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Australian Taxation Law

WHAT IS CAPITAL GAIN? Capital gain or loss is the difference between the cost of an asset and its sale proceeds. It is not a special type of tax that one has to pay. It is apart of income tax known as CAPITAL GAIN TAX (CGT).all assets are taxable under capital gain tax (CGT) unless specifically exempted. When a person sells an asset or lets it out to someone else it is called capital gain tax EVENT or CGT EVENT. By doing this one makes capital gain or loss. There are many other such capital gain tax (CGT) events, like management of fund, or getting a part of the capital gain distribution from a trust etc are some examples of capital gain tax (CGT) events. If an asset is held for at least 1 year then any gain is first discounted by 50% for individual taxpayers, or by 33.3% for superannuation funds. Net losses in a tax year may be carried forward, but not offset against income i.e. if one incurred capital loss in current taxable year it cannot be deducted from its income in current year but next years capital gain will be reduced by that amount. CHARGEABILITY: Any profit arising from the transfer of a capital asset is chargeable under the head capital gain. MEANING OF CAPITAL ASSET: The expression capital asset means property of any kind held by the assessee whether or not connected with his business or profession.

However the following assets are not included in the definition of capital assets. Stock-in-trade, consumable stores or raw materials held for the purposes of business or professions, Personal movable effect. However the following shall be regarded as capital assets; 1. Jewelry 2. Archaeological collections 3. Drawings 4. Paintings 5. Sculptures and 6. Any work of art Capital gain tax (CGT) in the context of the Australian taxation system applies to the capital gain made on sale of any tangible or in tangible asset, except for specific exemptions. The most convincing exemption is the family home. One of the most significant rollover is transfers to beneficiaries on death, so that the capital gain tax (CGT) is not a quasi death duty. But when an asset is acquired by way of gift or inheritance it is an exempted transfer and no capital gain is chargeable in the hands of the assessee.

Letting out a property for a period of time does affect capital gain tax (CGT) exemption on the main residence.

Generally, one can ignore a capital gain or loss one makes when one sells its home or main residence. It is called the main residence exemption. However, generally one cant obtain the full main residence exemption if one has used any one part of the residence to produce income. it is further explains that capital gain tax implications of using a part of ones house for income earning purposes while continuing to live in it. Capital gain tax (CGT): Most real estate is subject to capital gain tax (CGT) .This includes vacant lands. Business premises, holiday homes and hobby farms. Main residence is mainly exempted from capital gain tax (CGT) unless let out or occupies more than two hectors of land. Main residence exemption While letting out a main residence to someone and in order to gain a full exemption from capital gain tax (CGT), generally the following conditions must be satisfied, (it must be kept in mind that special rule and exceptions for each of these conditions are explained further in the article): the person must have an ownership interest in the house; the house must have been the main residence for the whole period the person owned it; the house must not have been used to produce further income; and Any land, on which the house is situated, must be no larger than two hectares.

A main residence can be defined as a dwelling, which is used wholly, or mainly for residential accommodation. Examples include: a home or cottage;

an apartment or flat; a strata title unit; a unit in a retirement village,

A residence will be fully capital gain tax (CGT) exempt if it is maintained as a main residence for the entire ownership period, and it is not used to produce extra income. Where the main residence is also used to produce income A full main residence exemption is not usually accessible where any of the following is applicable: when the main residence or any part of the main residence, was used to produce income during all or part of the period the person owned it; or The person would be allowed a deduction for interest incurred on money borrowed to acquire the residence (interest deductibility test i.e. while acquiring the residence the assessee was allowed a deduction on the interest on loan taken by him/her to purchase the house). The interest deductibility test will apply irrespective of whether or not the money was borrowed to acquire the house. The test is applied on the assumption that the money was borrowed to acquire the residence. If a business or professional practice was run in part of the main residence, a portion of the interest on money borrowed to acquire the residence would be deductible if: part of the residence was set aside purely as a place of business, and is identifiable as such; and That part of the residence is not easily adaptable for private use. For instance, a dentists surgery located within the dentists home.

