Capital Gains Tax - Case Study Example

Your name: Course name: Professors’ name: Date Part One Introduction Capital gains refer to the gains made by an individual or an entity upon disposal of an asset. Capital gains tax means the tax charged or the tax liability due to an individual or entity as a result of the sale of an asset (Lymer & Oats 2012, p.56). Capital Gains Tax was presented to the Australian tax system in September 1985. All Australians globally are liable to the CGT. The rule applied to all assets received on or after the specified date. Assets acquired before the date are referred to as pre-CGT items and gains or losses made on them are ignored (Lymer 2011, p.33). The difference between the cost incurred in acquiring an asset and the cost of selling the asset brings about capital gain or capital loss depending on situations. The capital gains are applicable to taxation and this tax forms part of income tax. The tax is not considered separately, but it is usually referred to as CGT (Publishing 2013, p.17). Capital loss is not applicable to taxation, however, it can be used on the successive years to reduce the amount of capital gain. If the capital gains are less than capital losses, it means that one does not have a capital gain on the asset. In this case, one can carry the capital loss forward and subtract it with capital gains in the subsequent or future years (Simon 2012, p.23). Capital loss or gain can be realized when disposing fixed assets such as homes, shares, etc. Capital gain tax also is applicable to intangible assets. For instance, business goodwill is applicable to capital gain taxation. On the other hand, most personal assets are relieved from capital gain tax. Some of the personal assets exempted from CGT includes home car, personal assets like furniture, among others (James & Nobes 2012, p.42). When someone acquires an asset liable for capital gain tax, keeping records of the asset is paramount as one might be required in the future to pay tax accumulated on the asset. The records will ensure one does not pay more tax on the asset than necessary (Bhat 2012, p. 64). A CGT event occurs when an individual makes a capital gain or loss. Background Information The CGT rules and regulations initially introduced allowed indexing of one year accumulated cost of an asset by CPI; that is, Consumer Price Index, before calculating the gain. This meant that; inflation price rise was not included in the calculation. However, this rule applied only between 20th September 1985 and 20th September 1999. From 1999, 50% discount on the gains above cost base was introduced, and it applies to date. This rule applies to all assets acquired by a sole proprietor or an entity in the course of business. However, there are exemptions to these rules as per the Australian small businesses capital gains tax concessions and the Income Tax Assessment Act 1997 which include: a) Any asset acquired before 20th September 1985 unless any substantial alterations are made to the asset for example additions or on demise of original owner. b) The payments that are made under designated government schemes. c) Collective development fund shares. d) Cars including other small vehicles such as motorcycles. This provision is limited to vehicles that carry less than nine people and have a carrying capacity less than one tonne. Cars normally depreciate fast in value. Therefore, this is a disadvantage. However, it also applies to antique cars whose value rise in time, thus, an advantage. e) Life insurance submitted by original owner. f) Losses or gains from gambling. g) Losses and bonds sold at a discount. h) Collectables attained for up to $500 plus jewellery and art stamps, etc. held for personal pleasure. It can be an advantage to the tax payer if value of the collectables rises (Alworth & Arachi 2012, p. 34). i) Personal injury compensation arising from work-related damages. j) Personal use assets attained for up to $10000. They include home furniture, home generators, etc. Also included are capital losses arising from personal asset use. Roll over provisions From the definition, a rollover happens when one reinvest funds acquired from a mature security to a fresh issue comparable or same to the security (Australian Taxation Office 1998, p.67). It also occurs when someone transfers his/her retirement plan to another without being taxed. Rollover lets someone defer capital gain to future income year. Another significant exemption is the family home (rollover provisions) which cover disposals including transfer to the beneficiary on death so that capital gains tax is not a quasi-death duty (Australian Taxation Office 2003, p.56). This means that property transferred to the beneficiary on death should not be subjected to capital gains tax as it has already been subjected to inheritance tax that will lead to double taxation. Roll over provisions serve to reduce tax on small enterprise owners retiring, and on dynamic assets being sold, and letting a rollover when selling one active asset to buy another (Cooper et. al 2012, p.24). Gifts A gift made by a living person is treated as a disposal, and the giver is taxed at that price while a receiver takes it at a reduced cost basis (Mccluskey, Cornia & Walters 2012, p.45).however, a gift that arises from the death of a person is treated differently. The gift arising from a person demise is issue to roll over provisions. Death When the owner of a capital gains tax asset dies, the beneficiary is taken to have acquired the asset at a reduced cost base or cost base. It is not treated as a disposal and thus is not subject to capital gains tax. According to European Commission (2012, p.34), the acquisition is effected on the date of death of the previous owner. However this rule applies to only Australian residents or tax advantaged entities such as superannuated funds, churches or charities. Capital losses which are unused by the departed person is dissolute following the death (Australian Taxation Office 2001, p.89). These damage cannot be recovered