Capital Gains Tax

Capital Gains Tax Cost Base Provisions

Explanation

The Government has decided to amend the Income Tax Assessment Act 1936 (ITAA) to ensure that, where the established cost base reduction rules do not apply:

• expenditure must be included in the cost base of an asset only to the extent that net revenue deductions are not allowable as a result of the expenditure; and
• the indexed cost base of an asset must be calculated by reducing the indexed expenditure on the asset by any net revenue deductions allowable as a result of the expenditure.

In principle an item of expenditure should either be deductible for income tax purposes, or included in the capital gains tax (CGT) cost base of an underlying asset, but not both. The CGT provisions reduce costs and expenditures that form part of the cost base to the extent that they are allowable as deductions. Section 82 of the ITAA also specifically attempts to prevent double deductions.

However, anomalies in the current tax treatment have given rise to double deductions in respect of certain capital expenditure items. A taxpayer can effectively claim the cost of the capital expenditure twice - first from income tax under capital allowance provisions, and second from inclusion of expenditure in the cost base of the underlying asset resulting in a reduction in CGT gains, or an increase in CGT losses, when the asset is sold.

Examples where this problem can arise include in respect of expenditure on: extending telephone lines; connecting mains electricity; traveller accommodation; and buildings and structural improvements covered by Division 10D of the ITAA.

To limit the increase in compliance costs arising from this measure, a single calculation will need to be undertaken at the time of disposal of an affected underlying asset. This concession will allow taxpayers to calculate the adjusted indexed cost base of an asset by reducing the indexed expenditure on the asset by the total of any net revenue deductions allowable.

Interaction of Controlled Foreign Company Measures and Capital Gains Tax Provisions

• The measure will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of tax minimisation practices. In the absence of the measure, to the extent that the revenue base would not be protected, there would be a significant revenue loss compared to the forward estimates.

The Government intends to correct several anomalies that have been identified concerning the interaction of the controlled foreign company (CFC) measures and the capital gains tax (CGT) provisions. Three of the anomalies could, in combination, prevent the intended taxation in Australia of capital gains on the deemed disposal of tainted assets (assets held to derive tainted income such as interest and dividends) of a CFC. (A deemed disposal can occur, for example, when a CFC, which holds an asset which has been subject to rollover relief, ceases to be a member of a group.) A further anomaly which will be corrected is that shareholders of a CFC that holds a tainted asset and has taken advantage of the rollover provisions, may reduce their Australian tax liability by diluting their interest in the CFC between the time the rollover relief is obtained and when an asset disposal takes place.

Capital gains derived or deemed to be derived by a CFC on tainted assets are intended to be taxed in Australia (with a credit for foreign taxes paid) unless the CFC satisfies an active income test or the gains have been comparably taxed in another jurisdiction. Unless these anomalies are corrected, the interaction of the CFC measures and the CGT provisions will not operate as intended and companies could avoid the imposition of Australian tax by holding mobile assets through a CFC (rather than in Australia).

The Government proposes to amend the Income Tax Assessment Act 1936 (ITAA) and the Income Tax Regulations to ensure that:

• tainted income consisting of capital gains on assets deemed to be disposed of by a CFC on its ceasing to be a member of a group, or ceasing to be a CFC, is included in the attributable income of the Australian resident controllers (as the ITAA is currently worded there is uncertainty as to whether this is the case);
• all capital gains accruing, for the purposes of Part IIIA of the ITAA, on the deemed disposal of an asset are taken into account in applying the active income test to a CFC;
• all capital gains accruing for the purposes of Part IIIA of the ITAA are included in the kinds of capital gains that are taken into account in determining whether the gains are designated concession income; and
• taxation of capital gains on the disposal of tainted assets is not avoided or minimised by arrangements designed to dilute the Australian taxpayer's attribution interest in the CFC that holds tainted assets that have received rollover relief.