CGT event K2

What is CGT event K2?

If applicable, CGT Event K2 enables a taxpayer who has become bankrupt the opportunity to recognise a capital loss in respect of a debt repayment where:

  • the taxpayer had a net capital loss that was not completely used up (i.e. applied against capital gains) prior to the income year the taxpayers bankruptcy commenced; and
  • the above-referred debt was taken into account in working out the above-referred net capital loss; and
  • in circumstances where certain provisions in the tax law (addressed below) prevent the taxpayer from utilising the net capital loss to offset against capital gains because of the taxpayers bankruptcy.

The rules dealing with CGT Event K2 are primarily contained in section 104-210 of Income Tax Assessment Act 1997 (Cth) (ITAA).

To assist with understanding CGT Event K2, it is helpful to first consult section 102-5 of the ITAA. It provides that a taxpayers assessable income must include their net capital gain worked out using a five-step method statement. Those five steps are summarised below:

  1. Reduce capital gains made during the income year by capital losses (if any) made during the income year.
  2. Apply any previously unapplied net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of capital gains under step 1.
  3. Reduce by the discount percentage each amount of a discount capital gain remaining after step 2 (if any).
  4. If capital gains qualify for any of the small business concessions, apply those concessions to each capital gain.
  5. Add up the amounts of capital gains (if any) remaining after step 4.

Subsection 102-5(2) follows on to provide that if during an income year a taxpayer becomes bankrupt or is released from debts under a law relating to bankruptcy, then any net capital loss the taxpayer made for an earlier income year (as would typically be permitted to be used to offset against capital gains in step 2 of the above-referred method statement) must be disregarded in working out whether the taxpayer made a net capital gain for the income year or a later one.

Section 102-10 sets out how to calculate a net capital loss. It states that a net capital loss arises for a taxpayer in a particular income year where the taxpayers capital losses (for that income year) exceed the capital gains made that income year.

In essence, what we can see here is that from the income year a taxpayer becomes bankrupt, the taxpayer loses the ability to utilise their previously unapplied capital losses by setting them off against capital gains in the income year they become bankrupt or in any future income year. This is (presumedly) because the taxpayers bankruptcy status means they are potentially no longer directly bearing the burden of debts which have brought about capital losses.

It is important to note that subsection 102-5(2) can apply (to deny net capital loss utilisation) even if a bankruptcy is annulled. That is in circumstances where the taxpayer enters into a scheme where they are released from debts from which they would have been released if they had instead been discharged from the bankruptcy. Again, this measure is presumedly a response to the taxpayer no longer bearing the economic burden of debts which establish capital losses in circumstances where those debts are released.

With this context in mind, CGT Event K2 happens if:

  • the taxpayer makes a net capital loss for an income year that, because of subsection 102-5(2), cannot be applied in working out whether the taxpayer made a net capital gain for the income year or a later one; and
  • the taxpayer makes a payment in an income year (the payment year) in respect of a debt that was taken into account in working out the amount of that net capital loss; and
  • ignoring subsection 102-5(2), some part of the net capital loss (the denied part) would have been applied (if the taxpayer had made sufficient capital gains) in working out whether the taxpayer had made a net capital gain for the payment year.

The time of CGT Event K2 is when the taxpayer makes the relevant debt payment.

How to calculate CGT Event K2 capital gain or loss

Under CGT Event K2, it is only possible to trigger a capital loss and not a capital gain.

The capital loss is equal to the smallest of:

the amount the taxpayer paid; or

that part of it that was taken into account in working out the denied part; or

the denied part less the sum of capital losses the taxpayer made as a result of previous payments the taxpayer made in respect of the debt that was taken into account in working out the denied part.

This method of calculating the capital loss ensures that the amount of capital loss recognised under CGT Event K2 appropriately corresponds with the amount of a net capital loss that prevented from being used to offset against capital gains (for reasons of the taxpayers bankruptcy).

Note that any amounts the taxpayer receives as recoupment of the debt payment (and that is not included in the taxpayers assessable income) will need to be disregarded when calculating the capital loss.

Note also that the debt payment amount can include the market value of any property given (as addressed in section 103-5 ITAA).

CGT discounts and concessions

The general CGT discount (Division 115 ITAA) and the small business CGT concessions (Division 152 ITAA) are not relevant to CGT Event K2 on the basis that the event only recognises capital losses.

That is, there is no capital gain which is triggered and thus available to be discounted or eliminated.

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.