Incorrect Accounting Advice re CGT - Help please Depreciator!

[DaleGG]

The law - Part 2 - Legislation

Hi again

You will notice that at no stage does the law mention adding back the depreciation on plant or chattels - just the building write off claims.

I can also scan and add seminar notes from the NTAA if you like.


INCOME TAX ASSESSMENT ACT 1997

CHAPTER 3 - SPECIALIST LIABILITY RULES
PART 3-1 - CAPITAL GAINS AND LOSSES: GENERAL TOPICS


PART 3-1 - CAPITAL GAINS AND LOSSES: GENERAL TOPICS
History

Pt 3-1 inserted by No 46 of 1998.




Division 110 - Cost base and reduced cost base
History

Div 110 inserted by No 46 of 1998.




Subdivision 110-A - Cost base

What does not form part of the cost base

SECTION 110-45» Assets acquired after 7.30 pm on 13 May 1997
View History ITAA 1936


110-45(1)
View History
This section prevents some expenditure from forming part of the *cost base, or of an element of the cost base, of a *CGT asset *acquired after 7.30 pm, by legal time in the Australian Capital Territory, on 13 May 1997. (The expenditure mentioned in this section can include giving property: see section 103-5.)

For the cost base of interests in partnership assets acquired after that time, see section 110-50.

For exceptions to the application of this section, see section 110-53.

History

S 110-45(1) amended by No 173 of 2000, s 3 and Sch 4 item 34, by inserting ``, or of an element of the cost base,'' after `` *cost base'', applicable to assessments for the 1998-99 and later income years.



110-45(1A)
View History
This section also applies to expenditure incurred after 30 June 1999 on land or a building if:


(a) the land or building was *acquired at or before the time mentioned in subsection (1); and


(b) the expenditure forms part of the fourth element of the *cost base of the land or building.

History

S 110-45(1A) inserted by No 114 of 2000, s 3 and Sch 4 item 18, applicable to assessments for the 1998-99 income year and later income years.



Deductible expenditure excluded from second and third elements

110-45(1B)

Expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it.

History

S 110-45(1B) inserted by No 114 of 2000, s 3 and Sch 4 item 18, applicable to assessments for the 1998-99 income year and later income years.



Other deductible expenditure

110-45(2)
View History
Expenditure (except expenditure excluded by subsection (1B) does not form part of the cost base to the extent that you have deducted or can deduct it for an income year, except so far as:

(a) the deduction has been reversed by an amount being included in your assessable income for an income year by a provision of this Act (outside this Part and Part 3.3 and Division 243); or

[
Note:
Division 20 contains some of the provisions that reverse deductions. section 20-5 lists some others. ]


View History


(ab) the deduction is under Division 243; or
View History



(b) the deduction would have been so reversed apart from a provision listed in the table (relief from including a balancing charge in your assessable income).

[
Note:
In the table, provisions of the Income Tax Assessment Act 1997 are identified in normal text. The other provisions, in bold, are provisions of the Income Tax Assessment Act 1936. ]


Provisions for relief from including a balancing charge in your assessable income
Item Provision Subject matter
1 section 40-340 Roll-over relief for *depreciating asset
...........
2 section 40-365 Involuntary disposal of *depreciating asset
...........
3 Section 73E Research and development activity expenditure



History

S 110-45(2) amended by No 119 of 2002, s 3 and Sch 3 items 64 and 100, by inserting para (ab), applicable to CGT events happening on or after 1 July 2001.

The amendment made by item 64 applies to debts that are terminated after 27 February 1998.

S 110-45(2) substituted by No 77 of 2001, s 3 and Sch 2 item 270. For application provisions see note under s 17-35. S 110-45(2) formerly read:

Other deductible expenditure

110-45(2) Expenditure (except expenditure excluded by subsection (1B) does not form part of the cost base to the extent that you have deducted or can deduct it for an income year, except so far as:


(a) the deduction has been reversed by an amount being included in your assessable income for an income year by a provision of this Act (outside this Part and Part 3-3 and Division 243); or

Note: Division 20 contains some of the provisions that reverse deductions. section 20-5 lists some others.


(ab) the deduction is under Division 243; or


(b) the deduction would have been so reversed apart from a provision listed in the table (relief from including a balancing charge in your assessable income).

Note: In the table, provisions of the Income Tax Assessment Act 1997 are identified in normal text. The other provisions, in bold, are provisions of the Income Tax Assessment Act 1936.


Provisions for relief from including a balancing charge in your assessable income
Item Provision Subject matter
 1 Subdivision 41-A Common rule 1 - roll-over relief for related entities
...........
 2 section 42-285, 42-290 or 42-293 Depreciation of *plant
...........
 3 section 58 Depreciation of plant
...........
 4 subsection 59(2A) or (2D) Depreciation of plant
...........
 5 section 73E Research and development activity expenditure
...........
 6 section 122JAA General mining expenditure
...........
 7 section 122JG Quarrying expenditure
...........
 8 section 123BBA Expenditure on transport of minerals
...........
 9 section 123BF Expenditure on transport of quarry materials
...........
10 section 124AMAA Expenditure on prospecting and mining for petroleum
...........
11 section 124GA Expenditure on forestry roads
...........
12 section 124JD Expenditure on timber mill buildings
...........
13 section 124PA Expenditure on industrial property''


S 110-45(2) amended by No 72 of 2001, s 3 and Sch 2 items 73 and 74, by inserting ``and Division 243'' in para (a) and inserting para (ab), applicable to debts that are terminated after 27 February 1998.

