Taxation Mid-Semester Exam Notes: Lecture weeks 1-4

Lecture 1

What is tax?
OECD (Organisation for Economic Cooperation and Development) defines
tax as: compulsory, unrequited payments to general governments. Taxes
are unrequited in the sense that benefits provided by government to
taxpayers are not normally in proportion to their payment.

Why tax?
- The overall purpose of taxation is to raise revenue
- The goods and services the government provides should affect the
amount of revenue raised. The government provides or subsidises
social goods and merit goods.
Social Goods (or Public Goods): are subject to joint consumption use
by one person does not reduce others ability to access the good. They are
non-excludable, as in you cannot effectively exclude someone from the
good. Examples include: fresh air, street lighting, knowledge, parks, open
source software.
Merit Goods: are based on need. They are goods/services that society
considers should be provided on the basis of need and not the ability to
pay. Many merit goods have positive externalities and examples include
health care, food stamps and education.
Other reasons to tax:
Social engineering the government trying to change peoples behaviour,
for example: higher taxes on Alco pops or cigarettes. This does have
problems such as undesirable side effects rather than buy Alco pops,
youngsters buy pure spirits, or people buy cigarettes and have more
health problems they can now not afford.
Correct free-market imperfections if the allocation of goods/services in
free market is not efficient.

What makes a good tax?

1. SIMPLE: Measured in the compliance costs of the tax for example,
paying a tax agent. Also the administrative costs to government to
administer the tax. The tax should be simple enough that the
taxpayer is aware of their obligations and know how much they
have to pay.
2. EQUITABLE:
- Vertical equity: Those in different positions should be treated (taxed)
differently. In Australia we have progressive taxation, the income
tax rate increases as income increases.
- Horizontal equity: Those in similar positions should be taxed in the
same way, for example those with different types of income should
be taxed at the same rate as it is still the same amount of income
if two people earn $40,000 a year they would be taxed at the same
rate even if one person had four children to support. Horizontal
equity does not account for anything but amount of income.
3. EFFICIENT: Decisions should not be influenced by tax, tax should be
neutral. However, sometimes the government deliberately tries to
influence behaviour through tax. Also, tax is often the highest cost
of a business and so will obviously affect decision-making.
History of Taxation
England:
- Modern tax introduced in 1842 schedular system where different
classes of income taxed under different rules.
Australia:
- Income tax introduced in Australia in 1915 (due to WW1) Income
Tax Act 1915 (Cth).
- This did not follow the English taxation system but did not reject it,
all income taxed under the same act and at the same rate.
Constitutional Background: taxation is a concurrent power both
federal and state can tax.
Commonwealth tax: income tax and goods and services tax (GST), both
administered by the Australian Tax Office (ATO).
State taxes: Indirect taxes land tax or stamp duty, administered by the
Office of Sate Revenue (OSR).
Vertical Fiscal Imbalance: federal taxes raise the most revenue but
the Cth must distribute some of this to the states.

Sources of tax law

Legislation: Income Tax Assessment Act 1936 (Cth): ITAA36
Income Tax Assessment Act 1997 (Cth): ITAA97 if it is this act it will have
divisions, the first number will be the division. * means that there is a
definition in the dictionary section.
There is currently a tax law improvement project to rewrite the 1936 Act
and make it easier to understand but it has not been fully completed.
Other Legislation:
- Income Tax Rates Act 1986 (Cth)
- Fringe Benefits Tax Assessment Act 1986 (Cth) (FBTAA)
- A New Tax System (Goods and Services Tax) Act 1999 (Cth)
- Taxation Administration Act 1953 (Cth)
Case Law:
- Decisions of courts, interpretation of legislation via doctrine of
precedent.
Taxation Office Rulings:
- ATOs interpretation of the law secondary source of law.
- May not be held to be correct in court, but the Tax Office is bound
by its rulings not binding on the taxpayer but they are put on
notice that they will be taken to court.
- Private rulings: Particular taxpayer.
- Public rulings: Area of tax law and not an individual person.
- Determinations: Question asked on a specific scenario.
- Guidelines: Fact sheets etc.

