What is Capital Gain?
Questions:
Case study 1: Capital Gains Tax Dave Solomon is 59 years of age and is planning for his retirement. Following a visit to his financial adviser in March of the current tax year, Dave wants to contribute funds to his personal superannuation fund before 30 June of the current tax year. He has decided
to sell the majority of his assets to raise the $1,000,000. He then intends to rent a city apartment and withdraw tax-free amounts from his personal superannuation account once he turns 60 in August of the next year. Dave has provided you with the following details of the assets he has sold:
(a) A two-storey residence at St Lucia in which he has lived for the last 30 years. He paid $70,000 to purchase the property and received $850,000 on 27 June of the current tax year, after the real estate agent deducted commissions of $15,000. The residence was originally sold at auction and the buyerplaced an $85,000 deposit on the property. Unfortunately, two weeks later the buyer indicated that he did not have sufficient funds to proceed with the purchase, thereby forfeiting his deposit to Dave on 1 May of the current tax year. The real estate agents then negotiated the sale of the residence to
another interested party.
(b) A painting by Pro Hart that he purchased on 20 September 1985 for $15,000. The painting was sold at auction on 31 May of the current tax year for $125,000.
(c) A luxury motor cruiser that he has moored at the Manly Yacht club. He purchased the boat in late 2004 for $110,000. He sold it on 1 June of the current tax year to a local boat broker for $60,000.
(d) On 5 June of the current tax year he sold for $80,000 a parcel of shares in a newly listed mining company. He purchased these shares on 10 January of the current tax year for $75,000. He borrowed $70,000 to fund the purchase of these shares and incurred $5,000 in interest on the loan. He also paid $750 in brokerage on the sale of the shares and $250 in stamp duty on the purchase of these shares. Dave has contacted the ATO and they have advised him that the interest on the loan will not be an allowable deduction because the shares are not generating any assessable income. Dave has also indicated that his taxation return for the year ended 30 June of the previous year shows a net capital loss of $10,000 from the sale of shares. These shares were the only assets he sold in that year.
(a) Based on the information above, determine Dave Solomon’s net capital gain or net capital loss for the year ended 30 June of the current tax year.
(b) If Dave has a net capital gain, what does he do with this amount?
(c) If Dave has a net capital loss, what does he do with this amount?
Capital gain is not only for rich peoples, it is also for middle class peoples who are holding any capital asset and sale it during the year. It is just one of the other source of income like income from salary, income from house property and other sources (Burkhauser, Hahn, and Wilkins 2015). Capital gain in Australia is determined as per various guidelines given by Australian Tax Authority (ATO).
How is Capital Gain calculated?
Capital gain is the difference between Net sales Consideration and Cost of Acquisition. It is derived from deducting Cost of Acquisition from Net sales Consideration. Net sales consideration is obtained by subtracting expenses on sale from Gross sales consideration. Cost of acquisition includes all other charges required for bringing the asset into existence (Harding 2013). Capital gain is taxable in the year in which asset is sold
Capital asset means any asset, which is not held in the ordinary course of business for sale. It does not include personal property held like clothes, furniture etc. However, jewellery and archeological collection is not included in the definition of capital asset (Alvaredo et al. 2013).
Capital assets are of two types:
- Short-term Capital asset- Capital asset held for less than 12 months.
- Lon Term capital Asset- Capital asset held for more than 12 months
According to ATO, There are three methods for computing capital gain:
- Indexation method- This method is applied if capital asset is acquired before 21st Sept 1999 and is a long term capital asset. In this method Customer Price Index (CPI) is used for computing capital gain. Indexation benefit is available until Sept 1999.
- Discount method- This method is applied long-term capital asset acquired after 21st Sept 1999 and is a. 50% discount for individual and 33.33% for super endowment fund.
- Residual method- This is applied for gain derived from sale of short-term capital asset (Woellner et al. 2012).
There are various capital assets, gain on sale of which is exempted from capital gain tax, such as residential house, motor car, collectables valuing less than $ 500, personal affect items etc.
(a)
In this problem, Mr. Dave sold his residential house for $ 850000 in the current year, which he purchased almost 30 years back for $ 70000. Advance money forfeited because of previous agreement is treated as income from other source as per ATO.
