What is Capital Gains Tax? To understand Capital Gains Tax you need to know the difference between “income” and “capital”.
In simple terms, the money you receive into your bank account from working as an employee is taxable income. When you buy or sell a share on the stock exchange, or a house (basically many types of fixed assets), for taxation purposes, you are buying or selling capital. Taxation in Australia works using this principle.
For example, the dividend of $1 per share received from shares you own in Telstra Ltd is ordinary taxable income. The 1,000 shares you might own themselves are capital.
What is a capital gain?
If you purchased your Telstra Ltd shares at $4.00 per share and then sold them at $5.00 per share you have made a gain of $1 per share. For tax purposes, you have generated capital income of $1 per share because you sold the shares for more than you paid for them.
The ATO will tax you on the dividends received from Telstra shares as if it were ordinary income and will tax you on the capital gain on the profits from the sale of the shares according to the CGT rules. There is a formula for calculation of CGT.
Some other examples of capital assets
CGT assets are any kind of property, or any legal or equitable right that is not property and includes:
- shares in public and private companies
- goodwill of a business
- real estate, buildings and property
- an interest in a partnership
- units in a unit trust
- options
- foreign currency
- debts
Some things that are not capital or CGT assets
- any capital assets acquired before 20 September 1985
- cars and motorcycles
- decorations for valor
- life insurance policies
- assets used to produce exempt income
You are taxed on your income, that is fairly straight forward, but how are capital gains taxed?
Capital Gains Tax Events
The CGT event is all about timing; when was the asset purchased and when was it sold.
As stated above, any asset acquired before 20 September 1985 is not subject to Capital Gains Tax. Any asset acquired after this time is subject to the CGT provisions and a “CGT Event” will be triggered when the asset is disposed of, that is, sold or when the taxpayer stops owning the asset.
The Income Tax Assessment Act actually contains a list of CGT Events. The event has a code (such as A1). Each different CGT event has a different timing regime and can occur in different circumstances.
A complete list of all CGT Events can be found in section 104.5 of the Income Tax Assessment Act. Some examples include:
- A1 – Disposal of a CGT asset
- C1 – loss or destruction of a CGT asset
- E1 – creating a trust over a CGT asset
- E3 – converting a trust into a unit trust
- E5 – beneficiary becoming entitled to a trust asset
- F1 – granting a lease
- G1 – capital payment for shares
- I2 – trust stops being a resident trust
- etc…
There are many more CGT Events. You should always consider if the disposal of an asset will be considered to be a CGT event.
Capital losses
It is worth noting that if you sell a CGT asset for less than you purchased it for, there is a good chance that for tax purposes you have made a “capital loss”. Capital losses can be used to offset future capital gains.
If you are buying or selling a business or property. It is important to consider the CGT implications of the transaction. You should always consult with your accountant and lawyer if you are considering entering into such a transaction.
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