TABL5551/TABL5559
Term 1, 2024
Week 3: 28 February,2024
Announcements
Don’t forget to attend tutorials! Very important. Solutions to
tutorial problems are not posted on Moodle.
Assignment has now been made available for you to start on.
Due date: April 5,2024 by 6.00 pm(Week 8) . Submission is via
the submission link on Moodle.
Recap :
• Income tax = (Taxable income x Rate) less Tax offsets (s 4-10 of ITAA 1997)
• Taxable income is Assessable income less deductions(section 4-15 of ITAA 1997)
• Assessable income: ordinary income and statutory income (s 6-1 of ITAA1997)
• Ordinary income: income according to ordinary concepts (s 6-5 of ITAA1997)
• Not specifically specified in legislation
• Examples: salary and wages, business income, interest income; rent
• Statutory income (s 6-10 of ITAA 1997)
• Income that is specifically included in a provision of legislation
• Example: net capital gain
• Exempt income section 6-15 of ITAA 1997.
• If income is both ordinary income and statutory income the statutory provisions will
usually prevail.
Recap :
Tax Loss
• Tax loss is calculated in accordance with section 36-10 of ITAA
1997
• Tax loss = Deductions less Assessable income + Net Exempt
Income
Recap :
Calculating Tax Payable
• Calculate taxpayer’s taxable income
• Calculate the basic income tax liability on the taxable income according
to applicable tax rates
• Calculate the taxpayer’s tax offsets
• Subtract offsets from basic income tax liability
• Credit is given for tax withheld / tax instalments paid
• Add levies and surcharges
• Resulting figure is the tax payable or the tax refund (shown in “notice of
assessment”)
Recap:
• Last week, we looked at the taxation treatment of proceeds of
business
• We looked at the considerations that arise when examining a
continuing business vs. isolated transactions
– It is not always clear if a transaction arises in the context
of an existing business, or is an isolated one
Recap of last week
• Important to determine if the transaction is an isolated one or
not because the considerations will differ accordingly
– There is some overlap, e.g. profit-making intention
Taxpayer in business Taxpayer not in business
Receipts and profits made by a
taxpayer in the ordinary course of
business will be income
Receipts and profits made outside the
ordinary course of business, but as
part of the taxpayer’s overall business
activities, will be income, if the
taxpayer entered the transaction with
a profit-making intention
Receipts or profits made by a taxpayer
not in business will be income, if:
a) taxpayer entered the transaction
with profit-making purpose, and
b) the transaction is a commercial
one, or a business operation
Recap of last week
• Reluctance of courts to make an income finding in isolated
transaction cases
• Case in point: Jones v Leeming
• Then we had the decision in Whitfords Beach – key point from
the decision is that taxpayer can change their intention or
purpose of holding an asset
• Greig case in 2020 considered the terms ‘business operation’
and ‘commercial transactions’ – note facts were very extreme
• Introduction to Myer case – key case on isolated transactions
Recap of last week
• Significance of case is that decision was made of 2 ‘strands’:
– 1st strand: profit from a transaction entered into with the
purpose of making a profit, and in the course of the
taxpayer’s business, is income although the transaction is
not within ordinary course of taxpayer’s business
– 2nd strand: where taxpayer receives an amount in
exchange for an income stream, the amount will take on
an income nature, under compensation receipts doctrine
• We also started looking at the fourth income schedule
(compensation receipts principle) which we’ll complete today
Plan for today
• Today we’ll look at the fifth income schedule (factorial income)
• We’ll also go through most of the capital gains tax (CGT)
regime and continue this next week (Week 4)
3.1 Compensation Receipts Principle in
Context of Returns from Property
• At common law, if a taxpayer obtains a compensation receipt,
the receipt will take the character of the thing it is replacing
• There is no reason this principle could not apply where a
taxpayer obtains returns from property
• Example: landlord receives insurance payout to replace lost
rental income
• 2nd strand of Myer provides that an amount received in return
for an income stream takes on an income nature
• The taxpayer is converting future income for present income
3.2 Factorial Income Principle or
Periodicity Principle
• Fourth income schedule complete
• There is a fifth income schedule (mentioned in your lecture
program): it is a factorial approach to characterising a receipt
or amount
• Receipts and amounts may be income even where they don’t
