Contents
- What is CGT event G1?
- What time does the CGT event happen?
- Who does the CGT event apply to?
- How is the capital gain or capital loss calculated?
- How to calculate the non assessable part?
- Foreign Residents and CGT event G1
- Pre CGT asset
- Other exceptions from CGT event G1
- Problems with liquidator distributions
- Events which trigger CGT event G1
- Problems and considerations with a return of share capital
- Anti overlap provision
- CGT concessions
What is CGT event G1?
CGT event G1 addresses a situation where a company makes certain payments to a shareholder.
Specifically, the requirements are that:
- The company makes a payment to a shareholder in respect of share owned; and
- The payment is not in relation to CGT event A1 (disposal of shares) or CGT event C2 (ending of shares) occurring; and
- Some or all of the payment (the non assessable part’) is not a dividend or a distribution by a liquidator (taken to be a dividend under section 47 of the ITAA 1936); and
- The payment is not included in the assessable income of the shareholder.
The rules regarding CGT event G1 are contained in section 104-135 of the Income Tax Assessment Act 1997.
What time does the CGT event happen?
CGT event G1 happens at the time the company makes the relevant payment.
Who does the CGT event apply to?
The CGT event happens to the shareholder receiving the relevant payment from the company.
How is the capital gain or capital loss calculated?
The taxpayer will make a capital gain if the amount of the non assessable part exceeds the cost base of the share/s. If there is an excess, the cost base and the reduced cost base of the shares should be reduced to nil.
If the amount of the non assessable part is not more than the cost base of the share/s, that cost base and its reduced cost base are to be reduced by the amount of the non assessable part.
It is not possible for the taxpayer to make a capital loss from CGT event G1.
You may notice that the reduction of the cost base mechanism under this CGT event is unique compared with most other CGT assets. The exception is CGT E4 which operates in a very similar manner to CGT event G1. E4 addresses a situation where a trust makes a payment to a beneficiary which comprises a non assessable part.
How to calculate the non assessable part?
The non assessable part is calculated as the amount of any payment made by the company to a shareholder less any part of the payment that is:
- A dividend or a liquidator distribution under section 47 of the ITAA 1936; or
- Non assessable non exempt income; or
- Repaid by the shareholder (the taxpayer); or
- Compensation paid by the shareholder that can be reasonably be regarded as repayment of all or part of the payment; or
- An amount referred to in section 152-15 (which exempts a payment of a small business 15 year exemption amount to a CGT concession stakeholder).
Note that the non assessable part is not reduced by any part of the payment that the shareholder can deduct.
Remember the amount of payment can include the value of property or other non monetary thing which is distributed.
Foreign Residents and CGT event G1
A foreign resident shareholder can disregard any capital gain from CGT event G1 if the shares held are not Taxable Australian Property to them. The relevant time to consider residency status is just before the CGT event happens .
The topic of Taxable Australian Property has been addressed in other BrisTax articles.
Division 855 of the ITAA 1997 provides that Taxable Australian Property includes:
- Australian real property
- An indirect interest in Australian real property e.g. through shares or units in a land rich entity.
- A CGT asset that the taxpayer has used to carry on a business through a permanent establishment in Australia.
- An option or right over one of the above.
Pre CGT asset
Any capital gain or capital loss made by the taxpayer as a result of CGT event G1 will be disregarded if the CGT asset was acquired by the taxpayer before 20 September 1985.
Other exceptions from CGT event G1
The taxpayer should disregard a payment that involves personal services income whereby that income is included in the shareholder’s assessable income or another individual or entity’s assessable income by operation of section 86-15 of the ITAA 1997.
The taxpayer should disregard a payment that is a dividend as defined in section 6(1) of the ITAA 1936.
The taxpayer should disregard a payment that is a liquidator distribution (per section 47 of the ITAA 1936) if the company ceases to exist within 18 months of the date of payment. The payment will instead be addressed under the rules of CGT event C2 at the time the company shares are cancelled.
Problems with liquidator distributions
As mentioned above, if a liquidator distribution (e.g. an interim distribution) is made to a shareholder and 18 months or less passes until the company ceases, CGT event C2 will apply to handle the payment instead of CGT event G1.
However, what this means is that if a liquidator distribution is made and over 18 months passes, CGT event G1 will apply in respect of the distribution / payment.
A practical problem that arises is that the shareholder and even the company itself may not have certainty around whether the company will cease to exist within 18 months of the date of payment.
