Every time you sell a CGT asset, you make a capital gain unless of course you make a loss. But calculating this capital gain (or loss) is only the first part of the exercise. The second part is working out your net capital gain.
Net Capital Gain
Because it is your net capital gain that will hit your assessable income.
s102-5 (1): Your assessable gain includes your net capital gain (if any) during the income year.
It is your net capital gain that you pay income tax on. So-called ‘capital gains tax’.
But talking of capital gains tax we both know that there is actually no ‘capital gains tax’ as such. It is just a popular phrase to refer to the income tax you pay on the portion of your assessable income that is your net capital gain.
Now of course you already know how to calculate a net capital gain. But in the middle of the battle it is easy to forget a few steps along the way. It is easy to rush to the small business CGT concessions. To start adding up, counting and sorting.
And to completely forget the very first words of the basic conditions.
s 152-10 (1): A capital gain….
Part 1: Do you have a capital gain?
So this is the first part of the exercise. Do you even have a capital gain? Because if you don’t, Part 1 of the show is all you will see.
Step 1 – Is the asset a CGT asset?
The short answer is most likely ‘Yes’. Anything you find in a business is almost always a CGT asset.
You find the definition of a CGT asset in s108-5.
s108-5: A CGT asset is any kind of property or a legal or equitable right that is not property.
So that means pretty much anything – land, buildings, plant & equipment, trading stock, goodwill, patents, trademarks, shares, options, receivables, cars, a partnership interest, cash in Australian and foreign currency, cryptocurrencies like bitcoin and any unpaid present entitlements – all are CGT assets.
So what is not a capital asset you might wonder. There is actually not a lot. Any asset last acquired before 26 June 1992 and not an asset under former Part IIIA ITAA 36 is not a CGT asset. Whatever former Part IIIA was about. So let’s just assume you bought everything after the 26 June 1992. And deferred tax assets are not a CGT asset since not an equitable right at this stage.
Collectables and personal use assets are CGT assets. But they fall under slightly different rules set out in Subdivision 108-B and C. A small business is less likely to have collectables or personal use assets. So we will ignore those here.
So why is all this relevant? The obvious answer is that without a CGT asset you can’t have a capital gain. But there is another reason. And that reason sits in the maximum net asset value test. You include all CGT assets in the maximum net asset value calculation, whether they fall under the CGT provisions or not. But for now the main point is that all business assets are usually CGT assets apart from a deferred tax asset.
Step 2 – Does an exemption apply?
Even though pretty much anything is a CGT asset, not everything is treated as a CGT asset for tax purposes. There are some assets that are explicitly excluded for CGT purposes.
Trading stock (covered by Div 70) is specifically disregarded for CGT purposes.
s118-25 (1) (a): A capital gain or capital loss you make from a CGT asset is disregarded if, at the time of the CGT event, the asset is… your trading stock…
Plant & equipment is depreciated under Div 40 and also specifically disregarded for CGT purposes.
s118-24: (1) A capital gain or capital loss …from a … depreciating asset is disregarded…where the decline in value of the asset was worked out under Division 40…(2) However, subsection (1) does not apply to…a capital gain or capital loss you make from CGT event J2 or CGT event K7 …
The same applies to patents, but not to trademarks. The definition of intellectual property in s40-30(2) ITAA97 does not include trademarks.
And you also disregard a capital gain or loss from a car, motorcycle or similar vehicle for CGT purposes. The same applies to medals awarded for valour or brave conduct.
s118-5:A capital gain or capital loss …from any of these CGT assets is disregarded… a car, motor cycle or similar vehicle…a decoration awarded for valour or brave conduct…
Some assets fall under income provisions without a specific exclusion from the CGT provisions. In that case the anti-overlap provision kicks in. The anti-overlap rule says that a capital gain is only subject to CGT to the extent it is not otherwise taxable. This is what it sounds like:
s118-20 (1): A capital gain …is reduced if…a provision of this Act …includes an amount … in…your assessable income or exempt income; …
So the other income provisions have priority over the CGT provisions.
An example is foreign currency. Foreign exchange gains and losses are handled in Div 775. And so the moment a gain or loss falls under Div 775, it falls outside of the CGT provisions thanks to the anti-overlap rule.
So this often leaves goodwill, trademarks and real property as the big ticket items in the ‘CGT pot’.
Step 3 – Is it a post-CGT asset?
Anything acquired before 20 September 1985 is pre-CGT and not subject to CGT.
s149-10: A CGT asset …is a pre-CGT asset if…last acquired ..before 20 September 1985…
Goodwill is deemed to be ‘acquired’ at the start of the business. So if the business started after 20 September 1985, goodwill is a post-CGT asset. If it started before that day, goodwill is a pre-CGT asset since inherently connected with the business.
Step 4 – Is there a CGT Event?
Without a CGT event there is no capital gain and hence no need for a concession.
s100-20: You can make a capital gain or loss only if a CGT event happens.
But whether there is a CGT event or not is not enough. We also need to know which of the 54 CGT events it is. Because the small business CGT concessions don’t apply to all CGT events. Div 152 specifically excludes some CGT events. For example K7 and J2, J5 and J6.
CGT event K7 is about the balancing adjustment for depreciating assets. The small business CGT consessions don’t apply to K7. So ignore K7 for this exercise.
CGT events J2, J5 and J6 relate to the rollover provisions in Div 152-E when you park the capital gain for a replacement asset.
So you need to know what CGT event it is. The most common one is CGT event A1, a straight forward sale.
Step 5 – What are the capital proceeds?