fit into one of the first four income schedules, based on looking
at all the circumstances
• Most recent application of the factorial approach was by High
Court in 2010 in FCT v Anstis
3.2 Factorial Income Principle or
Periodicity Principle
• Anstis involved government youth allowance payments to a
university student
• In that case, payments held to be income because taxpayer
could rely on them for living expenses and could expect to
continue receiving them as long as they satisfied requirements
• Keily v FC of T is another example
• In that example, recurrence and regularity of old age pension
payments key in finding the payments were ordinary income
3.2 Factorial Income Principle or
Periodicity Principle
• Relevant criteria: a) regular b) recurrent c) periodical d)
expected e) paid for, paid to and used to meet living expenses
• Factorial approach could extend to unemployment benefits,
scholarships and other income support payments from the
government
• Note provisions in income tax legislation which may make
certain government payments exempt income (won’t make its
way into taxpayer’s assessable income)
• Must look at all the factors; regularity and recurrence are
significant factors, but not decisive alone
3.3 History of Capital Gains Taxation in
Australia
• Taxpayer could have an amount under the capital gains tax
(CGT) regime that is included in their assessable income
• Before 1985, capital gains generally not taxed, outside of a
few limited provisions
– Problem: not effective and had many shortcomings
• On 20 September 1985, Australia introduced a comprehensive
regime to tax capital gains
• CGT regime was introduced on a prospective basis, i.e. it
applies to the disposal of assets acquired on or after 20
September 1985
3.4 Role of Capital Gains Taxation within
the Income Tax Assessment Act 1997
• CGT is not a separate tax; you don’t pay CGT
• Net capital gain is included in taxpayer’s assessable income
• Net capital loss is quarantined; can only be applied against
capital gains:
3.4 Role of Capital Gains Taxation within
the Income Tax Assessment Act 1997
• Objective of CGT regime: tax gains that were not taxed prior to
20 September 1985
• CGT is the last resort, after you have considered the income
tax provisions
• Start with the income tax provisions; do not go straight to CGT
because you might miss key provisions
3.5 Broad Outline of Australia’s Capital
Gains Tax (CGT)
• Key features of Australia’s CGT regime:
a. CGT is not a separate tax from income tax
b. The tax base is generally ‘assets’ (some exceptions to this)
c. CGT regime only applies to assets acquired after 19
September 1985
d. Generally, the CGT regime is a realisation-based tax
e. The CGT regime contains numerous ‘deeming’ provisions
f. There are numerous exemptions and exceptions built into
the CGT regime
3.5 Broad Outline of Australia’s Capital
Gains Tax (CGT)
• Key features of Australia’s CGT regime (continued):
g. There are a number of rules directed at coordinating the
CGT regime with the non-CGT income tax regime
3.6 Paradigm/Model CGT Framework: Essential
Elements of First Charging Provision of CGT
• Topic we’ll spend most of our time on today
• Understanding the fundamental structure of the CGT regime will
help when we’re looking at each aspect of the regime more
closely in later topics
• The reference to ‘first charging provision’ is not a reference to a
particular section in the legislation
• It refers to the various rules that apply to the situation where a
taxpayer sells or relinquishes a pre-existing asset
• This is the most common type of CGT transaction
3.6 Paradigm/Model CGT Framework: Essential
Elements of First Charging Provision of CGT
• Parliament also intended for the CGT regime to tax certain capital
receipts that do not involve a taxpayer selling or relinquishing a
pre-existing asset
• Example: restrictive covenants (agreeing not to do something)
• This is what we call the ‘second charging provision’ – we will deal
with this in topic 3.11
3.6 Paradigm/Model CGT Framework: Essential
Elements of First Charging Provision of CGT
• There are 7 key aspects of the first charging provision:
1. Existence of a CGT asset
2. Taxpayer has acquired the CGT asset
3. Taxpayer acquired the CGT asset on or after 20 September
1985
4. Taxpayer has disposed of the CGT asset (a CGT event
occurred to the CGT asset)
5. Taxpayer disposed of the asset on or after 20 September
1985
3.6 Paradigm/Model CGT Framework: Essential
Elements of First Charging Provision of CGT
• There are 7 key aspects of the first charging provision (continued):
6. The taxpayer’s cost base or reduced cost base for the CGT
asset needs to be determined
7. The capital proceeds received from the CGT event needs to
be determined
• Capital gain or capital loss only arises if a CGT event occurs, e.g.