A person would not be entitled to a deduction for an interest expense where they use a home study for convenience, to undertake work normally done at their place of work. In this circumstance, the person would still be eligible for a full main residence exemption. Thus KAREN can apply for deductibility test if she can clearly distinguish the cost of the portion of her residence which she uses for her hair dressing business. This in turn will reduce her capital gain in two ways. Firstly the cost of the resident house will reduce by the amount out the cost of the portion of the house used for hair dressing business and secondly she will get a reduction of the interest amount. When a capital gain tax (CGT) event occurs and the interest deductibility test applies, only that proportion of the main residence used to produce income and the period for which income was received, is taxable with respect to the capital gain. Floor space is generally used to calculate the percentage of use In our case Karen used a part of the house for her hair dressing business. Thus the above provisions are applicable. If she uses the entire house for business purpose then her capital gain will be reduced under the head business and professions.

Discontinue living in the main residence: Karen has a discontinuous stay at her residence thus the following provisions are applicable. If a person acquires a new residence before selling their old one, both residences can be treated as their main residences for a period of up to six months providing that:

the old dwelling was their main residence for a continuous period of at least three months in the preceding twelve months before disposal;

the residence was not used to produce measurable income in any part for the time when it was not the persons main residence; and

The new house becomes the persons main residence.

If it takes longer than six months to dispose of the old residence, both residences are only exempt for the last six months prior to the disposal date. exemption will apply when a capital gain tax (CGT) residence. In certain instances a dwelling can be treated as a persons main residence even if they no longer live in the house. However, the person will first need to live in the dwelling and establish it as their main residence. For example, in our case Karen purchased a house and rented it out immediately. Later she stopped renting the house and moved in. Karen cannot elect to treat the residence as her main residence during the period of time she rented the house out, as the house was not main residence before she rented it out. As such, a partial exemption will apply if she chooses to dispose of the residence. If after a person ceases to live in the dwelling, and it is not used it to produce income, the residence can continue to be treated as their main residence for an unlimited time. In our case Karen frequently vacated her residence and let it out on rent. Thus she will not be fully exempted from capital gain tax. If Karen would have sold the house when she shifted instead of letting it out n purchased a new house instead she would Only a partial

event happens to the old

have got exemption on the full cost of new house. This in turn would have reduced the capital gain to a great extent. It would have been even better if she purchased the new house for business purpose, because there is a wide scope of deductions under the head business and professions because lot of allowance can be received under this head. Effect of investing in funds: As far as research work it concerned Karen should do some research work into trusts because this may help her gain some reduction in her capital gain. Because the capital gains tax (CGT) is calculated by adding the net capital gain to ones taxable income in the year of sale. Therefore if one can reduce his/her taxable income by making a large deductible contribution to superanuity fund one can reduce the amount of CGT payable.

Effect of depreciation allowance: One is completely entitled to claim all deductions and capital gain tax rulings remain the same. one will however be required apply ones depreciation deductions to ones capital gain when and if one decide to sell ones residence. Capital Gains Tax is only levied on half the gain so half your depreciation deductions are not subject to inclusion in the calculation. .Also the assessing tax officer (ATO) can deem that one has received depreciation allowances whether one actually claimed and received them or not. One must remember that the additional cash flow from the depreciation is likely to be far more useful up front than not having it at all. It can be utilised for additional repayments, adding value to your asset or as a buffer for vacancy. If one considers the indexing value, the dollars are actually worth far more now than years down the track. Thus even

research on allowance and depreciation may prove to be beneficial to Karen because if depreciation allowance is available then capital gain will certainly reduce to a great extent. WHAT ARE ACTIVE ASSETS? Active asset are assets of the business which are used in its routine operations. Active assets can be tangible assets like building, plant and machinery, furniture and fixtures etc, and intangible assets like goodwill, patents, copy rights etc .In case of capital gains on such assets there is a50% active asset reduction allowance This concession allows one to reduce the capital gain arising from an active asset by 50%. To qualify for the 50% active asset reduction one needs to comply with all the conditions that apply to all the capital gain tax (CGT).if Karen conceders the residence as an active asset 50% of its current fair market value will be deductible. Thus there are many options available to Karen to reduce her taxable capital gain. There are a number of allowances available too. Karen needs to do a proper research work on the most suitable allowances and provisions available to her to reduce her taxable capital gain. There are not only allowances but many other techniques too to reduce the taxable capital gain. For instance sale of ole house and purchase of a new house, declaring the part of the house used for hair dressing business as a part of business asset etc.