Capital gains tax

When you make some money from selling a business asset or investment, this will give you a 'capital gain'. Or to put it a little more succinctly, a capital gain is the difference between the money that is made from selling an asset or investment and the price that you paid for it (less some costs).

The investments or assets that you sell, and that are potentially capital gain generators, can be more recognisable assets (such as property like a building or block of land) but can also be shares in another company or units in a trust or managed investment fund. But an asset can also be intangible, such as contractual rights that the business has or even the goodwill of the business.

Of course it's never as simple as that, especially when you throw the word 'tax' into the discussion. And capital gains tax (CGT) can arise to complicate a range of seemingly ordinary activities that any business may undertake over the year.

Apart from selling assets, including land or buildings, keep your CGT antenna out if selling a part of the business, buying out a partner, making extensions to a factory or warehouse, altering your business structure (say by creating a trust and transferring the business assets into it), buying a new arm for your enterprise, receiving a payout or compensation for lost or destroyed assets and so forth. The amount of capital gains that is subject to tax varies with the type of asset, but is also influenced by various other factors, including how long you have owned the investment.

Exemptions
There are always exceptions of course, and in this area the principal exception is the family home (but the exemption does not apply to any part that you use to derive income from a home business), but also includes private cars and minor collectables.

Also, a gain is exempt from CGT if it is also assessable under any other part of the tax law – for example, if it qualifies as ordinary income. In these circumstances where multiple tax laws apply, the CGT rules take last place. As prime examples, sales of depreciating assets and trading stock are not taxed under the CGT rules because they have their own tax regimes.

How CGT works
The tax is triggered by what the tax legislation quaintly calls a CGT 'event', which means in the main that you sell an asset. But these events can also include giving it away, if it's destroyed or lost, or you stop being an Australian resident.

CGT operates by treating the gains you make as income – so the tax imposed on these gains is not an additional tax, but is lumped in with the income tax you pay through your annual income tax return. So any increase in value from the time the asset was acquired or created (its capital gain) is taxed in the year the asset is sold.

As mentioned, the amounts that are subject to tax vary, but the resulting capital gain amount is lumped in with your income, and taxed at whatever marginal rate you would then pay. The amount that is added into your assessable income is known as the 'net capital gain'.

This is worked out by taking the money you make from selling the asset and subtracting what the Tax Office calls your 'cost base'. The cost base includes the price you paid, any costs incurred in buying and then selling it, and certain other incidental costs.  Also, if an asset was bought before September 1999, you may be able to increase the cost base by an 'indexation' factor, which essentially adjusts the cost base to account for inflation so you're not paying tax on the inflation portion of the gain.

This amount is the gross capital gain. Next, take away any eligible capital losses. Finally, apply any applicable 'discount' factor (that is, where the asset has been held for at least 12 months) – basically, this is a portion of the net gain that is tax-free (more details in the member section).

Sometimes the tax law will require that the proceeds and cost base of the asset are not what was actually paid and/or received, but rather, the market value of the asset at that time. There may also be other adjustments depending on the circumstances. This is basically to prevent people from minimising their tax by, say, selling the asset to a relative for a ridiculously low price.

For smaller businesses (usually defined as those that turnover less than $2 million a year) there are a range of concessions that the Tax Office allows, but especially when it comes to CGT.  There is for example the 15-year asset exemption, a 50% active asset reduction, a retirement CGT exemption and CGT rollover provisions.

And what if you make a loss?
Of course as nice as it would be otherwise, there's no rule that says when you sell an asset you're going to make money on it. So it is possible to make a 'capital loss' if the money you realise from selling an investment is less than what you paid.

And even then, there is no consolation prize of being able to take that capital loss off the total of your income for the year. The Tax Office won't allow deductions of capital losses from your income. What the tax law does allow you to do is to offset your capital losses against capital gains made in the same year, so that you pay less tax on the gains, and to 'carry forward' any remaining capital losses to be deducted from any future capital gains.

Records
Essential to all this is to keep good records. So make sure you keep all receipts and any details of financial transactions, insurance and valuations, and records of repairs or brokerage and so on, and especially records on sale or disposal.

Incomplete records could lead to paying more tax then you need to. Make sure you record the nature of the asset and related transactions, and how the asset resulted in a capital gain or loss, the dates involved and the persons or other businesses involved.

If you are thinking of selling up, the small business concessions may really help. But remember the CGT implications whenever you sell any asset, and the tax consequences. A little forward planning can help to minimise the amount of tax incurred as a result of the asset sale.

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