The term “capital gains tax” (CGT) is perhaps the biggest misnomer in tax. It is not its own, separate tax on capital gains per se.
For an individual, it is included as part of that person’s assessable income and subject to tax at their marginal tax rate. When a taxing point for CGT happens (referred to as a CGT event) there is a torrent of rules that taxpayers must adhere to so they can fulfil their tax obligations correctly.
Knowing where to start is the hardest part.
The most common CGT event which happens is when a taxpayer disposes of a CGT asset (such as shares or real estate). Assuming that an asset has been disposed of, there’s a step-by-step framework to consider. The framework for working out the capital gain in the law looks curly, but is simple when broken down. So here it is, broken down and mapped out.
Has there been a capital gain?
Figuring out if a capital gain has resulted from the sale of an asset is the first step.
To do this, there are certain steps, as determined under the relevant legislation:
- work out your capital proceeds from the disposal
- work out your “cost base” for the CGT asset (or “reduced cost base” if a capital loss arises)
Subtract the cost base from the capital proceeds.
If the capital proceeds exceed the cost base, the difference is a capital gain. Conversely, a capital loss arises where the asset’s “reduced cost base” exceeds the capital proceeds.
Working out discount percentages
Tax legislation sets aside some rules that allow you to apply discount percentages to a capital gain. The discount is limited to certain CGT events (such as a disposal under CGT event “A1”). Further, you must be an eligible resident taxpayer of Australia and have held the CGT asset for at least 12 months.
The applicable discounts include:
- a 50% discount if the gain is made by an individual, or by certain trusts. This also includes gains made by a partner in a partnership (eg, an individual)
- a 331/3% discount if the gain is made by a complying superannuation entity, by a First Home Saver Account (FHSA) trust, or by a life insurance company from a CGT asset that is a “complying superannuation/FHSA” asset.
A capital gain that is eligible for discount is generally referred to as a “discount” capital gain.
Working out your net capital gain
Say you’ve had three assets disposed of during an income year. What you must do is perform three separate capital gains tax calculations (including determining any discount capital gains) and then amalgamate any capital gains and capital losses to figure out your total net capital gain for that year.
To do that, you must:
- Reduce your capital gains for the given income year, in the order you choose, by your current year capital losses for the income year. Note that you can choose to apply capital losses to either discountable or non-discountable capital gains. (If the capital losses for the income year exceed the capital gains, the difference is your net capital loss.)
- Reduce any remaining capital gains, in the order you choose, by any unapplied net capital losses for previous income years. Again noting that you can choose to apply these unapplied capital losses to either discount or non-discount capital gains.
- Reduce any remaining discount capital gains by the relevant discount percentage (see above).
- If you are eligible for special small business CGT concessions, apply the small business concessions to further reduce your capital gains (whether or not the gains are discount capital gains).
- Add up any remaining capital gains that are not discount capital gains, and any remaining discount capital gains.
The total is your total net capital gain. This is included in your assessable income.
Note that if you have incurred “revenue” losses from other sources, you may be able to deduct “revenue” losses from a net capital gain that has been included in assessable income. Before that time, revenue losses are unable to be applied to capital gains.
Note that certain losses are subject to special rules before they can be applied (especially for companies and trusts).
A case study can help explain.
Sophia bought three parcels of various listed shares in August 2014. Each cost her $5,000 (including brokerage). In September 2015, Sophia sold two of the parcels of shares for $6,000. In October 2015, she sold the remaining parcel for $9,000.
On each sale (or “event”), Sophia calculated her capital gains as follows:
Cost base = $5,000
Proceeds from sale = $6,000 $6,000 – $5,000 = capital gain of $1,000
Cost base = $5,000
Proceeds from sale = $6,000
$6,000 – $5,000 = capital gain of $1,000
Cost base = $5,000
Proceeds from sale = $9,000
$9,000 – $5,000 = capital gain of $4,000
Total discount capital gain = $6,000
At the end of the 2016 income year, Sophia calculated her net capital gain.
She recalled a sale from earlier in the year, however, where she sold shares which gave rise to a capital loss of $1,000. She also had incurred a “revenue” loss from operating her rental property of $800.
Assume that she derived no other assessable income or incurred any other allowable deductions during the income year.
Sophia calculated her net capital gain for the 2016 financial year as follows:
- Application of capital loss to discount capital gain as follows:
(Discount capital gain – capital loss)
($6,000 – $1,000) = $5,000
- Apply 50% discount:
$5,000 x 50% = $2,500
- The net capital gain above is included in her assessable income. The revenue loss from the rental property can be applied as follows:
Net capital gain included in assessable income – current year loss = taxable income $2,500 – $800 = $1,700
Be mindful that this example is general in nature. CGT assets may be treated differently depending upon both the type of taxpayer as well as the type of CGT asset. This makes it necessary to consult a professional when determining capital gains as part of your taxation affairs.