Who must pay Income Tax?

Income tax is payable by each individual and company, and by some other
entities.
- Residents are taxed on their worldwide income (subject to
exceptions).
- Non-residents are only taxed on their Australian source income
(subject to exceptions).

How much Tax?

Income tax = (Taxable Income x Rate) Tax Offsets (s4-10 ITAA97)
Taxable Income = Assessable income Deductions (s4-15 ITAA97)
Assessable Income = Ordinary Income + Statutory Income (s6-1 ITAA97)

Income Examples
Ordinary Income: Income according to ordinary concepts, for example
salary and wages, and business income.
Statutory Income: Income that is specifically included in a provision of
legislation, for example, net capital gain.
Exempt Income: Exempt from income tax by a provision of Act, for
example, certain scholarships/ compensation from personal injury.
Non-assessable non-exempt income: certain parts of employment
termination payments/ foreign non-portfolio dividend (non-portfolio =
owns less than 10%).

Deductions: general and specific

Offsets: More valuable than deductions.

Calculating Tax payable:

1. Calculate assessable income

2. Calculate deductions
3. Calculate taxable income
4. Multiply taxable income by relevant tax rates
5. Calculate tax offsets
6. Calculate Income tax liability
7. Calculate Medicare levy (and surcharge if relevant)
8. Calculate Flood Levy (if 2011-12)
9. Calculate HELP Repayments (if relevant)
10.Calculate total income tax/ Medicare/ HELP

Company tax rate is a flat rate of 30% regardless of income or

residency

Tax returns and assessment: There is a requirement to lodge an annual

tax return s161(1) ITAA36. This includes companies and individuals there
are limited exemptions for individuals.
The ATO processes return based on the information given by the taxpayer.
They provide the taxpayer with a notice of assessment showing tax
refundable or payable. Return may be reviewed at a later date (normally
two years for individuals).

Lecture 2

Ordinary Income Income according to ordinary concepts.

Types: Income from personal exertion, Income from business, Income from
property.

Competing concepts of income

- Accounting concept: Income arises from commercial activities,
revenue expenses = profit.
- Economic concept: Income = consumption + change in wealth
(savings). Leads to problems with unrealised wealth and
consumption may not be paid for.
 - Judicial concept: Income is what comes in (Liquidator North Sydney
Investment and Tramway co v CT (NSW)(1898)). Flow vs. gain
income is a flow and profit is a gain.

Income propositions: developed from past cases (precedent not

statute)
Negative propositions (amounts that are not ordinary income)
1. Amounts not convertible into money must be either money
or convertible into money to be income.
- Cooke & Sherden: non-transferable holiday prize that could not be
changed into money not considered income. Income is what comes
in, it is not what is saved from going out.
- Tennant v Smith: Security guard given rent-free accommodation not
considered ordinary income as not transferrable into money. Not on
what saves his pocket, but on what goes into his pocket.
- Payne v FCT: KMPG worker transferred frequent flyer points to a
flight for parents through work, they were not considered income.
2. Ordinary Income does include amounts of capital capital
can only be considered through statutory provisions.
- Gaining rent vs. selling a house. Rent would be income whereas
selling the house would be a capital gain.
- Dixons criteria: Sun Newspapers case payment to restrict
publication by rival publisher. Distinction between business
structure set up to earn income and process by which income is
earned.
1) Character of advantage sought: lasting qualities may play a part.
2) Manner in which it is to be used, relied upon and enjoyed:
recurrence may play a part.
3) Means adopted to obtain it: Periodic payment or one-off payment
for future use or enjoyment?
- Fruit and tree analogy: Eisner v Macomber 252 US 189 (1920). The
tree represents capital and the fruit represents the income from the
tree. Payment for sale of tree or compensation for its destruction
would be capital. Payment for fruit or compensation for damage of
fruit would be income.
- California Copper Syndicate Ltd v Harris (1904): The amount from
sale of land was income as it was always the companys intention
to profit from the land. They did not use the land for mining as
intended, they only sold it for a profit and so it can be considered
income. Was the gain made by realizing the value of the asset
(capital), or was it from carrying on business in a scheme of profit
making.
- For example, the sale of shares. They could be sold by a passive
investor in which case the proceeds from sale will be capital.
Conversely, they could be sold by a share trader income.
- Fixed and circulating capital: accounting distinction between
fixed and working capital
- Current (circulating assets): cash or other assets to be consumed or
converted into cash within 12 months.
- Non-current (fixed) assets: all other assets.
- Sale of current assets = revenue or income
- Sale of fixed assets = capital
- Memorex Pty Ltd v FCT: leased computer equipment and sold
equipment at the end of the lease. Court argued it was income as
 it was an inevitable part of the business. The decision was reached
based on the characteristics of the business.
- Why is income vs. capital important? Pre 1985 there was no
capital gains tax, capital receipts were not included in income. Now,
they are included in income via CGT provisions, but there are
various exemptions and concessions.

