First, I set out the following brief outline of the Capital Gains tax.
Capital Gains tax was introduced on assets acquired after 19th September 1985. If a property was acquired before this date, no capital gains tax is payable on its sale.
The costs involved in acquiring an asset are deductible. For a property, this would include legal fees, stamp duty, valuation fees etc. Likewise, the costs of disposing of an asset are deductible. For a property, this would include legal costs, stamp duty, estate agent's costs etc.
The full profit on the sale of an asset is not subjected to tax. The cost price is increased by the CPI index, thereby reducing the profit.
The sole or principal residence of the tax-payer is exempt from capital gains tax. Land up to 2 hectares adjacent to a residence will form part of the residence and be exempt from capital gains tax.
A windfall capital gain will not push you into an unduly high tax bracket. The reason for this is that a concessional rate is applied to capital gains. In most cases, the rate applied will be the top rate applicable to your other income.
In any year, the profit made on one property may be offset against the loss made on another. However, a net capital loss cannot be deducted from other income. It can be carried forward indefinitely and deducted from any future capital gain.
Many people are unaware that if they inherit assets from a deceased estate, they will also have inherited a Capital Gains tax liability. Let us take an example. Fred bought a block of investment units in 1988 for $200,000. He died in 1995. He left the units to his wife Mary. Mary sold the units in 1996 for $800,000. Mary will have to pay tax on the increase in value since Fred bought the units in 1988. A deduction for CPI increase will be allowed. The actual tax payable by Mary will be $233,241 approx..
How may one reduce or avoid Capital Gains tax? Here are some suggestions.
1. Assets bought prior to 18th September 1985 are exempt from Capital Gains tax. Consequently, if you have assets which were bought prior to 18th September 1985, hang onto them! Let us look at the following example. Tom bought an investment property in 1984 for $100,000. He still owns and rents out the property. It is now worth $300,000. If Tom were to sell the property now, the profit of $200,000 would be tax-free. If Tom hangs on to the property until he dies, then the whole profit at date of death will be exempt from Capital Gains tax. Suppose his friend Dick bought a similar investment property for $100,000 in 1984. Dick sold his property for in 1990 for $200,000. He then bought a similar property for $200,000. This property is now worth $300,000, exactly the same value as Tom's above. The results are as follows. Dick will be exempt from Capital Gains tax on the profit of sale of $$100,000 in 1990. However, if he were to sell his property now, he would be taxable on the profit of $100,000. Likewise, if he sells at any time in the future or retains until he dies, he will have to pay tax on the profit. Contrast his position with Tom who will never pay tax on his property so long as he retains it.
2. The family home is exempt from Capital Gains tax. Also, up to two hectares of land adjoining the home is exempt. Consequently, if you have money to invest, you should consider buying a bigger family home or making extensions to the existing one. The advantages of buying a bigger family home, instead of an investment property, are a) no Capital Gains tax on sale of property and b) a bigger home to enjoy. The disadvantage, of course, is that you will receive no rent on your own home. Let us take an example. John Brown bought a home in 1990 for $100,000. In 1992, he built extension on to it costing $50,000. He sold the home in 1995 for $300,000. The profit of $150,000 will be tax-free. You should also bear in mind that if you inherit a family home, any profit made on sale will be tax-free if you sell it within 12 months of date of death. The government intends extending this period from 12 months to two years. So, hang on to any family home you inherit for one to two years.
3. On the sale of a business, 50% of the profit on sale of Goodwill is exempt from tax. The full profit on the sale of all other assets is taxed. Consequently, when you are negotiating for the sale of a business, you should try to agree with the buyer to apportion as much as possible of the sale price to goodwill. Of course, the opposite will apply if you are buying a business. You should try to agree with the seller to apportion as much as possible of the purchase price to goodwill. Let us take an example. John Smith is selling his business. He agrees on a sale price of $500,000. The assets comprise lease, fixtures, equipment, stock and goodwill. The profit on all of these will be taxable. However, as stated above, only 50% of the profit on goodwill will be taxable. Assume the goodwill cost $10,000. If $300,000 is apportioned to the sale price of goodwill, only 1/2 of the profit of $290,000 will be taxed. Often, on the sale of a business, the amount of the sale price to be apportioned to goodwill and to other assets, such as a lease, is a matter for agreement between the buyer and the seller.
4. Profit on sale of ordinary cars is exempt from Capital Gains tax. However, vehicles designed to carry over one tonne are not exempt. You will, no doubt, rightly point out that cars are not usually sold at a profit. Quite so. But consider a vintage car as an investment. The profit on sale of such a car would be exempt from Capital Gains tax. Let us take an example. Martin buys a vintage Rolls Royce for $20,000 in 1990. He sells it for $100,000 in 1995. The profit of $80,000 is exempt from tax.
5. Superannuation funds pay tax at the rate of 15%. Normally, if you sell an asset, it will be taxed at your top tax rate, normally 35.55% to 44.5% Consequently, it pays to have an asset owned by your superannuation fund instead of by yourself. How can you achieve this? First, you can make sure that you are putting as much as possible of your income into a superannuation fund. You can, if you want to, form your own superannuation fund. You can then buy an investment property, put the property into your superannuation fund, get a tax deduction for the contribution and, when you sell the property, the profit is taxes only at 15% and not 44.5% Let us take an example. Harry is self-employed and aged 50. He has no superannuation. He forms his own superannuation fund. He buys an investment property for $100,000. He puts the property into his super fund. He claims a deduction for super contributions of $40,000 so to reduce his taxable income to nil. Two years later, he sells the investment property for $200,000. The profit of $100,000 will be taxed at only 15%. If he had held the property in his own name, the profit of $100,000 would be taxed at his upper rate which, in his case, was 44.5% Also, while he owned and rented out the propety, it was taxed only at 15% and not 44.5%
6. Because of the technicalities of the taxation laws, companies, in general, are taxed at a much higher rate of Capital Gains tax. In effect, if an asset is owned by a company, the company loses the following capital gains rebates viz. a) the CPI increase and b) the 50% goodwill deduction. Let us take an example. Smith Pty Ltd buys a business for $100,000 in 1990. It sells the business for $500,000 in 1995. Smith Pty Ltd (and the shareholder/directors) will pay full Capital Gains tax at, probably, 44.5% on the profit of $400,000. If the business had been owned by the shareholder/directors personally, rather than through a company, they would have got deductions for a) the CPI increase from 1990 to 1994 and b) a 50% reduction on the tax payable on the sale of the goodwill.
The moral is: if have assets which you expect to increase over time, do not put them in the name of a company. Put them in the names of individuals. Assets which are likely to increase over time are a) land and buildings and b) goodwill.
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