by the estate or the beneficiaries. Workings and Explanation When a property is transferred from the deceased to Jane, she enjoys capital tax gains exemption. This is because she qualifies in the following ways: • The property acquired is worth is in 1.85 hectares of land. According to the small business and proprietors capital gains concessions, a house or unit which is the taxpayer's residence and up to 2ha of land adjacent to it is exempt from capital gains tax. She, therefore, will not pay tax • Roll over provisions as a result of death- Jane acquired the property through intestacy as a result of death of the owner. This, therefore, means that she acquires it at the previous owner’s cost base and reduced cost base on the date of owner’s death. Jane qualifies for this provision because she is an Australian citizen. She, therefore, will not be charged capital gains tax Once the property belongs to Jane, she applies for an exempt of Australian Business Number from the Australian Tax Office. She holds the property for one year when she goes for holiday. This means that in the one year she holds the property she doesn’t pay any taxes as it is still personal property (Australian Taxation Office 1991, p.87). As at 12/12/2012 the property is divided into three equal parts Therefore, assuming they are divided equally, 1.85/3= 0.617 ha each. 1.45/3= $ 0.4833 per block The block that is used for her residence will not be subjected to capital gains as it is not applied for commercial purposes, and it does not exceed 2ha. However, the other blocks that are sold will be subjected to capital gains tax. This is because it is being sold by an owner who is alive (Australian Taxation Office 1999, p.45). The sale is, therefore, treated as follows; 24th march, 2013 $ 1.35- $ 0.4833 = $ 0.867 $ 0.867 is a gain on sale of the plot, therefore, since it is after 20th September 1999, 50% discount of $0.867 equals $ 0.4335. The balance ($0.4335) is subjected to capital gains tax. 9th April, 2013 $ 1.45 - $ 0.4833 = $ 0.967 $ 0.967 amounts to capital gains and therefore is subjected to 50% discount and the balance subjected to capital gains tax. Part Two Ordinary Income versus Statutory Income Ordinary income refers to income that arises from business and is subjected to ordinary or highest rates of tax (Kirby & Kirby 2010, p.64). Commissions, salary and wages, rent and allowance, among others are examples of ordinary income under taxation rules. Ordinary income is offset with standard tax deductions. Typically, ordinary income concept encompasses the following. 1. The amounts that one receives as a reward when performing services. For example, employee’s wages. 2. the amounts someone receives when carrying out business; that is, profits acquired when carrying out a business, and 3. The amounts that a person receives on one’s investment. These include interest on deposits, dividends on share, royalties paid on a patent and rent on an investment property. However, the following are exempted from ordinary income: Some gifts received. This is on the light that some gifts given to individuals or business owners, may at some level be connected with the operation of the business and may be part of making profit by either the individual or the business owner. Windfalls Inheritance Treasure trove. This may include money buried, etc. Some prizes. Just like some gifts. On the light that some prizes given to individuals or business owners, may at some level be connected with the operation of the business and may be part of making profit by either the individual or the business owner. Some winnings from gambling games. Some people do gambling as a business are sometimes it is associated with profits and losses. For professional gamblers the profits attained is part of their salary or remuneration. Amount acquired as principal of the loan. When an organization is allocating shares to its shareholders, the amount received is exempted from the ordinary income. Statutory income, on the other hand, refers to extraordinary income. Statutory income in most cases has lower rates of tax or may not be assessable for tax purposes except when expressly stated (Deutsch & Orow 2010, p.27). Statutory income mainly consists of capital gains, capital allowances and foreign exchange gains. Capital gains are normally offset with capital losses. There is a variation between the receipt of ordinary income and capital gain. The distinction is fundamental to the “ordinary income.” This is due to the fact that capital gain is not included in the “ordinary income.” In addition, the Tax Laws provide a vast system of capital gain tax (Gilders 2013, p.87). Thus, with respect to statutory income, capital gains taxation is fundamental. The tax law deals with the following transactions: the profits made on traditional securities, which arises from the interest-bearing investments form part of statutory income; the net capital gains are also added to the statutory income; also the statutory income regulates the rules regarding the gains made when an individual or organization redeems interest-bearing liabilities (Kenny 2013, p.17). Proceeding made after selling a corporate bond is an example of statutory income. Precisely, when a person buys a corporate bond to be used for investment, the amount he gains when selling the corporate bond is not perceived as an ordinary income. However, the tax law offers that if a person makes a profit after selling the bond, the profit should be included to the taxable income as statutory income. References Alworth, J., & Arachi, G 2012, Taxation and the Financial Crisis, OUP Oxford, Oxford, Australia 2013, Australian income tax legislation 2013. Vol.2. 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Mccluskey, WJ, Cornia, GC & Walters, LC 2012, A Primer on Property Tax Administration and Policy, Wiley, Chicester,. Publishing, O 2013, Taxing Wages 2013, OECD Publishing, Paris. Simon, J 2012, Economics of taxation: principles, policy and practice 2012, Fiscal Publications. Birmingham. Read More