Application of Capital v Income:

License and know-how payments
- Knowledge is not property, Brent v FCT (1971): sale of husbands
life story, considered ordinary income as no asset was sold.
- If patent or copyright involved, sale of exclusive rights will normally
be capital (but not always).
Grants of licenses
- Murray v ICI Ltd (1967): Three types of licenses
1) Ordinary (non-exclusive license): Income
2) Exclusive license: capital
3) Sole license: grey area to what extent are the grantors rights
to earn income restricted.
Restrictive covenants
- Agreement not to divulge information/ not to work for a competitor/
not to operate in set radius etc.
- Can be capital or income, depends on the length of the restriction
does it affect process or structure.
- Dickenson v FCT (1958): 10 year agreement for petrol station to
only sell Shell petrol capital.
- Higgs v Olivier (1951): 18 month agreement for Lawrence Olivier
not to act in films capital.
-
Cancellation of agreements compensation
- What is the size of the contract? Does losing the contract result in
loss of organizational structure?
- California Copper Products Ltd v FCT (1934) cancellation resulting
in termination of business capital.
- Kensall Parsons & Co v IRC (1938) cancelled contract minor part of
taxpayers business income.
Compensation for injury
- What is the compensation for?
- If it is for permanent impairment: Tinkler v FCT (Capital).
- If its is to compensate for loss of earnings: FCT v Smith (1981)
(Income).
- Unliquidated damages (lump sum): McLaurin v FCT (1961) (capital).
3. Gifts unrelated to employment, services or business do not
have the character of income.
- Squatting Investment Co Ltd: Gifts v Mere gift mere gift unrelated
to earning activities
- Voluntary payments that are related to business will be income
(tips).
- Presumption is that gifts will not be income: Hayes v FCT.
- Scott v FCT: Gift of 10,000 pounds to solicitor from longstanding
friendly client: not income.
- FCT v Dixon: Periodic payments made by employer while employee
serving in WWII. Due to the periodic nature and the fact that the
taxpayer relied on them: income.
 - Prizes: depends on whether person is professional or amateur. If
professional, may be carrying on business (FCT v Stone) and (Kelly v
FCT).
4. The proceeds of gambling and windfall gains are not income
- Windfall gains: lack of commercial element, luck and good fortune
(Lottery).
- Gambling: Martin v FCT: not income betting on horses. Depends on
if you are a professional gambler or not.
- Illegal activities: gains from illegal activities are income, FCT v La
Rosa (2003) claimed deductions on losses from stolen money.
5. Mutual receipts are not income
- One cannot derive income from oneself.

Positive propositions (characteristics of ordinary income)

1. Amounts must be beneficially derived: unrealized gains are
not income. For, individuals, accruals do not count as income.
Superannuation is not considered income superannuation acts as
a trust and does not come into the taxpayer (until a later date).
2. Income is to be judged from the character it has in the
hands of the recipient: Just v FCT, Colonial Mutual Life Assurance
Society Ltd v FCT.
- Constructive receipts: s6-5(4), giving the income to someone else is
still income you instructed where the income should go.
3. Recurrence, regularity and periodicity: Income will generally be
a series of periodic payments (wages, interest, dividends etc).
Certain regular payments may not be income and one-off payments
can be income.
4. Amounts from employment or the provision of services are
income (salary, wages).

