Top Tax & Accounting Q&As - October 2016
by Knowledge Shop Editor, on 18/10/16 14:44
This month's top tax & accounting Q&As live from the Knowledge Shop Help Desk:
- Capital Gains Tax for a non-resident on the sale of shares
- Applying the margin scheme on the sale of property
- Treatment of tax distribution that don’t actually happen
- CGT on the sale of Australian home by temporary residents
- Calculating gains and losses on the sale of a rental property and the assets in the property
1. Capital Gains Tax for a non-resident on the sale of shares
Our client is an Australian expat that is living and based in Hong Kong (since 2014).
They have investments here in Australia. Our client sold shares held in public companies and realised that there was a capital gain.
As a non-resident, is there any different tax treatment for capital gains on the Australian shares?
I assume that the client was previously a resident of Australia before moving to Hong Kong in 2014 and was not a temporary resident just before this time. Please let me know if this is incorrect.
1. The general rule is that non-resident taxpayers are only subject to CGT in Australia in relation to assets that are classified as 'taxable Australian property' (TAP). This is because section 855-10 ITAA 1997 states that you disregard any capital gain or loss if you were a non-resident just before the CGT event and the asset is not taxable Australian property. Therefore, the key issue here is to confirm whether the shares are classified as TAP. There are two ways the shares could be classified as TAP.
a) When the client became a non-resident this would have triggered CGT event I1 and the client would have been deemed to have disposed of all CGT assets at that date for their market value (refer to section 104-160 ITAA 1997). The only real exceptions to this are for pre-CGT assets and taxable Australian real property (e.g. land and buildings in Australia).
If the market value of the assets was more than their cost base at the time the client became a non-resident then a capital gain would have arisen in that income year. However, the legislation allows the client to disregard any capital gain or loss made under CGT event I1. This would have the effect of treating all the client’s assets as TAP which would mean that they will be subject to Australian CGT when they are sold, even while the client is a non-resident.
If the client held any of these particular shares when they ceased being a resident and they chose to disregard any capital gain or loss that would have arisen under CGT event I1 then the shares should be subject to Australian CGT on sale.
b) If the client acquired the shares after they ceased being an Australia resident or they did not make the election to disregard any capital gain or loss made under CGT event I1 when they became a non-resident then it would be necessary to consider whether the shares could still be classified as TAP.
In broad terms, shares in a company are classified as TAP if:
- The shareholder and their associates hold at least 10% of the company; and
- More than 50% of the market value of the company’s assets is attributable to Australian real property (directly and indirectly).
2. Note that the CGT discount would not generally be available to the extent that the client was a non-resident while holding the shares.
2. Applying the margin scheme on the sale of property
Can an entity that bought properties under the margin scheme (and not taken input credit as a result of the GST on purchase) sell it using the margin scheme?
Note that the property is residential plots of land without any construction on it.
For example, it purchased a lot for $400,000 (which had $20,000 GST included in that price). It now sells the plot of land for $770,000 total.
What will be the GST that the entity will have to pay? Whether $70,000 ($770,000/11) or $33,636 ($370,000/11) assuming that it prefers to use the margin scheme if possible.
When someone is selling land and this would trigger a GST liability they can use the margin scheme on the sale as long as certain conditions are met.
One of the main conditions is that the client and the purchaser agree in writing to apply the margin scheme before the supply occurs.
The other main condition is that the supply must not be ineligible for the margin scheme. In broad terms, the way the rules work is that the client can generally use the margin scheme on sale of the property if the margin scheme was used when they bought the property (i.e. the previous owner used the margin scheme when selling to your client). Refer to section 75-5 GST Act.
If the margin scheme is used then the GST liability for the client should be 1/11th of the margin, being the difference between the GST-inclusive sale price and the GST-inclusive purchase price. Based on your example, the GST liability should be $33,636.
3. Treatment of tax distribution that don’t actually happen
A trust makes a distribution to a private company, however no cash actually transfers. Does this create an unpaid entitlement or Division 7A loan in the financials?
If the company is a Small Business Entity, and given that it hasn't actually received the distribution - can it be backed out of the tax return as a "debtor" and only record the income and therefore pay the tax when the cash is received?
Or, as it is a trust distribution and the company is presently entitled, is the cash verse accrual question for the company accounts and tax return irrelevant?
