Australia's capital gains tax (CGT) system, while comprehensive, is also punctuated by a number of generous concessions and exemptions that significantly reduce the tax burden on individuals and entities alike. Among the most notable of these is the exemption for a person's principal place of residence, effectively shielding the primary home from CGT. This, along with other concessions, makes Australia's CGT regime more accommodating than those of many other countries. Understanding these concessions and how to apply them can lead to substantial tax savings under the right circumstances and with the right advice.
Case Study: John Smith's Investment Property
Let's explore a simple case study to illustrate how CGT works in practice. John Smith buys an investment property for $400,000. Five years later, he sells the property for $750,000. To determine the capital gain, we subtract the cost base (purchase price) from the sale price, resulting in a gross capital gain of $350,000.
In Australia, individuals are eligible for a 50% CGT discount if the asset is held for more than a year. Applying this discount to John's gross capital gain reduces it to $175,000. This net capital gain is then added to John's income for the year and taxed at his marginal tax rate. It's crucial to note that the relevant tax year is the one in which the contract for sale was signed, not necessarily when the sale proceeds were received.
Non-CGT Taxable Items
It's important to distinguish capital gains from other types of income that are not subject to CGT. This includes profits from sales of trading stock of a business or earnings from a business, such as property development. Additionally, gains arising from a profit-making undertaking or scheme are also typically treated differently from capital gains and are taxed as ordinary income, without the benefit of CGT discounts.
CGT Discounts and Exemptions
The CGT discount for individuals and beneficiaries of a trust is 50%, provided the asset has been held for more than a year. For superannuation funds, the discount is 33 1/3%. It's critical to note that companies do not receive a CGT discount, highlighting the importance of the asset's holding structure on its tax treatment.
Principal Place of Residence Exemption
One of the most significant CGT concessions is the exemption for a principal place of residence. This exemption applies under certain conditions, such as the property being the taxpayer's home, being used mainly for residential purposes, and also leaseholds such as a long term lease. This exemption can be fully or partially applied, depending on specific circumstances, such as renting out part of the home.
Small Business CGT Concessions
There are capital gains tax (CGT) concessions for small businesses in Australia. Let's see how these rules play out for John Smith who started a business 20 years ago and is now selling it for $1M at the age of 60. To be eligible for these concessions, John's business must first meet basic eligibility conditions such as being a small business entity with an aggregated turnover of less than $2 million or passing the maximum net asset value test, which considers the total net value of the CGT assets owned by the business and related entities to be less than $6 million.
Apart from the above, (which we would use) John's situation also falls within the Small Business 15-Year Exemption. Under this exemption, if a business has owned an asset for at least 15 continuous years, and the owner is aged 55 years or over and is retiring or permanently incapacitated, there would be no assessable capital gain when the business asset is sold. This exemption essentially allows for the entire capital gain from the sale of the business to be disregarded for CGT purposes, which would be highly beneficial for John as he would not have to pay CGT on the sale of his business. This may be contributed to superannuation outside of the non-concessional contribution caps up to the CGT threshold for non-concessional contributions.
Furthermore, should John's circumstances require consideration of other CGT concessions, there are additional options available. These include the Small Business 50% Active Asset Reduction, which allows for a reduction of the capital gain by 50% on active business assets held for more than 12 months. Another relevant concession could be the Small Business Retirement Exemption, which provides an exemption on capital gains from the sale of a business asset up to a lifetime limit of $500,000. This exemption would be applicable if the proceeds were contributed to a complying superannuation fund or retirement savings account, especially relevant if John is under 55.
Lastly, the Small Business Rollover concession allows deferring the capital gain from the sale of an active asset, providing flexibility in managing the tax implications over time.
Early Stage Investment Companies
Early Stage Innovation Companies (ESICs) in Australia are designed to stimulate investment in innovative, high-growth potential startups. To encourage investment, the Australian Government offers significant tax incentives to eligible investors in these companies.
Tax Incentives Overview: Eligible investors who buy new shares in a qualifying ESIC can access two main tax incentives. Firstly, there's a non-refundable carry forward tax offset of 20% on the amount invested in an ESIC, capped at $200,000 per year for investors and their affiliates combined. Secondly, a modified capital gains tax (CGT) treatment allows investors to disregard capital gains on qualifying shares held for at least 12 months but less than 10 years, while capital losses on shares held for less than 10 years must also be disregarded. The cap on the tax offset does not limit shares qualifying for the modified CGT treatment.
Criteria for Qualifying as an ESIC: To qualify as an ESIC, a company must pass either the 'early stage test' and one of two innovation tests—the '100-point innovation test' or the 'principles-based innovation test'. The 'early stage test' looks at the company's incorporation date, expenses, and income in recent years, ensuring it is indeed in its early stages. The '100-point innovation test' allocates points based on certain innovative criteria, with companies needing to accumulate at least 100 points. The 'principles-based innovation test' requires the company to be focused on developing new or significantly improved innovations for commercialization, with a high growth potential and the ability to scale in a broader market.
Investor Eligibility: These incentives predominantly target sophisticated investors, defined by meeting certain asset and income thresholds under the Corporations Act 2001. However, 'mum and dad' investors can also avail themselves of these incentives, provided their total investment in innovative start-ups does not exceed $50,000 in an income year. This cap is designed to protect retail investors from the high-risk nature of investing in start-up companies
Seeking Professional Advice
Before acquiring or selling an asset, it's imperative to seek professional advice from your accountant or specialist tax lawyers at Abbott and Moulry Lawyers to ensure that the asset is held in the most tax-effective structure and that all potential CGT concessions and exemptions are fully utilised. Tax planning is a complex area, and the advice of a skilled tax professional can provide invaluable guidance, ensuring compliance while optimizing tax outcomes.
Finishing up Australia's CGT regime offers several pathways to reduce tax liabilities through various concessions and exemptions. By understanding these rules and planning strategically, individuals and businesses can significantly enhance their financial outcomes. However, the intricacies of tax law require careful navigation, underscoring the importance of professional advice in both the acquisition and disposal of assets.