Lecture 3

5. Amounts derived from carrying on a business are income

- London Australia Investment Co Ltd v FCT (1997): Is there a
business? What is the nature of the business? Does the transaction
fall within that business?
- ITAA97 s995-1: Business includes any profession, trade,
employment, vocation or calling but does not include occupation as
an employee (not specific definition).
- Characteristics that may indicate business (Ferguson v FCT): profit
making purpose (Tweedle v FCT (1942)), repetition and regularity
(London Australia Investment CO Ltd v FCT (1977)), organization
and system (FCT v Walker (goat case)), size and scale of operations
(Thomas v FCT), nature of activity (Edwards v Bairstow) etc.
- When did business commence? Relevant for deductions (Softwood
Pulp & Paper).
- What is the nature of the business?: Its scope. California Copper
principle is the gain a mere enhancement of value? (capital), or is
the gain made in carrying out a scheme of profit making? (income).
- FCT v Whitfords Beach (1982): Bought land and originally had no
intention of profit, then developers bought the land and the
intention was to profit so any gain was deemed income.
6. Amounts derived from property are income: for example, rent,
interest, dividends, royalties and annuities.
- Rent: Yancheep Sun City td Ltd v CT (1984)
- Interest: Riches v Westminster Bank Ltd, substance over form:
Lomax v Peter Dixon & Sons Ltd.
- Annuities: Series of payments made under contractual obligation
for a specified number of years Edgerton-Warburton. Does not
have to be for the length of recipients life, can be fixed term, as
long as it is a periodical sum Moneymen.
- Royalties: A royalty that is income by ordinary concepts is
assessable under ITAA97 s 6-5; otherwise a royalty can be statutory
income under s15-20. At common law, a royalty that is ordinary
income usually involves a payment calculated by reference to the
quantity taken or is linked to the use of property in a manner
proportionate to the benefits derived.
- From the facts of McCauley v FCT (1994) 3 AITR 67, for a payment
to be considered a royalty under the ordinary concepts, the price
paid must be in relation to the amount taken. Here the payment
was for the right to cut timber from a farmers property that met the
common law definition of a royalty, being in relation to the amount
of timber cut.
- Conversely, Stanton v FCT (1995) 92 CLR 630 involves a payment
that is not considered a royalty, as it is not based on the quantity
taken. This case considered the issue of royalties and whether or
not a fixed sum payable for the right to cut timber from land with a
calculation in reference to the amount of timber left standing at the
end of an agreement was a royalty.
- s15-20 as statutory income: Assessable income includes an amount
that you receive by way of royalty within the ordinary meaning of
royalty (compensation for use of property).
- Dividends: Amounts paid to shareholder out of profits derived by
company. Dividends can fall under both ordinary and statutory
income - income should only be taxed once and by s6-25 the more
specific rule should prevail mainly statute prevails.
7. Amounts received as substitutes for or compensation for
lost income are themselves income.
- Myer Emporium Case: Two points. An extraordinary transaction will
be assessable income if the taxpayer entered into the transaction
with the intention of purpose of making a profit from the
transaction. A lump-sum amount that replaces future income will
itself be income.
- In the case, Myer sold interest on a loan that would be received, and
the income from this sale was still income as it substituted the
interest they would have received.
- It is important to note how much impact the cancellation has on the
business as it could be capital like California Copper the
cancellation of a contract led to the termination of taxpayers
business.

s15-2: value to you Statutory income will catch benefits that

are not convertible into money.
- Rule from Tennant v Smith that benefits not convertible into money
are not ordinary income. s 15-2 catches this as allowances or other
things provided in respect of employment or services are
assessable.
 - Assessable income includes value to you of all allowances,
gratuities, compensation, benefits, bonuses and premiums provided
to you in respect of/directly or indirectly in relation to employment
or services rendered by you. Regardless of whether it is liquid or
not.
- Allowance is assessable, but reimbursement is not because it is
money got back from employer.
- s15-2 does include amounts assessable under 6-5 and Fringe
Benefits (non-assessable non-exempt income s23L ITAA36)
- Value to you test: Donaldson v FCT (1974) What a prudent person
in the taxpayers position would pay for the rights rather than to not
obtain them.
- Connection to employment or services: Smith v FCT Was the
benefit a consequence of the employment or services?
- Non-cash business benefits are treated as if convertible to cash
under ITAA36 s21A.

