Senate

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 2.4 - CGT events

Overview

Division 104 catalogues all of the various categories of CGT events that can result in a capital gain or loss and establishes the basis on which the gain or loss is calculated in each case.

Part A summarises the rules.

Part B explains the changes to the 1936 Act.

Part C explains why some provisions of the 1936 Act have not been rewritten. Part D provides cross references to all CGT events.

A. Summary of the new law

Guide to Division 104: CGT events

What the division does

Division 104 lists all the events that may results in a capital gain or capital loss. It also specifies for each kind of event:

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how to calculate the amount of any gain or loss;

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the time of the event, which in turn determines when the gain or loss is made; and

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cases in which gains or loss are disregarded for CGT purposes.

Summary of CGT events

The Division includes as a Guide a table which lists the CGT events, identifies when each event occurs and sets out how a capital gain or loss is calculated. [section104-5]

Calculating a capital gain or loss

You make a capital gain if the money or property you receive because of a CGT event exceeds the associated costs; and you make a capital loss if the money or property you receive because of a CGT event is less than the associated costs.

Exceptions

Certain capital gains and capital losses are disregarded. These fall into two broad categories:

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exclusions that are known at the time a CGT event happens (eg. if it is about an asset acquired before 20 September 1985);

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exclusions that arise at a later time (eg. title in an asset does not pass to an entity at the end of an agreement which allowed that entity to have use and enjoyment of the asset).

B. Discussion of changes

New Dictionary terms

Change

Section 995-1 of the Income Tax Assessment Act 1997 will be amended to insert additional definitions in the Dictionary. Some of the changes in terminology affect the operation of the law. These changes are explained in the notes that follow the table below.

Explanation

The definitions, and their equivalents in the old law, are identified and commented on in the table.

General changes

CGT events

The CGT provisions of the 1936 Act apply where there is a disposal of an asset acquired after 19 September 1985. They also apply to a range of events that do not involve the disposal of an asset. The approach of the 1936 Act is to fit the law to these events as if they were about the disposal of an asset (by deeming them to be disposals). This has produced additional layers of complexity.

Rather than continue this approach, the rewritten provisions apply CGT to events on the basis of their true nature. This makes clear much that is obscured in the 1936 Act.

As well, all CGT events are now listed at the start of the CGT provisions so that taxpayers can readily establish how the rules apply to their situations.

Clarification of timing rules

The 1936 Act is not always clear about when a disposal or a deemed disposal actually happens and when a capital gain or a capital loss occurs. The rewritten provisions identify when each CGT event happens. The following table identifies events where the uncertainty about timing has been remedied.

Section 104-70 Capital payment for trust interest: CGT event E4

This section treats the payment by a trustee of a non-assessable amount to a beneficiary for a trust interest as a CGT event. This may result in a capital gain or a cost base adjustment to the beneficiary's trust interest, but does not result in a capital loss.

1. Change

CGT event E4 does not apply to payments subject to withholding tax.

Explanation

Technically, the 1936 Act could apply to payments subject to withholding tax even though these amounts have already been taxed.

2. Change

Provide for annual cost base adjustments.

Explanation

Taxpayers with interests in trusts are currently required to reduce the cost base of the interest each time they receive a non-assessable distribution. This can cause an excessive compliance burden.

3. Change

Treat payments in kind in the same way as money payments.

Explanation

Broadly, under the 1936 Act, if a trustee pays an amount to a beneficiary the cost base of their trust interest is reduced by the payment. It is ambiguous as to how payments in kind should be treated. The rewrite ensures consistent treatment.

4. Change

CGT event E4 does not apply to an amount that has been assessed to the trustee.

Explanation

Strictly speaking, the old law could have inappropriately applied Part IIIA to such a transaction.

Section 104-80 Disposal to beneficiary to satisfy income right: CGT event E6

This section treats as a CGT event the disposal of a trust asset by the trustee to a beneficiary in satisfaction of the beneficiary's right to receive trust income.

Change

Specify that the trustee makes the capital gain or loss at the time of disposal.

Explanation

The 1936 Act is silent on timing.

Section 104-85 Disposal to beneficiary to satisfy capital interest: CGT event E7

This CGT event covers the disposal of a trust asset by a trustee to a beneficiary in satisfaction of an interest of the beneficiary in the trust capital.

Change

The trustee makes the capital gain or loss at the time of disposal of the asset to the beneficiary.

Explanation

The present law is silent on timing.

Section 104-90 Disposal by beneficiary of capital interest: CGT event E8

This section treats as a CGT event the disposal by a beneficiary of a capital interest in a trust.

Change

Clarify that this does not apply to the disposal of a trust interest acquired before 20 September 1985.

Explanation

This clarification is consistent with administrative practice.

Section 104-120 Lessor pays lessee to have lease changed: CGT event F3

This CGT event, which gives rise to a capital loss only, is where a payment is made by a lessor to a lessee to have a lease changed.

1. Change

Specify that the lessor makes the capital loss when the lease is changed.

Explanation

The 1936 Act is silent on timing.

2. Change

Clarify that the event can apply even if the lessee entered into the lease before 20 September 1985.

Explanation

The present law is unclear in these circumstances.

Section 104-130 Lessor receives payment for changing lease: CGT event F5

The receipt of an amount by a lessor for agreeing to change a lease is a CGT event.

1. Change

Specify that the lessor makes the capital gain when the lease is changed.

Explanation

The 1936 Act is silent on timing.

2. Change

Clarify that the event only applies if the lease was granted, or an extension or variation of the lease began, after 19 September 1985.

Explanation

The 1936 Act is unclear about this timing link.