The ATO view expressed in Taxation Determination 2001/27 suggests that a shareholder in receipt of an interim liquidator distribution may assume that the company will cease within 18 months (and therefore deal with the payment under the rules of CGT event C2 when completing a tax return). That is, unless advice is received from the liquidator indicating otherwise.
One might question why it matters which CGT event occurs. Here are a few reasons why it is important to identify the correct CGT event. Firstly, capital gains and capital losses are calculated according to the rules of each particular CGT event. The rules vary between the different CGT events. For example, G1 involves a reduction to the cost base if there is a capital gain. However, there is no similar cost base reduction in respect of CGT event C2.
Further, the time at which the CGT event is triggered may be different depending on the relevant CGT event. This may affect the shareholder’s eligibility for certain tax concessions. For example, the CGT discount is not available unless a taxpayer has held shares for at least 12 months before the CGT event occurs.
Take as an example a liquidator who makes an interim distribution to a shareholder. The shareholder has only held the underlying shares in the company for 8 months at the time of payment. The shares in the company are cancelled 8 months after the time of payment. Here, CGT event C2 applies as the company ceases to exist within 18 months of the date of payment. Because CGT event C2 occurs, the CGT discount should be available to reduce the capital gain as the event occurs at the time the shares are cancelled. This means there is 16 months between the date of acquisition of the shares and the date of the CGT event (which exceeds the 12 month requirement).
If CGT event G1 had instead occurred, the CGT discount would not be available to reduce the capital gain as CGT event G1 is triggered at the time of payment. There would have been 8 months between the date of acquisition of the shares and the date of the CGT event (which is less than the 12 month requirement).
The relevant CGT event will also affect the testing which occurs under section 115-45 of the ITAA 1997 (a provision which may deny the shareholder with access to the CGT discount where a CGT happens to their shares).
Based on the criteria of that section, it less likely that CGT event C2 would upset the shareholder’s entitlement to the CGT discount compared with a situation where CGT event G1 happens. This is because section 115-45 is more likely to deny a deduction for companies that are ‘newer’ or experiencing rapid expansion involving the acquisition of bulk CGT assets.
Events which trigger CGT event G1
Because of the broad definition of a ‘dividend’, CGT event G1 will not apply to most distributions from a company as these will constitute the payment of a dividend.
A dividend is defined in section 6(1) of the ITAA 1936 as follows
‘…any distribution made by a company to any of its shareholders, whether in money or other property; and any amount credited by a company to any of its shareholders as shareholders…but does not include:…the amount debited to the company’s share capital account…’
It is worth noting that once it is established that a payment constitutes a dividend, the dividend will only be assessable to the shareholder to the extent it is paid out of profits of the company. The term ‘out of profits’ is defined broadly.
As you can see from the above definition of a dividend, a distribution that is a return of capital and debited against the company’s share capital account will not constitute a dividend.
Therefore, the most common trigger for CGT event G1 is a return of share capital. CGT event G1 will happen when the return of capital payment is made if the shareholder owns the shares at the relevant record date and at the payment date. The capital gain will essentially be the component of the payment that is a return of capital less the cost base of the relevant share/s. Where the return of capital payment exceeds the cost base, the cost base of the relevant shares should be reduced to nil. Where the payment does not exceed the cost base, there is no capital gain but the cost base of the relevant shares should be reduced by the amount of payment.
If the taxpayer owns shares on the record date but not at the time of payment, CGT event C2 is applicable instead. CGT event C2 is relevant as the right to receive the capital return is considered to be a distinct intangible asset. The right ends (is satisfied) when the payment is received by the shareholder. In this case, the shareholder would make a capital gain under CGT event C2 if the capital proceeds from the right being satisfied (i.e. the capital payment being received) exceeded the cost base of the right. There is a capital loss if the capital proceeds are exceeded by the reduced cost base of the right. There are special rules to work out the cost base of the right in this instance. Refer to Division 110 and Division 112 of the ITAA 1997 for further guidance.
Problems and considerations with a return of share capital
There are several matters to consider in respect of the return of share capital.
The first thing to consider is that a payment will only constitute a return of share capital (and not a dividend) if the payment is sourced from an untainted share capital account by the recognition of a debit to reduce that credit balance of that account. In this way, the return of capital should not exceed the sum of share capital contributed by shareholders.
For example, take Wayne who is the sole shareholder of Wayne Pty Ltd. Wayne acquired his shares for $1,000. This capital contribution is credited to the share capital account shown in the financial statements of the company. The company can fully or partially return the capital contribution back to Wayne by making a special return of capital payment. The amount which can be returned to Wayne is limited by the amount which is credited to the share capital account (assuming the share capital account is untainted).