Royalties:
Royalties are compensation for use of property A royalty that is income
by ordinary concepts is assessable under ITAA97 s 6-5; otherwise a royalty
can be statutory income under s15-20.
At common law, a royalty that is ordinary income usually involves a
payment calculated by reference to the quantity taken or is linked to the
use of property in a manner proportionate to the benefits derived.
- McCauley v FCT (1994), for a payment to be considered a royalty
under the ordinary concepts, the price paid must be in relation to
the amount taken. Here the payment was for the right to cut timber
from a farmers property that met the common law definition of a
royalty, being in relation to the amount of timber cut.
- Conversely, Stanton v FCT (1995) 92 CLR 630 involves a payment
that is not considered a royalty, as it is not based on the quantity
taken. This case considered the issue of royalties and whether or
not a fixed sum payable for the right to cut timber from land with a
calculation in reference to the amount of timber left standing at the
end of an agreement was a royalty.
- FCT v Sherrit Gordon Mines Ltd (1977) 137 CLR 612 taxpayer
supplied technical information relating to the construction of a
nickel refinery. Even though the payments were expressed as a
percentage of sales over 15 years, a majority of the High Court held
that the payments were not royalties.
- s15-20 as statutory income: Assessable income includes an amount
that you receive by way of royalty within the ordinary meaning of
royalty (compensation for use of property).
- Only case to ever mention s15-20: AAT case U33 (1987): exclusive
license to manufacture and sell ledgers. Got lump sum but made no
ledgers Held that it was not assessable under s15-20 because it
did not satisfy the ordinary meaning of royalty.

Lecture 4

Capital Gains Tax

 - Net capital gains are a part of statutory income capital cannot be
a part of ordinary income. CGT was introduced with effect from 21
September 1985.
- Net capital gain s102-5: reduce any capital gains during the year
by any capital losses. Apply any net capital losses from previous
years to reduce the amounts remaining after this. Reduce by the
discount percentage each amount of a discount capital gain
remaining. Add up the capital gains after all this and that is your net
capital gain for the income year. The discount is not available for all
CGT events, only available if asset acquired at least 12 months
before CGT event occurred also not available for companies. The
taxpayer must not have chosen indexation.
- Net capital loss s102-10: Add up capital losses made during the
income year, also add up the gains. Subtract gains from losses.
- Note that you cannot use capital losses in subsequent years to
offset other income, can only use to offset future capital gains.

CGT Events: One can only make a capital gain or loss if a CGT Event
occurs: s100-20.
Where two or more CGT Events apply use the event most specific to
situation except D1 or H2: s102-25(1) always apply D1 then if not
relevant H2 where relevant.

CGT Event A1 s104-10

(1) CGT event A1 happens if you dispose of a CGT asset.
(2) You dispose of a CGT asset if a change of ownership occurs from
you to another entity, whether because of some act or event or by
operation of law. However, a change of ownership does not occur if
you stop being the legal owner of the asset but continue to be its
beneficial owner.
(3) The time of the event is (a) when you enter into the contract for
the disposal; or (b) if there is no contract--when the change of
ownership occurs.
(4) Capital gain if proceeds > cost base
(5) Capital loss if proceeds < reduced cost base

CGT Event C1 s104-20

(1) CGT event C1 happens if a CGT asset you own is lost or destroyed.
(2) The time of the event is: (a) when you first receive compensation
for the loss or destruction; or (b) if you receive no compensation
when the loss is discovered or the destruction occurred.
(3) Capital gain if proceeds > cost base
(4) Capital loss if proceeds < reduced cost base