3. Change

Clarify that the capital gain or loss is the difference between the amount received for agreeing to the change and any expenditure incurred in relation to the variation.

Explanation

The present law does not say how to calculate the gain or loss.

Section 104-135 Capital payment for shares: CGT event G1

Under this section a payment of a non-dividend amount is a CGT event which can result in a capital gain or a cost base adjustment for the share, but not a capital loss.

1. Change

Treat payments in kind in the same way as money payments.

Explanation

Under the 1936 Act, where a company pays an amount to a shareholder the cost base of their share is reduced by the payment. It is appropriate that payments in kind should have the same effect as cash payments.

2. Change

Align the treatment of interim liquidation distributions with that of final distributions if the company is dissolved within 18 months from the interim payment.

Explanation

It is clear that a finalliquidation distribution is paid as a result of the cancellation of the share and is taken into account in calculating whether a capital gain or loss is made when the share is cancelled. It is unclear whether an interim distribution is accounted for immediately, under the cost base reduction rules, or when the shares are cancelled.

Under the rewritten law, all liquidation payments, whether interim or final, that culminate in the dissolution of the company within 18 months will be accounted for under CGT event C2 (cancellation etc. of a CGT asset).

If winding-up does not occur within 18 months, the interim payment will come within CGT event G1 and reduce the cost base of the shares as at the time of payment. This prevents any long-term deferral of tax.

Section 104-145 Declaration by liquidator that shares worthless: CGT event G3

This section makes it a CGT event when a companys liquidator declares that there are reasonable grounds to believe that shareholders are unlikely to receive any further distribution on a winding-up of the company. This allows shareholders to take the benefit of capital losses.

1. Change

Specify that the capital loss equals the shares reduced cost base and that the cost base is then written down to nil.

Explanation

The rewritten section directly equates the capital loss with the reduced cost base of the shares. It then resets the cost base to nil for the calculation of the capital gain or capital loss on a later disposal or cancellation of the share.

2. Change

Clarify that a liquidators declaration may be made after a distribution has been made during a winding-up.

Explanation

The making of a winding-up distribution does not preclude a later declaration by the liquidator. If it did it would unnecessarily limit the scope of this event.

Section 104-150 Forfeiture of deposit: CGT event H1

This section treats as a CGT event the forfeiture of a deposit relating to a prospective purchase or other transaction.

1. Change

Include an example to illustrate the meaning of the term prospective purchase.

Explanation

The example is consistent with the interpretation given by the Full Federal Court in Federal Commissioner of Taxation v Guy (1996)
137 ALR 193 ; 96ATC 4520; (1996)
32 ATR 590 . The Court concluded that the term prospective purchase brought within its scope the forfeiture of a holding deposit, a deposit paid in connection with the grant of an option, or a negative pledge or right of pre-emption. The term does not extend to a deposit paid by a purchaser under an actual contract of purchase.

2. Change

Clarify that the CGT event happens on forfeiture of the deposit.

Explanation

This interpretation is consistent with the interpretation of the existing provisions in Guy's Case .

Section 104-180 Company in a sub-group leaves wholly-owned group after a roll-over

This section is an exception to CGT event J1 which applies where a company ceases to be a member of a wholly-owned group, while it still owns a CGT asset that was rolled-over when it was a member of that group. The exception is when a sub-group, including the company and the other parties to the roll-over, breaks off from the wholly-owned group.

Change

Clarify that the holding company of the sub-group cannot be the ultimate holding company of the wholly-owned group.

Explanation

On a literal reading of the provisions of the 1936 Act, it could be argued that the holding company of the sub-group can be the ultimate holding company of the wholly-owned group. It could allow a single company leaving a group to avoid the intended taxing point in relation to a previously rolled-over asset. That would negate the purpose of the provisions.

Section 104-205 Partial realisation of intellectual property: CGT event K1

This section identifies the partial realisation of an item of intellectual property as a CGT event.

1. Change

Clarify that CGT event K1 applies to:

damages received for infringement of intellectual property; and

an amount paid by the Commonwealth or a State or an authorised person for use of a patented invention.

Explanation

It is appropriate that the CGT treatment of intellectual property

should match the special income tax treatment of intellectual property (see Division 373 of Schedule 1 of this Bill). The rewritten section achieves this.

2. Change

Ensure that no capital gain or loss can arise, in the case of a grant of a licence of intellectual property, if the property was acquired before 20 September 1985.

Explanation

It is unclear whether the present CGT provisions relating to intellectual property apply to the grant of a licence of intellectual property acquired before 20 September 1985. Therewritten provision is consistent with administrative practice.

3. Change

Clarify that the subsequent grant of a right in respect of intellectual property acquired before 20 September 1985 does not result in that property being treated as having been acquired on or after that date.

Explanation

The deemed disposal and reacquisition mechanism in section 160ZZD of the 1936 Act changes the status of pre-CGT intellectual property to post-CGT property. The rewritten provision rectifies this unintended consequence.

Section 104-215 Asset passing to tax-advantaged entity: CGT event K3

This section deals with cases where an asset passes from a deceased person to a tax-advantaged entity.

Change

Specify that the time for determining the status of a tax-advantaged beneficiary is when the asset passes to the beneficiary.

Explanation

The 1936 Act is unclear whether the relevant time is:

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when the former owner died; or

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when the asset passed to the beneficiary.

The rewritten provision adopts the Commissioners interpretation of the law.

C. Provisions of the old law that have not been rewritten

Redundant provisions

The following provisions are redundant and have not been rewritten:

D. Cross references to all CGT events

This table identifies cross references to provisions that specifically refer to a CGT event.