a taxpayer can obtain both a capital loss and a deduction for a net loss incurred on the realisation of a revenue asset that is not trading stock. A revenue asset in this context is one for which the taxpayer would return a net profit as assessable income or obtain a deduction for a net loss. An example of such an asset is a share held by a financial institution where the share is not trading stock, but is treated by the institution as an asset on revenue or income account.
4.3 A capital gain or capital loss made under the CGT provisions for a revenue asset is not, unlike trading stock, directly disregarded. Rather, the capital gain or capital loss on the revenue asset may be reduced to take into account an amount already recognised as assessable income or as a deduction. This prevents double taxation of a gain or double relief for a loss. The issue discussed in this Chapter relates to possible double relief for a loss.
4.4 Broadly, the reduced cost base of an asset (which is used for calculating a capital loss when the asset is realised) does not include an amount to the extent to which the owner has deducted or can deduct it. Among other things, such an amount includes an amount paid in respect of acquiring the asset and an amount of capital expenditure to increase its value.
4.5 Under the current law, it is not clear that a deduction for a net loss on realisation of a revenue asset represents the deduction of such an amount so as to be excluded from reduced cost base, and hence from the calculation of a capital loss on disposal of the asset.
4.6 For example, it has been argued that because only the net loss arising on realisation is deductible (and the acquisition cost and other capital costs are not themselves directly deductible), the deduction for the net loss does not represent the deduction of such amounts for the purposes of calculating the reduced cost base of the asset. Thus, it is contended that a capital loss can be obtained for an amount effectively deducted as a net loss under the revenue provisions.
A bank disposes of shares which it holds as revenue (non trading stock) assets. The shares were purchased on or after 20 September 1985 (post-CGT) for $100,000 and sold for $20,000. The bank cannot deduct the purchase price of the asset, but deducts the net loss ($80,000) realised on sale. The bank contends that it is also entitled to a capital loss of $80,000 representing the difference between the reduced cost bases of the shares ($100,000) and the capital proceeds on sale ($20,000).
4.7 A contrary view is that the deduction for a net loss under the revenue provisions is properly construed as a deduction of amounts paid in respect of acquiring the asset and other costs in respect of it, for the purposes of determining the reduced cost base of the asset. If this view is correct, this would mean that the bank in example 4.1 would be able to deduct the $80,000 net loss, but would not also make a capital loss for that amount.
4.8 Although the issue has not been judicially clarified, double relief for the one loss is clearly inappropriate. Clarification that double relief is not available is consistent with the policy approach to prevent loss duplication recommended in the Recommendations.
Summary of new law
4.9 The proposed amendments will ensure that the reduced cost base of a CGT asset (including an interest in a CGT asset of a partnership) will be reduced by any amount deducted (or would have been deducted but for the deferral rules proposed in item 15 of Schedule 4 of this Bill) as a result of the realisation of the asset.
4.10 However, no reduction will be made for an amount referable to some cost which could never have formed part of the assets reduced cost base. Further, no reduction will be required if, on a correct construction of the law, the amount is already excluded from the reduced cost base of the asset under another provision dealing with the reduced cost base of a CGT asset.
Detailed explanation of new law
4.11 New subsections 110-55(9) and 110-60(7) will ensure that the reduced cost base of a CGT asset (including an interest in a CGT asset of a partnership) will be reduced by an amount deducted (or that would have been deducted but for the deferral rules in Schedule 4 of this Bill) as a result of the realisation of the asset. [Items 2 and 3 of Schedule 4]
4.12 The reference to the entitys share of any amount that the partnership deducted or can deduct, or could have deducted except for Subdivision 170-D, is a reference to a partners individual interest in the net income or partnership loss relating to the deduction that the partnership has deducted, or can deduct, or could have deducted but for Subdivision 170-D. Ordinarily the partners share of that deduction will be the same as the partners interest in the overall net income or partnership loss, unless the partnership agreement suggests that a different proportion is appropriate.
4.13 The proposed subsections refer to a deduction which arises as a result of a CGT event that happens in relation to a CGT asset. Ordinarily, this CGT event will be a disposal of the CGT asset (CGT event A1). CGT events that do not trigger deductions for losses on revenue assets will not be relevant in this context.
4.14 Although strictly only a capital gain or capital loss is made as a result of the happening of a CGT event, the wording is intended to link together the revenue and CGT consequences of the realisation (e.g. a disposal) of a revenue asset, notwithstanding that the deduction and capital loss may arise at different times under the income and CGT provisions.
4.15 No reduction will be required for an amount which is relevant in calculating a net loss on realisation of a revenue asset, but which could never qualify as an element of an assets reduced cost base. This ensures that a capital loss is not inappropriately reduced by an amount of a deduction on realisation of the asset.
4.16 Further, no reduction of the reduced cost base will be required for an amount if, on a correct construction of the law, the amount is already excluded from the reduced cost base of the asset under another provision. This ensures that if a deduction for a loss on realisation of a revenue asset is, as a matter of law, a deduction of an amount otherwise qualifying as an element of reduced cost base, there will not be an inappropriate double reduction.
4.17 In limited cases, a capital loss and a deduction will still be appropriately obtained on the realisation of a revenue asset. This could occur, for example, if the reduced cost base of an asset exceeds its actual cost for the purposes of calculating a net loss on realisation (e.g. because of the operation of existing Subdivision 149-B of the ITAA 1997). However, under the new law, the same economic loss will not be recognised twice.
Application and transitional provisions
4.18 The proposed amendments will apply in respect of CGT events happening to CGT assets on or after 21October1999. [Subitem 19(1)]
4.19 This Bill specifically provides that the proposed amendments are to be disregarded in applying sections 110-55 and 110-60 of ITAA 1997,and subsections 160ZK(1) and 160ZK(3) of the ITAA 1936,to CGT events or disposals that happened before 21October1999. [Subitems 19(2) and 19(3)]
4.20 This means that the proposed amendments cannot, by inference, support a view under the current law that capital losses and deductions were available in respect of the same economic losses on the realisation of revenue assets.