CGT Event C2 s104-25

(1) Happens where ownership of an intangible asset ends by the asset
being redeemed or cancelled; released discharged/ satisfied;
expiring; abandoned; surrendered or forfeited; exercised; converted.
(2) The time of event is where the taxpayer enters into the contract
that results in the asset ending or, if there is no contract, when the
asset ends.
(3) Capital gain if proceeds > cost base
(4) Capital loss if proceeds < reduced cost base
CGT Event D1 s104-35
(1) Happens where a taxpayer creates a contractual or other legal right
in another entity
(2) The time of the event is when you enter into the contract or create
the right
(3) Capital gain if proceeds > incidental costs
(4) Capital loss if proceeds < incidental costs

CGT Asset
s108-5(1): (a) any kind of property; or (b) a legal or equitable right that is
not property.
Property: Everything that a person has control over. Can be tangible (land
or a building) or intangible (shares, debts owed to you, goodwill).
A right that is not property can be the right to maintain an action for
personal injury or the right to damages for breach of contract for personal
services.

Personal use asset s108-20(2): a CGT asset (except a collectable) is

used or kept mainly for your, or your associates personal use or
enjoyment.
- s118-10(3): disregard capital gains where asset cost less than
$10,000.
- s108-20(1): capital losses disregarded.
- Costs of ownership not included in cost base s108-30.

Collectables s108-10(2): Artwork, jewelry, an antique, a coin or

medallion; or a rare folio, manuscript or book; or a postage stamp or first-
day cover.
- Capital gains disregarded where cost less than $500 s 118-10(1).

Separate CGT Assets

Buildings or structures on pre CGT land s108-55(2):

Eric purchases a block of land in 1983. In 1987, he constructs a

building on the land. The building is treated as a separate CGT asset.

Building where Div. 40 balancing adjustments would apply: s108-55(1):

Mills Pty Ltd constructs a timber mill on land it already owns. The
building is subject to a balancing adjustment on disposal, loss or
destruction. The timber mill is considered a separate CGT asset.

Depreciating assets that are part of a building or structure s108-60

Noja Company carries on a business of producing self-sealing stem

bolts from its factory. It installs new bathrooms for the employees. The
plumbing fixtures and fittings are depreciable assets. They are
separate CGT assets to the factory. The factory will be subject to the
CGT provisions, but the depreciable assets will be disregarded for CT
purposes (see exemptions)

Post-CGT land adjacent to pre-CGT land when titles are amalgamated

s108-65
 In 1980 David purchased a block of land. In 1990 David purchased the
adjacent block of land and amalgamated the two titles into one. The
second block is a separate CGT asset. A capital gain will be made on
the second block when the land is disposed of.

Improvements s108-70(2): Improvement to pre-CGT asset taken to be

separate asset if cost base of the improvement is more than the
improvement threshold (when the CGT event occurs); and more than
5% of capital proceeds from the event.
Improvement threshold: indexed annually: y/e 30 June 2012:
$130,418; y/e 30 June 2011: $126,619

In 1980 William purchased a boat. In 1990 he installed a new mast for

$30,000. He sold the boat in 2011 for $150,000. The improvement will
not be considered a separate asset as it is below the $126,917
threshold.

Acquisition and disposal of CGT assets: s109-5 you acquire a CGT

asset when you become its owner. Acquiring a CGT asset without a CGT
event s109-10 constructing a CGT asset, acquisition occurs when
construction commenced.

Capital gains/loss calculation steps: s100-45

1. Work out capital proceeds
2. Work out cost base
3. Subtract cost base from capital proceeds
4. If proceeds > cost base = capital gain
5. If not, work out reduced cost base
6. If proceeds < reduced cost base = capital loss
7. If proceeds < cost base > reduced cost base = no capital gain or
loss

General rules for capital proceeds s116-20

(1) The capital proceeds from a CGT event are the total of: (a) the
money you have received, or are entitled to receive, in respect of
the event happening; and (b) the market value of any other
property you have received, or are entitled to receive, in respect of
the event happening.
Modification rules Div. 116
1. Market value substitution: s116-30

Market value of asset taken to be capital proceeds if:

The taxpayer receives no proceeds; OR
Some of all of the capital proceeds cannot be valued and the
taxpayer did not deal at arms length; OR
Capital proceeds are more or less than market value and the
taxpayer did not deal at arms length
Example: Bill gives a rental property to his daughter and does not
receive any consideration. Bill is taken to have received the market
value of the property.