Capital proceeds is pretty much anything you receive in return for the asset:
s116-20: The capital proceeds …are the total of…the money…and…the market value of any other property you have received or are entitled to receive in respect of the event happening (worked out as at the time of the event)…
On paper this is a simple exercise. But it can be tricky. When the proceeds include stock in a private company for example, you need to get a valuation of that private company. Or when the proceeds include options.
You apply the market value substitution rule in s116-30 if you didn’t deal at arms length or got a C2 event on your hands.
Step 6 – What is the cost base?
A CGT asset’s cost base has 5 cost base elements.
s110-25: The cost base of a CGT asset consists of 5 elements.
The first element is…the money you paid… and the market value of any other property you gave,…The second element is the incidental costs you incurred…The third element is the costs of owning the CGT asset you incurred (if acquired after 20 August 1991)…The fourth element is capital expenditure you incurred…The fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset…
You reduce the cost base by net input tax credits per s103-30. And you use the the market value substitution rule in s112-20 if the acquisition didn’t happen at arms’ length or was a barter transaction.
Step 7 – What is the capital gain?
This is now a simple subtraction of capital proceeds less cost base, and voila you have your capital gain.
s100-35: You make a capital gain if you receive capital amounts from the CGT event which exceed your total costs associated with that event.
Or your capital loss.
s100-35: You make a capital loss if your total costs associated with the CGT event exceed the capital amounts you receive (or are entitled to receive) from the event.
If you have a capital loss, then you know all you need to know. There is no second part for you. You offset this loss with current capital gains and if you don’t have enough, you wait. You do a capital loss carry forward to future years until you have sufficient capital gains to offset this loss.
If you have a capital gain on the other hand, then eventually this capital gain will hit your assessable income as a net capital gain. But you don’t want that. Because it means that you pay tax on it. So you look at ways to reduce your capital gain. And this is what happens in Part 2.
Part 2: Do you have a net capital gain?
This second part can take you on a long journey. It can take you past capital losses, through the 50% CGT discount, on a huge detour via the small business CGT concessions, before you finally reach your net capital gain. This second part is mapped out in the so-called method statement in s102-5:
Method Statement in s102-5
You work out your net capital gain in this way:
Step 1. Reduce the capital gains …by the capital losses you made during the income year.
Step 2. Apply any previously unapplied net capital losses from earlier income years
Step 3. Reduce by the discount percentage [Div 115]
Step 4. If any .. capital gains qualify for …the small business concessions in Subdivisions 152-C, D and E, apply those concessions
Step 5. Add up the amounts of capital gains (if any) remaining after Step 4. The sum is your net capital gain for the income year.
“Reduce the capital gains by the capital losses” – this is how it starts. But before you do this, you need to quickly leave the room and check out something else – the 15-year exemption.
Step 0 – Held for more than 15 years?
There is a fork in the road now. Which way you turn depends on how long you held the CGT asset.
More than 15 years and you go straight to Subdiv 152-A and more importantly Subdiv 152-B. If you hit the 15-year exemption jackpot, you walk away with the entire capital gain tax-free. If you don’t, you come back here and keep going.
Step 1 – Are there any current capital losses?
So now we start looking at capital losses. The ones you put aside in Part 1.
The fact that we looked at the 15-year exemption before all this, is important. It means that if you hit the 15-year exemption jackpot, you don’t need to use up any of your capital losses. But that only applies to the 15-year exemption. For everything else, you first look at capital losses.
Remember the method statement in s102-5? This is the first step.
s102-5: You work out your net capital gain in this way:
Step 1. Reduce the capital gains …by the capital losses…during the income year.
Given all the work you did in Part 1, this is a relatively easy step. If your current capital losses wipe out your current capital gains, you can stop here. Your net capital gain is nil.
Step 2 – Are there any carried forward capital losses?
If you still have a capital gain left, you move to any capital losses from prior income years.
Step 2. Apply any previously unapplied net capital losses from earlier income years
So you don’t get a choice. You always need to first use up your current capital losses before you can start tapping into prior year capital losses.
There is one exception to all this. If you become bankrupt during the income year, then you disregard any prior year net capital losses.
If you still have a capital gain on your hands after applying your prior year capital losses, you keep going.
Step 3 – Does the 50% discount in Div 115 apply?
So this is how the method statement continues:
s102-5: Step 3. Reduce by the discount percentage [Div 115]
For an individual or trust, this discount percentage is 50%, for a superannuation fund it is 33%. If…and this is a big if…If held for more than 12 months .
s115-25: To be a discount capital gain, the capital gain must result from a CGT event … acquired …at least 12 months before the CGT event.
For a company, you can skip this step. Companies do not receive a Div 115 discount.
Step 4 – Do the small business CGT concessions in Div 152 apply?
Four words – and so much depending on these four words: Small Business CGT Concessions.
s102-5: Step 4. If any .. capital gains qualify for …the small business concessions in Subdivisions 152-C, D and E, apply those concessions
Sounds simple. But to get there is like a trip to the moon and back.
Did you notice how it refers to Subdivisions C, D and E, but not Subdivision 152-B. That is because we already looked at the 15-year exemption.
Step 5 – What is your net capital gain?
So now you add everything up, and finally get your net capital gain. You finally know what will hit your assessable income. Here are the final words of the method statement:
s102 -5: Step 5. Add up the amounts of capital gains (if any) remaining after Step 4. The sum is your net capital gain for the income year.
MORE
Improving the Small Business CGT Concessions ED
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Last Updated on 23 March 2020