The cash / accrual distinction is not really relevant in this case. Section 97 ITAA 1936 applies to tax beneficiaries on their share of the taxable income of a trust if they are presently entitled to some of the income of the trust for that year. Therefore, even if the company accounts on a cash basis for income tax purposes it would still need to recognise its share of the taxable income of the trust despite not having received a physical distribution by the end of that year (e.g. cash etc.).
Note that the position can be different when it comes to determining the taxable income of the trust itself. For example, if the trust uses a cash basis for recognising income then it may be possible to defer the inclusion of certain amounts when calculating the taxable income of the trust until amounts have actually been received.
If the distribution made by the trust to the private company is not actually paid then it will be necessary to consider the potential application of Division 7A. While it would generally be a good idea to account for the unpaid amount as an unpaid distribution or unpaid present entitlement in the accounts, for tax purposes the ATO could start treating the amount as a loan for Division 7A purposes in the following year if it is not paid or placed under a complying sub-trust arrangement. This needs to be managed carefully to ensure that a deemed unfranked dividend is not triggered.
4. CGT on the sale of Australian home by temporary residents
Our clients (retired US citizens) have lived in Australia as temporary residents for over 10 years. They have sold their principal residence that’s never been rented and moved to a new Australian residence.
Is the property excluded from taxable Australian property and accordingly is capital gain tax free under the principal residence exemption available to Australian residents?
I assume that the property you are referring to is located in Australia. If so, it should be classified as taxable Australian property (TAP). This means that it should be subject to CGT in Australia regardless of your client’s residency status.
The main residence exemption can apply to residents, non-residents and temporary residents. Therefore, a full exemption can potentially apply on sale of the property if:
- The client established the property as their main residence as soon as practicable after it was acquired;
- The land area does not exceed 2 hectares;
- The property has been the client’s main residence for the entire ownership period (or is deemed to be their main residence under the absence rule);
- The property has not been used to produce assessable income; and
- The client (or their spouse, if relevant) has not treated any other property as their main residence for CGT purposes during the time they owned this property.
If all of these conditions are not met then it may be possible for the client to apply a partial exemption.
5. Calculating gains and losses on the sale of a rental property and the assets in the property
Our client purchased a rental property in 2013. The client obtained a Quantity Surveyors report and has been claiming Division 40 and Division 43 allowances since the date of purchase based on the report. He has now sold the property.
When it comes to calculating the cost base for the CGT calculation on the sale of the property the previous Division 43 claims are clearly a reduction in the cost base for the purposes of calculating his capital gain on disposal of the property.
However, we are not certain how to treat the prior Division 40 claims. Do we allocate some of the original purchase price to the purchase of the Division 40 assets? For example, the Quantity Surveyors report includes an estimate of the cost of the Division 40 assets at the date of purchase, approximately $20,000. Do we use that as a basis for allocating $20,000 of the original purchase proceeds toward the acquisition of these depreciable assets? Then on sale of the property, do we estimate the written down value of these depreciable assets (perhaps calculating their written down value based on the depreciation claimed to date in the QS report approximately $14,000) and then allocate $6,000 (being $20,000 less $14,000 of prior year Division 40 claims) of the final settlement proceeds to the disposal of the depreciable assets, resulting in a net balancing adjustment of nil?
If this is the correct procedure, how and where would we report this nil balancing adjustment on the income tax return?
Assuming the above is the correct approach, and that we need to reduce the sale proceeds received by an amount apportioned/allocated to the depreciable assets, will this be an audit flag as the sale proceeds disclosed in the income tax return will be lower than the sale proceeds possibly showing in other records e.g. real estate sales?
If the client has sold items together with the property that are separate assets in their own right then technically these do need to be treated separately for tax purposes. You can see the ATO's comments on this here.
You would generally need to start by ensuring that the cost base of the property does not include any amounts paid to acquire the separate depreciating assets. It should be reasonable to use the quantity surveyor report information for this.
You would also need to apportion the capital proceeds on a reasonable basis to ensure that any amounts that relate to the separate assets are not dealt with as part of the CGT calculation on sale of the property. While it is common in cases like this to apply sale proceeds to depreciating assets based on their written down value at that time, you would need to check that the written down value is a reasonable reflection of the current value of those assets.
If the balancing adjustment is nil because the sale proceeds relating to the depreciating assets are the same as their written down value then our understanding is that this should not be reflected on the individual tax return.
You are correct in saying that the information obtained by the ATO from other sources on the property sale could be different to what is reported in the tax return. The key thing here would be ensuring that appropriate records are kept on the client's files to support the calculations and position that has been taken.