CGT Event G3

The capital loss is equal to the reduced cost base of the shares or the financial instrument (in the hands of the taxpayer) at the time of declaration.  

Remember that the reduced cost base is a slightly different concept from the cost base of an asset. Both the reduced cost base and the cost base comprise five elements of costs. However, the reduced cost base has a narrower third element that (unlike cost base) does not cover ownership costs such as non deductible interest on money borrowed to acquire a CGT asset. 

It is not possible to make a capital gain under CGT event G3.  

If the capital loss is recognised under CGT event G3, the cost base and reduced cost base of the share/s or financial instrument/s are reduced to nil just after the declaration is made.  

In that way, if/when a future CGT event happens in respect of those shares or financial instrument e.g. on dissolution of the company, the taxpayer is prevented from realising another capital loss or from minimising a capital gain.  

For example, take a shareholder who elects for CGT event G3 to apply to their shares following a valid declaration. It’s possible the shareholder receives a further distribution in relation to their shares (after the time of declaration) which triggers CGT event G1 or C2. The cost base and reduced cost base of shares will be nil for the purposes of calculating a capital gain or capital loss under those CGT events. Practically, that means any capital gain will be higher and any capital loss lower than if CGT event G3 had not been previously triggered into relation to the shares or financial instrument.   

CGT event G3 provides a shareholder or instrument holder with the opportunity to recognise a capital loss at the time of declaration (if one is made), rather than at a later time such as where the shares or financial instruments are transferred to another person, or are cancelled in a way that allows for the recognition of a capital loss under CGT event C2.   

The bringing forward of a capital loss under CGT event G3 will often be beneficial for the taxpayer where the taxpayer has capital gains that can be offset by the capital loss. The timing of recognition of capital loss is important when it comes to offsetting under the section 102-5 ITAA97 method statement. Remember that the section 102-5 method statement provides the rules for calculating net capital gains, including how capital losses may be applied against capital gains. Essentially, the capital loss must be made in the same or a previous income year from a capital gain in order to be applied against that capital gain.  

Take the example of a taxpayer who makes a single undiscounted capital gain of $100,000 on 1 May 2023. There are a no other capital gains or capital losses for the income year, except that the taxpayer receives notice that a liquidator declaration has been made on 28 June 2023 over the shares owned by the taxpayer. The shares have a reduced cost base of $80,000. By the end of the income year ending 30 June 2023, the shares were not cancelled in a way that would trigger CGT event C2. The taxpayer has two options:  

• 1. Elect for CGT event G3 to apply and offset the capital gain of $100,000 by an  $80,000 capital. The taxpayer makes a net capital gain of $20,000 that forms part of their assessable income and is taxed at marginal rates.  

• 2. Elect for CGT event G3 not to apply and wait until CGT event C2 (or another CGT event) occurs before realising the capital loss. The taxpayer makes a net capital gain of $100,000 that forms part of their assessable income and is taxed at marginal rates. They will obtain the benefit of the $80,000 capital loss in the income year a CGT event C2 (or another CGT event) occurs to the shares. 

In this example, there are compelling reasons for the taxpayer to make a CGT event G3 election.   

If you consider the above example and the operation of the section 102-5 method statement, you will also note that the benefits of CGT event G3 are most pronounced where a taxpayer has:  

• large capital gains 

• undiscounted capital gains  

• is unlikely to have capital gains (particularly significant capital gains) in future financial years that will fully absorb a capital loss on worthless shares or financial instruments that are recognised in those later financial years.  

Remember that a capital loss can only be used to offset against a capital gain, not assessable income generally.  

To the extent the capital loss is not utilised against capital gains, it may be carried forward and applied against capital losses in subsequent income years (subject to certain limitations and tests not addressed in this article).  

Conceivably, there could be circumstances where it is against the interests of a taxpayer to opt into CGT event G3. For example, where the taxpayer would prefer not to expend the capital losses on discounted capital gains, but instead apply the capital losses against anticipated future undiscounted capital gains. Also perhaps where the taxpayer would prefer to utilise the capital losses against capital gains made in an income year where the taxpayer is expected to have higher taxable income. The utilisation of the losses at this point may result in greater tax savings based on the sliding scale nature of the individual marginal tax rate.  

The other conceivable benefit to forgoing the G3 election, is where the capital losses (if brought forward under CGT event G3) would not be available to be recouped because of a restriction under, for example, the company loss rules (for a corporate shareholder).   

Obviously, the advantage of bringing forward the capital loss will only be achieved if the loss can be recognised in an earlier income year from the income year in which the shares or financial instrument are subject to another CGT event (e.g. CGT event C2). For example, there would be limited benefit to recognising a capital loss under CGT event G3 were a declaration to be made on 30 October 2023, but where the shares were cancelled under CGT event C2 on 30 November 2023 (assuming the relevant taxpayer has an income year which runs from 1 July – 30 June). This is because both CGT event G3 and C2 would happen in the same income year.  

A capital loss under CGT event G3 is disregarded if the shares or financial instruments were acquired prior to 20 September 1985 (i.e. pre CGT).   

CGT event G3 is also not relevant where:  

• the shares or financial instruments were revenue assets at the time of declaration.  