2. Apportionment: s116-40
 s116-40(1): If payment received relates to more than one CGT event,
capital proceeds from each event are so much of the payment as is
reasonably attributable to the event
Example: Betty sells a block of land and a boat for a total of $100,000.
The transaction involves two CGT events. The $100,000 must be
divided between the two events.

How to divide? Market values? E.g. if the land had a market value
of $90,000 and the boat had a market value of $25,000, could
calculate as follows:
Land: [$90,000 (market value) / ($115,000) (market values of land
+ boat combined)] x $100,000 (amount received) = $78,261
Boat: [$25,000 (market value) / ($115,000) (market values of land +
boat combined)] x $100,000 (amount received) = $21,739

s116-40(2): If payment received in connection with a CGT event and

something else, capital proceeds from the event are so much of the
payment as is reasonably attributable to the event.
Example: You are an architect. You receive $70,000 for selling a block
of land and giving advice to the new owner. This transaction involves
one CGT event: the disposal of the land. The capital proceeds from the
disposal of the land are so much of the $70,000 as is reasonably
attributable to that disposal.

What is reasonably attributable? May be based on the market value

of the land and market value of advice given, apportioned as in the
example for s116-40(1).

3. Non-receipt rule: s116-45

If the taxpayer does not receive (or unlikely) to receive, some or all of
the capital proceeds from the CGT event, the capital proceeds are
reduced y the amount not received
Example: Lyn sells a painting to Rhonda for $5,000. Lyn agrees to
accept monthly installments of $1,000. Lyn receives $2,000, but then
Rhonda stops making payments. Lyn is unable to get to locate or get
in touch with Rhonda. It becomes clear that Lyn is not likely to receive
the remaining $3,000. The capital proceeds are reduced to $2,000.
4. Repaid rule: s116-50

If the taxpayer is required to repay some/all of capital proceeds, the

capital proceeds are reduced by amount repaid
Example: Simone sells a block of land for $50,000. Jerry (the
purchaser) later finds out that Simone misrepresented a term in the
contract. Jerry sues Simone and the court orders her to pay $10,000 in
damages to Jerry. The capital proceeds are reduced by $10,000.

5. Assumption of liability: s116-50

If another entity assumes a liability (e.g. mortgage), the capital

proceeds are increased by the amount of liability.
Example: Anton sells a block of land. He receives $50,000 cash and
Steve, the purchaser, becomes responsible for a $100,000 liability
under an outstanding mortgage. The capital proceeds are increased by
$100,000 to $150,000.

Cost Base General rules s110-25: Five elements

1. Money paid/property given in respect of acquiring
2. Incidental costs (cost of agent, accountant, legal advisor, surveyor,
stamp duty etc.)
3. Costs of owning (interest, repairs, land tax etc.)
4. Expenditure to increase or preserve value of asset or that relates to
installing or moving it
5. Expenditure to establish, defend or preserve title

COST BASE MODIFICATION RULES: Sub-div 112-A (Refer Slide 29)

Market value substitution: s112-20

s112-20(1): 1st element of cost base replaced by the market value of

the asset if the taxpayer did not incur any expenditure to acquire it
(unless it is event D1); or some or all of the expenditure cannot be
valued; or non-arms length transaction.
(There are some exceptions in s112-20(2)/(3) but these are not
considered in this course)
Example: Bill gives a rental property to his daughter and does not
receive any consideration. His daughter will be taken to have paid
market value, and this will be the 1st element of her cost base

Split, changed or merged assets: s112-25

Split or changed assets: see s112-25(1)-(3): If a CGT asset is split into

two or more assets, the cost base needs to be worked out for each
asset. Essentially the cost base of the original asset is apportioned
across the (multiple) split assets.