Mr. Dave is not liable to pay CGT on sale of two-storey residence as capital gain on sale of residential house is exempted since he has lived there for more than 5 years.
b)
Painting was sold for $125000 in the current year, which was purchased for $ 15000 almost 30 years ago. Indexation method will be applied here since it was acquired before 21st September 1999
|
Net sales Consideration |
125000 |
|
|
Less: |
Indexed Cost of Acquisition (15000*123.4/71.3) |
25961 |
|
Long Term capital gain |
99039 |
(c)
Motor Cruiser, was sold in the current year for $ 110000 that was purchased in 2004 for $ 60000. Discount method shall be applied here as it was acquired after 21st September 1999,
|
Net sales Consideration |
60000 |
|
|
Less: |
Cost of acquisition |
110000 |
|
Long Term capital Loss |
50000 |
(d)
Shares that was sold on 10th January of the current year and was acquired in 5th June of the current year. Therefore, the shares are short term as it were held for less than 12 months and so residual method will be applied.
|
Gross Sales Consideration |
80000 |
|
|
Less: |
Brokerage |
750 |
|
Net Sales Consideration |
79250 |
|
|
Less: |
Cost of acquisition |
75000 |
|
Stamp duty on purchase |
250 |
|
|
Short Term Capital Gain |
4000 |
So, Total capital Gain of Mr. Dave is given below: $
Long-term capital gain on sale of
Residential House Nil
Paintings 150961
Long-term capital loss on sale of
Cruiser (50000)
Short-term capital gain on sale of
Shares 4000
Types of Capital Assets
Set off of Capital Loss bought forward from previous year (10000)
Long term capital gain 94961
Net Capital gain is the summation of all capital gain and loss derived during the year and after adjusting capital loss of previous year, which could not be set off during the previous year and so bought forward to the current year. Since, Mr. Dave has long-term capital gains of $ 94961 he is required to pay tax during the current year. He can also contribute toward personal superannuation fund. He has to preserve different credentials when any noteworthy operation occurs like transaction receipt, court case expenses, everyday expenditure relating to upkeep, expenses relating to stamp duty and brokerage on purchase or sale of capital asset, interest on loan taken to acquire capital asset (Faccio and Xu 2015).
Net Capital loss arises when capital loss during the year exceeds capital gain during the year or if there is no capital gain during the year. Capital loss can be set off only with capital gain and not with any other source of income. Short-term capital loss can be set off with short-term capital gain as well as long-term capital gain whereas long term capital gain can be set off only with long term capital gain and cannot be set off with Short term capital gain. Capital loss not set off during the year can be carried forward for indefinite period of time and set off only against capital gain and not from any other source. Assessee can’t decide on whether to set off his/her capital loss during the current year or not. If he has a capital loss then he must set off if there is a capital gain otherwise the capital loss will be lapsed.
Conclusion
In short, it can be concluded that Capital gain is assessable as income of the year and Capital gain tax is payable on it. Mr. Dave is required to pay capital gain tax as he has capital gain during the year. He can also adopt various tax planning and save payment of CGT (Ehling et al. 2013). Capital gain tax is one of the major source of income of Australian Government.
References
Alvaredo, F., Atkinson, A.B., Piketty, T. and Saez, E., 2013. The top 1 percent in international and historical perspective (No. w19075). National Bureau of Economic Research.
Burkhauser, R.V., Hahn, M.H. and Wilkins, R., 2015. Measuring top incomes using tax record data: A cautionary tale from Australia. The Journal of Economic Inequality, 13(2), pp.181-205.
Ehling, P., Gallmeyer, M.F., Srivastava, S., Tompaidis, S. and Yang, C., 2013, December. Portfolio choice with capital gain taxation and the limited use of losses. In EFA 2008 Athens Meetings Paper.
Faccio, M. and Xu, J., 2015. Taxes and capital structure. Journal of Financial and Quantitative Analysis, 50(03), pp.277-300.
Harding, M., 2013. Taxation of dividend, interest, and capital gain income.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2012.Australian taxation law. CCH Australia.
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