there has been a disposal of a CGT asset (CGT event A1)
• There are numerous CGT events under the CGT regime
3.7 Assets, Exempt Assets and Asset
Classification
• CGT asset is defined to mean:
– Any kind of property, or
– A legal or equitable right that is not property
• Key features attached to property are: a) right to exclude others
from it b) right to use and enjoy it c) right to sell it
• Note property can be tangible or intangible
• Many CGT assets easy to recognise, e.g. real estate, land,
shares in a company, units in a unit trust
3.7 Assets, Exempt Assets and Asset
Classification
• Legal or equitable rights would cover contractual rights, which are
not property
• Examples: restrictive covenants and leases
• Personal freedoms and personal liberties are not rights that are
covered by the definition (see Hepples v FCT)
• A business is not a CGT asset – it is the assets that make up the
business that are the CGT assets
• Part of an asset can be a CGT asset, e.g. taxpayer sells half of a
block of land
3.7 Assets, Exempt Assets and Asset
Classification
• The notion of an asset can be modified under the CGT regime
• The common law principle is that everything on land forms part of
the land
• The CGT regime contains modifications to this common law
principle, including in the 2 scenarios below:
– Construction of a building post-CGT on pre-CGT land: the
building will be a CGT asset (section 108-55)
– Buildings or structures on land purchased post-CGT that are
depreciating assets: assets are subject to the uniform capital
allowance system (section 108-60)
3.7 Assets, Exempt Assets and Asset
Classification
• CGT assets fall into one of three categories:
Collectables Personal use assets Other assets
artwork, jewellery, antique,
etc., used or kept mainly for
your personal use or
enjoyment: s 108-10(2)
an asset that is not a
collectable, that is used or
kept mainly for your personal
use or enjoyment: s 108-20(2)
assets that are (i) not
collectables and (ii) not
personal use assets
3.7 Assets, Exempt Assets and Asset
Classification
• Characterising the CGT asset is important because collectables
and personal use assets have special rules:
Collectables Personal use assets Other assets
- Disregard capital gain or capital
loss if collectable acquired for
$500 or less: s 118-10(1)
- Capital losses from collectables
can only be used to reduce capital
gains from collectables: s 108-
10(1)
- Disregard any capital loss made
from a personal use asset: s 108-
20(1)
- Disregard capital gain if personal
use asset acquired for $10,000 or
less: s 118-10(3)
All the normal
CGT rules apply
3.8 Acquisition and Disposal (CGT Events)
• In the normal course of events, a taxpayer acquires a CGT asset
before they dispose of the asset – a CGT event occurs when they
dispose of the CGT asset
• Australia’s CGT regime is generally realisation-based, meaning it
only applies where there has been a disposal of a CGT asset
• Generally easy to identify if a disposal has occurred, however the
CGT regime contains special rules under which an acquisition or
a disposal is deemed to have occurred (section 109-5)
• Example: for CGT event A1, if entity disposes of CGT asset to
you, you acquire it when the disposal contract is entered into
3.8 Acquisition and Disposal (CGT Events)
• CGT events: the different transactions or events that may result in
a capital gain or capital loss
• Some happen often and affect many people; others are rare and
affect few people
• This course will focus on a few key CGT events
• CGT event A1: taxpayer disposes of a CGT asset to someone else
(most common CGT event)
• CGT event C1: CGT asset is lost or destroyed
• CGT event C2: intangible CGT asset is cancelled, surrendered etc.
