Capital gains tax is generally thought of as a tax on the rich. However, increasing levels of share ownership by small investors means that it is affecting more and more middle income earners. It is extremely complex, and any attempt at a brief explanation is likely to be an over--simplification. The following is a very general overview.

Capital gains tax is a separate tax regime, but is dovetailed into the income tax. The legislation covering it is in the 1997 Act, Part 3—1 Divisions 100—149. Significant changes were made in 1999.

Assets acquired after 19 September 1985

Capital gains tax generally applies only to assets acquired after 19 September 1985. It is prospective; that is, it taxes only gains made after that date, and is charged only when the asset is disposed of (or, sometimes, deemed to be disposed of).

Originally, the cost of the asset for tax purposes was indexed, if it was held for 12 months or more, so that only the real gain (not the gain in value due to inflation) was taxed. This gain was taxed at ordinary income tax rates, but there was an averaging arrangement that reduced the tax payable on smaller gains.

Assets acquired before 21 September 1999 and held for at least 12 months do not continue to attract indexation after that date, though the indexed cost base may be used on disposal. If this option is taken, there is no discounting of the tax rate — it remains as before.

Assets acquired since 21 September 1999

For assets acquired since 21 September 1999 and held for at least 12 months there is no adjustment for inflation, and averaging is not allowed, but only half the gain is included in assessable income.

Residents and non-residents

Residents are taxed on capital gains arising from any source, non-residents on gains on assets situated in Australia (rather broadly defined).

Offsetting capital losses

A key point to note is that capital losses can only be offset against capital gains, not against income.

Because they reduced the long term capital gains tax rate, the 1999 changes had the incidental effect of making capital losses less valuable.

Exemption for active business assets

Small business taxpayers can obtain a complete exemption on active business assets if they are held for 15 years, or a 50% concession if they are held for less than 15 years.

Record keeping

A major issue in capital gains tax affairs is the keeping of records relating to taxable assets. Small share investors need to record all their trades to establish the base cost of their shares and the net capital gains tax liability.

Assets disposed of as gifts

Assets disposed of by way of gift are subject to capital gains tax. The recipient is treated as having acquired the asset at its fair market value.

Assets passing on death

Assets passing on death are not taxed at that point. Capital gains tax liability is deferred until the asset is sold. This is a very important concession, but to make the most of it action must be taken before the taxpayer’s death, usually by suitable provisions in a will.

‘Rollovers’

In some situations rollovers are available which result in the deferring of capital gains tax liability. These include cases of:

Offsetting inome losses

Income losses, except in some special cases, can be offset against realised capital gains.

Major capital improvements

Major capital improvements to assets acquired before 20 September 1985 are treated as new assets subject to capital gains tax, which leads to some tricky valuation problems.

Exemptions from capital gains tax

Major exemptions are discussed below.

The taxpayer’s home

The taxpayer’s main residence and surrounding land to a limit of two hectares is exempt.

A taxable gain could arise if part of the land is subdivided and sold. The rules on this exemption are so complicated that a book has been written on them.

Active assets

Fifty per cent of the gain from disposal of active assets is exempt where the net value of the taxpayer’s business interests is less than $5 million (a useful concession for small business). As an alternative to this the first $500,000 of the taxable gain is exempt if it is used for retirement purposes.

Proceeds of life insurance and superannuation policies

Proceeds of life and superannuation policies are exempt, unless the taxpayer was not the original owner.

Light motor vehicles

Gains on light motor vehicles, such as cars, station wagons and utilities, are exempt.

Personal use assets and collectibles

Gains on personal use assets acquired for $10,000 or less are exempt. These are assets for the personal use and enjoyment of the taxpayer and their family — clothing, white goods, furniture, sporting equipment, cameras, boats and so on. Cars are excluded.

This concession does not cover works of art, jewellery, rare books, stamps and coins and antiques (called collectibles).

Disposal of personal use assets above the $10,000 cost threshold can give rise to a taxable gain, but not an allowable loss.

Disposal of collectibles bought for more than $500 each gives rise to taxable gains, but losses made can only be offset against taxable gains on other listed assets.

It is therefore important to keep records of the purchase and sale of both collectibles and personal use assets that are likely to appreciate in value.

Interestingly, ATO statistics suggest that little or no tax is collected on personal use assets.

Sale of small businesses

People selling small businesses can roll over assets once every five years into another business and thus defer payment of tax on capital gains. This concession is not unlimited: the net value of the taxpayer’s business assets must not exceed $5 million.

Exempt bodies

Bodies presently exempt from income tax, such as charities and sporting bodies, are also exempt from capital gains tax.

Getting advice

It is no exaggeration to say that capital gains tax is a legal minefield, and even professional advice on specific problems is likely to be tentative. Advice is also available from the ATO.

Keep records!

Perhaps the most important piece of advice in relation to capital gains tax is that anyone acquiring assets that are likely to be subject to tax must keep records of their value at the time they were acquired until they are disposed of.

Thus if a valuable piece of art, for example, is acquired as a legacy, it should be valued and the valuation kept until it is sold.