As flagged above, a share capital account is capable of becoming ‘tainted’ where amounts other than share capital are credited to the account.
Section 975-300 of the ITAA 1997 defines a ‘share capital account’ as:
‘An account that the company keeps of its share capital; or any other account (whether or not called a share capital account) that satisfies the following conditions: (i) the account was created on or after 1 July 1998; and (ii) the first amount credited to the account was an amount of share capital…’
There are ways to ‘untaint’ a share capital account, but an explanation of this process is outside the scope of this article.
The second thing to consider is the risk of an anti-avoidance provision applying. Under section 45A and 45B of the ITAA 1936, there are two types of behaviours addressed which may undo the tax treatment of a payment as a return of capital.
Section 45A applies where a capital benefit is streamed to some shareholders but not others (or potentially where a capital benefit is stream to all shareholders but where the capital benefit is disproportionate to shareholding). The shareholders which receive the capital benefit are ‘advantaged’ somehow as they possess tax attributes which causes them to particularly benefit from the receipt of capital. For example, where the shareholder receiving the capital return has capital losses that may be applied against a capital gain which flows from the capital receipt.
Section 45B applies more broadly than section 45A and concerns situations where capital payments are made to shareholders in substitution for dividends. For the provision to apply there must be:
- a ‘scheme’ which involves a person obtaining a capital benefit; and
- the capital benefits result in a taxpayer obtaining a tax benefit; and
- in regard to all relevant circumstances, it is reasonable to conclude that the persons which entered into the scheme did so for the purpose to enabling a taxpayer to obtain a tax benefit. This does not extend to situation where a tax benefit is achieved as an ‘incidental’ outcome to a scheme.
If section 45A or section 45B applies, a determination may be made by the ATO under section 45C that results in the payment from the company being treated as an unfranked dividend instead of a return of capital. The dividend will be assessable to the shareholder and no franking credits may be attached. This will deny the shareholder a tax offset for the company-level tax paid in respect of the dividend. If a section 45C determination is made, CGT event G1 will not be applicable to tax the return of capital payment.
Anti overlap provision
As discussed in another CGT related articles, the CGT regime applies with secondary priority to other provisions of ITAA which have authority to tax receipts. There is an anti overlap provision in section 118-20 of the ITAA 1997 which prevents a double taxation outcome in an instance where an income tax provision (e.g. section 6-5) and the CGT regime would simultaneously purport to tax a particular amount. To the extent that an amount is not dealt with another provision (aside from section 40-880 of the ITAA 1997), the CGT regime will apply.
CGT concessions
CGT discount and CGT event G1
The CGT discount is available to discount a capital gain made under CGT event G1. However, the eligibility requirements in Division 115 must be satisfied, including that the shares are held for at least 12 months before the payment date.
Note the potential application of section 115-45 which may deny a shareholder the CGT discount. The relevant test is whether a shareholder if they theoretically owned the CGT assets of the company would have been eligible for the CGT discount in respect of a majority of the CGT assets of the company.
Specifically, subsection 115-45(1) provides:
‘The purpose of this section is to deny you a discount capital gain on your share in a company or interest in a trust if you would not have had discount capital gains on the majority of CGT assets (by cost and by value) underlying the share or interest if: (a) you had owned them for the time the company or trust did; and (b) CGT events had happened to them when the CGT event happened to your share or interest…’
There are a number of exclusions to this basic rule along with conditions to be satisfied for the subsection 115-45(1) to apply to deny a deduction. To summarise, the two most primary conditions include that:
- The shareholder has a 10% of greater interest in the equity of the company before the time of the relevant CGT event. This is determined by reference to the value of shares held in the company compared with the total value of shares of the company (except shares that carry only limited rights to participate in the distribution of profits or capital).
- The total of the cost bases of CGT assets that the company owned at the time of the CGT event and had acquired less than 12 months before then is more than half of the total of the cost bases of the CGT assets the company owned at the time of the event.
Note that section 115-45 will not apply if there are at least 300 members of the company and the control of the company cannot be concentrated.
Small business CGT concessions and CGT event G1
The small business CGT concessions may be available to reduce any capital gain that arises from CGT event G1.
Obviously, the various conditions of eligibility set out in Division 152 of the ITAA 1997 will need to be satisfied.
This includes that the relevant share must satisfy the active asset tests by being an active asset for at least half of the period of ownership.
There are additional basic conditions that will need to be satisfied in respect of a non assessable payment as the relevant CGT asset is a share in a company.
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.