3.9 Timing Issues
• Timing issues in income tax context are important – determines
when assessable income, deductions, etc. are allocated
• In this course, we’ll briefly look at timing issues in the context of
CGT regime
• Timing issues affect the operation of various rules, including:
– CGT generally does not apply to pre-CGT assets
– Different cost base rules apply depending on acquisition date
– Determines whether cost base can be indexed
– Determines eligibility for CGT discount
3.9 Timing Issues
• We need to know when a CGT asset was acquired and when it
was disposed of
• Section 109-5 outlines acquisition dates for certain CGT events
– Example: for CGT event A1, time of acquisition is when the
contract for the disposal was entered into with seller
• Sale process involves 2 stages:
– 1st stage: contracts are exchanged between seller and
purchaser
– 2nd stage: settlement
3.9 Timing Issues
• Other question is when the CGT event occurs – for this we look to
the particular provision dealing with relevant CGT event
– CGT event A1: time of the CGT event is when the contract for
the disposal was entered into
– CGT event C2: time of the CGT event is date of contract that
results in asset ending (if there is a contract) or the date the
asset ends (if no contract)
• Several cases have considered timing issues in context of CGT:
McDonald, Gardiner and Sara Lee cases
3.9 Timing Issues
McDonald v FCT
2/9/85 Negotiations for the purchase of a property commenced
13/9/85
Taxpayer verbally made offer to purchase property for $200,000. Offer accepted by owner. Owner’s
solicitor wrote to taxpayer’s solicitor enclosing the contract of sale with note that no liability attaches to
either party until exchange of contracts
19/9/85 Taxpayer’s solicitor replied, asking whether a 5% deposit was acceptable instead of a 10% deposit
10/10/85 Taxpayer’s solicitor raised concern about the frontage of the property
18/10/85
Taxpayer’s solicitor sent contract to owner’s solicitor, saying the date of the contract was to be 13/9/85
(the date requested by the taxpayer)
31/10/85 Owner’s solicitor sent signed contract to taxpayer’s solicitor
11/88 Taxpayer sold property for around $600,000, making a profit on the sale
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• After identifying the appropriate CGT event, next step is
calculating the capital gain or loss that arises
• Calculation for most CGT events involves comparing the capital
proceeds and the cost base (or reduced cost base)
• The difference between the 2 amounts is the capital gain or loss
• Specific rules for calculating capital gain or loss apply to each
CGT event, e.g. formulas for CGT event A1 are in s 104-10(4):
– Capital gain = capital proceeds – cost base
– Capital loss = reduced cost base – capital proceeds
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• Follow the formula contained in the specific rules for each of the
CGT events
• Careful not to mix up cost base and reduced cost base – we will
look at when to use each today
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• Capital proceeds is broadly, what you receive, or are entitled to
receive, as a result of a CGT event: section 116-20(1)
• It is irrelevant when the taxpayer receives the capital proceeds:
section 103-10(2)
• Market substitution rule for capital proceeds applies if:
– Taxpayer receives nothing in exchange for a CGT asset (e.g.