Example: You buy a 10-acre block of land for $500,000. You

divide the land into ten 1-acre blocks. The cost base of each 1-
 acre block would be $50,000. (Note that the sub-division is not a
CGT event).

Merged assets: see s112-25(4) if two or more assets merged, cost base
is sum of cost base for the original assets.

Example: You own 2 blocks of land side by side. You merge them
onto one title and sell it as one block. You paid $50,000 for the
first block of land; and $70,000 for the second block of land. The
first element of the cost base when you sell the merged land is
$120,000.

Apportionment: s112-30

If you acquire a CGT asset and the expenditure you incurred relates
only partly relates to CGT asset, the expenditure must be apportioned.
What amount is reasonably attributable to the CGT asset?

Example: You acquire a truck for $24,000 and sell its motor for
$9,000. Suppose the market value of the remainder of the truck is
$16,000. What was the cost base of the motor? $24,000 x [($9,000 /
($9,000 + $16,000)] = $8,640. The cost base of the remainder of the
truck would be $24,000 - $8,640 = $15,360.

Assumption of liability: s112-35

If you acquire a CGT asset that is subject to a liability, the first element
of cost base includes amount of liability.

Example: Anton sells a block of land. He receives $50,000 in cash and

Steve, the purchaser, becomes responsible for a $100,000 liability
under an outstanding mortgage. The 1st element of Steves cost base
is $150,000.

INDEXATION: Division 114

NB: You will not be required to use the indexation method for CGT in this
course. The notes below are included as additional material so you can
understand how indexation was applied. (For this reason, the indexation
numbers are not included).

s 114-1: In working out the cost base of a CGT asset acquired at or

before 11.45 am (by legal time in the Australian Capital Territory) on 21
September 1999, index expenditure incurred at or before that time in
each element.
(The expenditure can include giving property: see section 103-5).

How to index expenditure? Refer to Subdiv 960-M. The steps are

essentially as follows: (please note they have been simplified for the
purposes of this handout).
 1. Ascertain the index number for the quarter in which the CGT event
happened to the asset.
These index numbers are provided, on a quarterly basis for all years
from September 1985 onwards, and can be found in s 960-280.

2. Ascertain the index number for the quarter in which a particular

item of expenditure was incurred.

3. Divide step 2 by step 1. This is the indexation factor for that item of
expenditure. Work out this indexation factor to 3 decimal places: if
the value of the fourth decimal is 4 or less round it down; if it is 5 or
more, then round it up.

4. Repeat this process for each item of expenditure in each element of

the cost base except the third element. The third element is not
indexed. (Note: different rules apply for indexing the first element if
the CGT asset is shares or units in a unit trust).

5. Multiply each separate item of expenditure in each element of the

cost base (except the third element) by its relevant indexation
factor.
(Note: If the indexation factor for an amount is one or less, then no
adjustment is made. This is rare and would only occur when there
has been deflation).
Aggregate all of the indexed amounts, plus any amounts that
cannot be indexed. This is the indexed cost base for the asset.

Indexation Example: (Taken from: Cooper and Evans on CGT)

Facts

A CGT asset was acquired for $200,000.

Acquisition occurred during the quarter ended 31 December 1992 when
the CPI index was 107.9.
Disposal occurred during the quarter ended 30 September 1997 when the
CPI index was 119.7.

Issue

What is the indexation factor and what is the indexed cost base?

Analysis

The indexation factor for adjusting the cost base is calculated as shown
below:
119.7
= 1.1094 to 4 decimal places
107.9

The fourth decimal place number is 4 or less. Consequently no adjustment

will be made to the third decimal place number. This gives an indexation
factor of 1.109.

The indexed cost base relating to the acquisition of the CGT asset is
calculated as follows:
 $200,000 1.109 = $221,800

Reduced Cost Base = cost of ownership excluded and no indexation for

inflation. Since 1997, deductible expenses have not been included in cost
base or reduced cost base.

Anti-Overlap provisions = prevent the same thing from being taxed as

a capital gain and ordinary income.

Exemption main residence: s118-110 gain or loss from CGT event in

relation to your main residence is disregarded.