• In respect of shares or a right to acquire a beneficial interest in a share, the taxpayer acquires the beneficial interest, an ESS interest, under an employee share scheme and an amount is included in the taxpayer’s assessable income under Division 83A in relation to the ESS interest.  

If a share or financial instrument is held on revenue account, CGT event G3 will not apply.  

Remember that there are two sub categories of assets (we’ll focus on the example of shares) which can be held on revenue account. The first, where shares are held as trading stock in a business of share trading. The second, where the shares are not trading stock but held with a profit making purpose. Share traders tend to be categorised as the latter.  Refer to Taxation Ruling 96/4 for further detail on the tax distinctions between revenue shares which are not trading stock versus revenue shares that are trading stock.  

For shares held on revenue account but not as trading stock, the loss on the share will be deductible to the taxpayer. The deduction may be applied against other income subject to the taxpayer satisfying the non commercial loss rules contained in Division 35 of the ITAA97. The deduction becomes recognised for tax purposes at the time the loss is incurred. That means there is no opportunity to bring forward the recognition of the loss to the time of declaration as contemplated under section 104-145. Consequently, the shareholder may have to wait until the share is disposed or deregistered before the loss is incurred and the deduction claimed.   

Remember that the classification of shares held by a shareholder into one of the below categories has significant repercussions for the treatment of the underlying share for taxation purposes, not only in respect of the treatment of losses, but in many other areas such eligibility for the CGT discount and eligibility for the small business CGT concessions. The possible classifications include:  

• trading shares in a business of share trading 

• revenue assets but not trading stock of a share trader  

• capital assets of a mere share investor.  

The classification of shares and financial instruments under one of the three categories is entirely fact dependent. The classification process is regularly a challenging exercise for taxpayers given the blurry lines which run across the three categories. Noting it is possible for a taxpayer to simultaneously hold, for example, some shares in one category and other shares in another category. This article is not intended to delve into classification concepts. However, we provide below a list of certain factors that may be relevant to classification: 

• If there is a significant commercial purpose or character (or not) to the share trading activity.  

• If the taxpayer has an intention (or not) to engage in a business of share trading activity. For example, by undertaking share trading activity on a full time basis.  

• If the taxpayer has a profit making purpose and a reasonable prospect of making a profit from the share trading activity.   

• The extent of repetition and regularity to the share trading activity.  

• If the share trading activity is of the same kind and carried on in a similar manner as expected in share trading business.  

• If the share trading activity is planned, organised and carried on a businesslike manner. For example, renting an office, operating to a business plan, keeping of records, setting budgets etc.  

• The size and scale of the share trading activity.  

• The amount of capital employed to carry on the share trading activity.  

• The income / profits derived from the share trading activity.  

• The complexity of the share trading activity.  

• The permanency of the share trading activity.   

• If the share trading activity is better categorised as a hobby.  

These matters will often turn on the availability (or not) of contemporaneous business records. 

For the most part, many taxpayers who casually buy and sell shares will be seen as merely investing and will hold their shares on capital account.  

Take Jarred who in 2018 acquired a share in J Pty Ltd. The share was acquired for $500. The cost base and reduced cost base of the share was also $500. The share was held by Jarred on capital account. The company was ultimately unsuccessful and a liquidator was appointed to carry out the winding up process. The shareholders of the company were paid distributions in relation to the liquidation after which time the liquidator made a written declaration on 25 June 2024 confirming (on reasonable grounds) that there was no likelihood of any further distributions to shareholders. Jarred understood that the company would not be de registered until the next financial year. Therefore, Jarred elected to apply CGT event G3 to bring forward the recognition of a capital loss so he could apply that capital loss against his other capital gains. He was entitled to a capital loss of $500 being the reduced cost base of the share. Jarred then reduced the cost base / reduced cost base of his share to nil. When the shares were eventually cancelled, Jarred did not obtain another capital loss as the cost base / reduced cost base of the share was nil.  

Revenue and capital losses within a company are effectively trapped within the company until those losses can be applied against company assessable income (in terms of revenue losses) or capital gains (in terms of capital losses).  

That means any losses held within the company are not able to be directly shared with or distributed to shareholders.  

Note that in order for those losses to be recouped and applied, the company must satisfy the continuity of ownership test or one of the business continuity tests (i.e. the same business test or the similar business test). The rules relating to these test are set out in Division 165 of the ITAA97.   

Section 165-208 of the ITAA97 expressly provides that the appointment of a liquidator will not change beneficial ownership or underlying control of the company. That means a company will not automatically fail the continuity of ownership test (and potentially forfeit losses) because of the appointment of liquidator.  

However, liquidation will often upset the continuity of business test because the company, during the liquidation process, will have usually stopped trading activity (and is therefore no longer carrying on the same or similar business) during the income year in which the losses are sought to be recouped.  

This presents risks for businesses relying on the continuity of business tests in order to recoup losses.  

If neither test is passed, present or carried forward losses may not be able to be applied against assessable income / capital gains from the disposal of assets or distribution of assets in specie during the liquidation of the company. This can present significant problems for companies with high value assets.