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Question :

What are the CGT consequences of all the above transactions for Worry Tyres Pty Ltd, David and John? In answering each of the foregoing you are to ensure the best tax outcome for each taxpayer. In your answer you must cite all references to Income Tax Assessment Act 1997, case law and any ATO rulings as appropriate.

Answer :

The main aim is to analyse the capital gains tax so incurred by Worry Tyres Pty. Ltd., David and John as per the situation given in the question. The CGT repercussions of the above three parties has been dealt with individually and separately below:

Worry is a company and a separate legal entity distinct from its shareholders1 . Its distribution of assets as on 30 June 2010 is as follows:

  1. A house acquired before 20 September 1985 worth $250,000; and
  2. Other assets acquired after 19 September 1985 worth $350,000

The house is a pre-CGT asset purchased by Worry before 20 September 19852 . Therefore, any capital gains or losses will be disregarded3 . The relevant event is E5 which deals with a beneficiary being entitled to a trust property as given under Section 104.75. Section 104.75 also states that if the asset was acquired by the trustee prior to 20th September, 1985, then the capital gain and loss shall be disregarded, which shall be followed in this situation and the capital gain or loss of Worry for the house property shall be disregarded as it was bought prior to September 20th, 1985. Event K6 can be applicable in this case as well, since the asset is a pre CGT asset, but not applicable as Section 104.230 states that the market value of post 1985 assets should be 75% or more of the net value of the company, which is not the scenario in this situation as the value of post 1985 assets is $350,000 out of $600,000 which is equal to 583.3%.

Worry is also in possession of post-CGT assets worth $350,000 in the year 2009-10. On 30 June 2010, Michael, who held the shares in Worry since the date of its incorporation, transferred the beneficial interest on these assets to John on which the capital gain tax event E5 arises, which entails a beneficiary being entitled to a trust asset under Section 104.75, which is John acquiring an interest in the other assets in this scenario. The section states that if the cost base of asset is more than the market value of the asset at the time, there shall be a capital loss and if it is less, then there shall be a capital gain. However, the capital gain or capital loss for Worry, pertaining to the other assets cannot be ascertained because of the lack of information in the facts. In the immediate situation, the value of the assets so transferred to John is $350,000, however, it is not mentioned the value at which these other assets were acquired. This lack of such information is highly detrimental because the cost base cannot be determined, which is essential as it needs to be subtracted from the capital gain to determine the net capital gain or loss as mentioned in Section 104.75 (3). (Company tax rate need not be mentioned as we cannot ascertain the capital gain or loss in the first place, however, for the sake of information, companies need to pay 30% tax on the net capital gain, however, since the net capital gain cannot be ascertained as the cost base cannot be determined, this information is without fruition. Small business entities: Again, we don’t know anything about the turnover of Worry Tyres Pty. Ltd., so, the question of it being a small business entity cannot be answered accurately without basing it on assumptions. Discussions on indexation: Indexation is a method of calculating the CGT by altering the cost base by increasing the amounts of the elements of the cost base by consulting a consumer price index. The cost base cannot be calculated in this scenario as the purchasing value of the asset is not mentioned, thus, the cost base cannot be indexed, leading its mention to be redundant. CGT event K6 and the 75% net value test: Has been mentioned)

b) At the time of the CGT event:

  1. You and your spouse or former spouse are separated; and
  2. There is no reasonable likelihood of cohabitation being resumed.

From the above requirements, it can be ascertained that the parties to the divorce settlement need to be separated and there should exist no reasonable likelihood for both the parties to resume cohabitation in the future again. If the facts are to be considered, the Family Court decided on 31 March 2016 on a property settlement which hints at the fact that the relationship has broken down irrevocably and the parties shall not continue cohabitation in the future and since the property settlement is being given in the year 2016 and the breakdown of the relationship took place in 2015, it can be safely assumed that the parties were separated at the time of the settlement. Thus, John does not have any capital gains tax liability on house property so transferred to David. As for the other assets acquired by John, he does not have to pay any capital gains tax on that as well, since he hasn’t sold those assets, thus, ruling out the chance of him having any capital gain or loss in the current period of time so mentioned in the facts.

For the sale of the stockbroking business, it can be concluded that the business was small business as the turnover never exceeded $2 million (including the year 2019) apart from 2014, which is in compliance with Section 328.110 which states that a business entity is a small business entity if business is being carried out in the current year and the aggregated turnover for the previous year was less than $2 million and the turnover for the current years is also likely to be less than $2 million. Owing to this, David is entitled to certain exemptions. One of these exemptions is the 15-year exemption, which allows for exemption on capital gains tax on sale of active asset (in reference to Section 152.140 which defines an active asset to be an asset which is being used for business purposes at time of the capital gains tax event) if the owner is retiring and the asset was held for at least 15 years. Owing to the lack of information regarding the time period for which the asset was held makes it impossible to calculate the capital gains tax payable on the sale of assets of the stockbroking business. However, the goodwill sold is not exempt as it as a capital gains tax asset as given under Section 108.5 and Section 100.25 and for that capital gains tax shall be paid. The capital gain in this scenario is $5 million owing to the goodwill, which has no exemptions and since the discounted method is not applicable to companies, the net capital gain shall be $5 million. However, since the income tax rates for the year 2010-20 are not available, it cannot be said for certain how much capital gains tax David would have to pay in that year. 

To summarize, Section 126.5 allowed for the roll-over of the house to David, thus, ensuring he shall pay the capital gains tax when a future capital gains tax event pertaining to the house takes place, which happens on 30th March, 2016. However, since David was using the property for his main residence with 10% of it let out. This allowed for a partial exemption for him, bringing his net capital gain to $3,750, using the discount method. However, since the net capital gain is below $18,200, the tax payable in such a scenario shall be nil as per the tax payable guidelines laid down by the Australian authorities. However, for the year 2019-20, David has a net capital gain of $5 million, the capital gains tax on which cannot be calculated owing to the lack of income tax rates of the year 2019-20.

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