they gift it to someone) or
– Capital proceeds are more or less than market value, and
parties were not dealing with each other at arm’s length
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• Cost base of CGT asset is generally the cost of the asset when
taxpayer bought it, plus certain other costs
• Section 110-25: cost base consists of following 5 elements:
– First element: money paid or property given, or required to be
paid or given, for the CGT asset
– Second element: incidental costs of acquiring the CGT asset
or that relate to the CGT event
– Third element: costs of owning the CGT asset (caution here)
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
– Fourth element: capital costs to increase or preserve the
value of the CGT asset, or to install or move it
– Fifth element: capital costs of preserving or defending the
taxpayer’s title or rights to the CGT asset
• Reduced cost base of a CGT asset has the same five elements
as the cost base, except for the third element
– Third element: any amount that is assessable because of a
balancing adjustment for the asset, or would be assessable if
certain balancing adjustment relief were not available
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• Inflation broadly increases the cost base to account for inflation, in
line with quarterly movements in the ABS CPI
• Indexation was a feature of the CGT regime when it started,
however indexation has been frozen as at 30 September 1999
• At this time, the 50% CGT discount method was enacted, allowing
eligible taxpayers to reduce their capital gain by 50%
– Only individuals, trusts and complying super funds eligible
(companies are excluded)
– CGT event must have happened after 21 September 1991,
and taxpayer must have held asset for 12 or more months
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
Asset acquired and sold
before 11:45am 21
September 1999
• Taxpayer must use indexation method to calculate capital gain, where
they satisfy the conditions
• Taxpayer does not have the choice to use the discount method
Asset acquired before
11:45am 21 September 1999
and sold after 11:45am 21
September 1999
• Taxpayer may use either indexation or discount method to calculate
capital gain, whichever gives the better result
• Taxpayer must satisfy the conditions of eligibility for the method chosen
Asset acquired and sold
after 11:45am 21 September
1999
• Taxpayer must use discount method to calculate capital gain, where
they satisfy the conditions
• Taxpayer does not have the choice to use the indexation method
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• Bob acquired a block of land in June 1993 for $100,000
• Bob sold it in May 2016 for $180,000
• Bob may use either indexation or discount method to calculate his
capital gain
• Bob’s capital gain using the indexation method is:
Capital proceeds $180,000
Less cost base $100,000 x 1.130* $113,000
Capital gain $67,000
* Sept 1999 (68.7) / June 1993 (60.8) = 1.130 rounded to 3 decimal places
3.10 Calculating Gain or Loss (Cost Base and
Capital Proceeds)
• Bob’s capital gain using the discount method is:
Capital proceeds $180,000
Less cost base $100,000
Capital gain (before 50% discount) $80,000
• If this is Bob’s only capital gain and he has no capital losses or net
capital losses, it will be discounted to $40,000 and this will be his
net capital gain
• The discount method produces a better result, i.e. lower capital
gain, for Bob, however we will see it is not always the best method
3.11 Second Charging Provisions of the CGT
Regime
• Focus is on those transactions Parliament also intended to tax
under the CGT regime that do not involve a taxpayer selling or
relinquishing a pre-existing asset
• This is what we call the ‘second charging provision’
• CGT event D1: happens if taxpayer creates a contractual right or
other legal or equitable right in another entity
• Capital gain for CGT event D1 is the money received, less the
incidental costs incurred in relation to the event
• CGT discount does not apply to capital gains from CGT event D1
3.11 Second Charging Provisions of the CGT
Regime
• CGT event D1 contemplates rights such as:
– Easements – right to use real property of another person for
a specific purpose, e.g. right to use another person’s land
– A profit à prendre – right to enter and remove product or part
of soil from another person’s land
– Licences – authorises licensee to do something, e.g. to
occupy another person’s land (distinguish from a lease)
– Restrictive covenants – person agrees to do something in
return for payment; payer acquires a contractual right
3.11 Second Charging Provisions of the CGT
Regime
• Important to work out whether the taxpayer is dealing with, or
realising, a pre-existing CGT asset (‘first charging schedule’), or
whether they are creating new contractual rights (CGT event D1)
• Ashgrove Pty Ltd v FCT dealt with this issue
– Taxpayer contracted to sell standing timber on pre-CGT land
that they owned to the purchaser
– Contract gave purchaser the right to cut standing timber and
granted the right to enter taxpayer’s land
– Issue: was the contractual right for the sale of trees, or for an
interest in the land?
3.11 Second Charging Provisions of the CGT
Regime
• Ashgrove Pty Ltd v FCT (continued)
– HELD: the contractual right was for the sale of the trees, and
the right to enter and sever the timber was ancillary to this
• CGT event F1: happens if a lessor (owner) grants, renews or
extends a lease
• Capital gain for CGT event F1 is the amount received for granting
the lease, less any costs associated with granting the lease
• CGT discount does not apply to capital gains from CGT event F1