Tax Fundamentals: CGT Events

Pop quiz! … How many CGT events are there?

Our Tax Fundamentals trainer, Lee-Ann Hayes asks this question often of her groups and enjoys the varying replies she gets back. She has heard everything from five to 200 CGT events. Occasionally, someone is a little closer to the mark.

Identifying the correct CGT event, however, is critical in working out the amount of a capital gain or capital loss. Each CGT event has its own rules on when the event occurs and how a capital gain or loss is calculated. A specific event may also set out possible exemptions or modifications. Additionally, ss. 100-20 and 102-20 of the ITAA 1997 both note that you can only make a capital gain or loss if a CGT event happens.

What are the CGT events?

Section 104-5 of the ITAA 1997 lists all the CGT events, and these are broken into the following general categories (and Subdivisions):

• Subdiv 104-A — Disposals
• Subdiv 104-B — Use and enjoyment before title passes
• Subdiv 104-C — End of a CGT asset
• Subdiv 104-D — Bringing into existence a CGT asset
• Subdiv 104-E — Trusts
• Subdiv 104-F — Leases
• Subdiv 104-G — Shares
• Subdiv 104-H — Special capital receipts
• Subdiv 104-I — Australian residency ends
• Subdiv 104-J — CGT events relating to roll-overs
• Subdiv 104-K — Other CGT events
• Subdiv 104-L — Consolidated groups and MEC groups.

So as we can see, an answer of ‘Five’ to ‘How many CGT events are there?’ is well off the mark.

With so many CGT events, it is possible that two or more CGT events may apply to the same transaction. The legislation deals with this possibility in s. 102-5 by providing some general rules when ordering multiple CGT events. The effect of this provision is that:

1. All CGT events will take priority over CGT events D1 or H2 — these events are the ‘last resort’ events.
2. If more than one CGT event can happen, the applicable CGT event is generally the one that is the most specific to the situation, however:
   • if CGT event J2 happens in addition to another CGT event, CGT event J2 happens in addition to that other event;
   • if CGT event K5 happens in addition to CGT events A1, C2 or E8, then both events will happen; and
   • if CGT event K12 happens in certain circumstances, it may also happen in addition to another CGT event.
3. If no CGT event apart from CGT event D1 or H2 happens, apply CGT event D1 before CGT event H2.

When applying the correct CGT event is critical to the tax outcome

A1 or E2?

The Federal Court case of Healey v FCT [2012] FCA 269 considered when applying the correct CGT event was critical to the tax outcome.

The broad facts in this case were that on 1 May 2004, by a document titled ‘Declaration of Trust’, the taxpayer (the trustee of a bare trust) had entered into a contract for the purchase of shares. The standard transfer forms for the transfer of these shares were also executed on this date, although the transfer of shares was not registered in the company’s register of members until 9 December 2005. Just prior to the transfer being registered in the company’s register, the trustee sold these shares to a third party by entering into a contract with the third party in November 2005. Settlement occurred in January 2006.

Critical to the tax impost on the trustee was when the trustee had acquired the shares. This is because a taxpayer must have held the CGT asset for at least 12 months in order to access the 50 per cent CGT discount. Section 109-5 contains the acquisition rules, and the acquisition date varies depending on which CGT event resulted in the taxpayer acquiring the asset.

The two relevant CGT events in this case were CGT event A1 Disposal of a CGT asset and CGT event E2 Transferring a CGT asset to a trust. CGT event A1 happens when the contract is entered into, while CGT event E2 happens when the asset is transferred. The acquisition rules also reflect this difference, providing that an asset acquired as a result of CGT event A1 happening is acquired when the contract is entered into, while an asset acquired as a result of CGT event E2 happening is acquired when the asset is transferred.

If the trustee in this case acquired the asset as a result of CGT event A1 happening, then it would satisfy the 12-month holding rule for the CGT discount (i.e. May 2004 to November 2005). If, however, it acquired the asset as a result of CGT event E2 happening, the 12-month holding period rule would not be satisfied as the trustee entered into a contract to sell the asset before it was transferred to the trustee. As an aside, the gain that ultimately was in question was approximately $14 million, so accessing the discount had significant financial consequences.

The Federal Court held that the relevant CGT event applicable to this transaction was CGT event E2. Consequently, the trustee was taken to have acquired the shares on 9 December 2005 when the shares were transferred rather than the earlier contract date. This meant that when the trustee sold the shares, it had not held them for at least 12 months.

A1 or B1?

Another example when two CGT events might apply to the same transaction was set out in ATO ID 2005/216 which considered whether CGT event A1 or B1 was the most appropriate in the situation.

The broad facts as set out in the interpretative decision were that a taxpayer’s child wanted to purchase a home but was unable to obtain finance (we shall call the taxpayer Dad and the child Junior). Consequently, Dad agreed to obtain a loan with the property registered in Dad’s name. As Junior expected to be in a position to obtain finance in five years, it was also agreed that Dad would transfer title to the property to Junior in five years if the amount outstanding on Dad’s loan at that time was paid by Junior. All outgoings in relation to the property, including Dad’s loan repayments to the bank were met by Junior.

In due course, Dad transferred the property in accordance with the agreement, however the value of the property had increased considerably during this time.

Two possible CGT events may have applied in this case, namely CGT event A1 or B1. CGT event A1 happens where you dispose of a CGT asset while CGT event B1 happens where you enter into an agreement with another entity under which:

• the right to the use and enjoyment of a CGT asset you own passes to another entity; and
• title in the asset will or may pass to the other entity at or before the end of the agreement.

In order for CGT event B1 to happen, the relevant agreement must be one under which title will or may pass at the end of a specific period or on the occurrence of a specific event. CGT event B1 will not happen if, under a loose family arrangement, title to an asset may pass at an unspecified time in the future.

In this case, Dad entered into a formal agreement with Junior to grant the right to use and enjoy the property. Under the agreement, title to the property was to pass to Junior in five years. In these circumstances, CGT event B1 happened in the income year in which Dad entered into the contract as it was the most specific CGT event that applied. As CGT event B1 happened when Junior was granted the right to use and enjoy the property, there will be no CGT consequences for Dad when the title to the property is ultimately transferred to Junior.

Note

If the title to the property does not actually pass to Junior at or before the end of the agreement, then any capital gain or loss Dad made from CGT event B1 happening would be disregarded. And Dad would be able to amend his earlier tax return to remove the capital gain previously included when CGT event B1 happened.

It is also worth noting that Junior will have acquired the asset at the same time as CGT event B1 happened to Dad. That may favourably influence Junior’s future main residence exemption.

As you can see, selection of the correct CGT event can significantly affect the ultimate CGT outcome for a taxpayer. Not only that, it can also influence the tax outcome for the next taxpayer in the asset’s ownership chain.

By the way … the answer is 54 CGT events.

If this is a subject that interests you, you may want to learn more about our Tax Fundamentals course, which takes place in Melbourne in September. Learn more here.