S 110-45(2) amended by No 114 of 2000, s 3 and Sch 4 items 19 and 20, by substituting ``Other deductible'' for ``Deductible'' in the heading and by inserting ``(except expenditure excluded by subsection (1B)'' after ``Expenditure'', applicable to assessments for the 1998/99 income year and later income years.

S 110-45(2) (table) amended by No 164 of 1999.



Recouped expenditure

110-45(3)
View History
Expenditure does not form part of any element of the cost base to the extent of any amount you have received as *recoupment of it, except so far as the amount is included in your assessable income.

History

S 110-45(3) amended by No 114 of 2000, s 3 and Sch 4 item 21, by inserting ``any element of'' after ``does not form part of'', applicable to assessments for the 1998-99 income year and later income years.



110-45(3A)
View History


[
(Repealed by No 95 of 2004) ]



History

S 110-45(3A) repealed by No 95 of 2004, s 3 and Sch 5 item 6, applicable to CGT events that happen after the end of the day the Bill for this Act was introduced into the Parliament [19 Feb 2004]. S 110-45(3A) formerly read:

Input tax credits

110-45(3A) The first, second and third elements of the cost base are reduced as follows:


(a) for the first element - by the amount of your *input tax credit (if any) for *acquisition or *importation of the *CGT asset in question;


(b) for the second element - by the amount of your *input tax credit (if any) for your *incidental costs referred to in subsection 110-25(3);


(c) for the third element - by the amount of your *input tax credit (if any) for your non-capital costs referred to in subsection 110-25(4).

S 110-45(3A) inserted by No 176 of 1999, s 3 and Sch 3 item 38, effective 1 July 2000.



Capital expenditure by previous owner that you can deduct after acquisition

110-45(4)

The cost base is reduced to the extent that you have deducted or can deduct for an income year capital expenditure incurred by another entity in respect of the *CGT asset. (This rule does not apply so far as the deduction is covered by paragraph (2)(a) or (b).)

Example:

Under Division 43 you can deduct expenditure incurred by a previous owner of capital works you own.

Landcare and water facility expenditure giving rise to a tax offset

110-45(5)
View History
Expenditure does not form part of the cost base to the extent that you choose a *tax offset for it under the former section 388-55 (about the landcare and water facility tax offset) instead of deducting it.

History

S 110-45(5) amended by No 77 of 2001, s 3 and Sch 2 item 271, by inserting ``the former'' before ``section 388-55''. For application provisions see note under s 17-35.



Heritage conservation expenditure giving rise to a tax offset

110-45(6)

Expenditure does not form part of the cost base to the extent that:


(a) it is eligible heritage conservation expenditure (as determined under former section 159UO of the Income Tax Assessment Act 1936); and


(b) you could have deducted it for an income year under any of these Divisions (about capital works):

(i) Division 43 of this Act;

(ii) former Division 10C or 10D of Part III of that Act;

but for the exclusions in paragraph 43-70(2)(h) of this Act and former subsections 124ZB(4) and 124ZG(5) of that Act.
[
Note:
Because eligible heritage conservation expenditure is the subject of a tax offset, it is also not deductible. ]



History

S 110-45(6) amended by No 101 of 2006, s 3 and Sch 2 items 688 to 690,by amending references to repealed inoperative provisions, effective 14 September 2006. For application and savings provisions see the CCH Australian Income Tax Legislation archive.



History

S «110-45» inserted by No 16 of 1999.

 

[Mry]

Section 110 is the area you want to focus on in discussions. It also discusses what you are allowed to reduce the cost base by.

The cost base is what is in your purchase contract. That is what Section 110 uses as the base. There is no notional apportionment for CGT purposes for depreciation on plant because Section 110 doesn't allow that, only for building write off in this instance.

The best way to point this out, as DaleGG has suggested, is to ask why the government had to pass legislation to reduce to cost base by the building write off that had been claimed. If you were supposed to apportion the cost base notionally between building, land and equipment, why was this section necessary to be passed in the first place? And why is there no similar section for plant and equipment?

A lot of accountants argue back that it isn't logical to approach it that way since you are purchasing a package, but tax isn't about logic at times, its about the law.

 

[Pushka]

Wow, you guys are doing so much to help me here!
OK, this is the latest update from the accountant:

Sale Price is $400,000
Less depreciating assets:$4649 = $395391

Purchase Price is $275,000
Less cost of depreciating assets included in purchase price $45872 = $229128

less Capital works deductions $26888
Add purchase costs: $10546
Add sales costs: $15199

= $227985

$395391 - $227985 = $167,366 CG. This is split between partner and I so in my tax return
H (total CG) states $83683, and in net CG (A) is $48,841 as asset held for more than 12 months.


If there was no depreciation involved (and which was what I was advised in the first place) then CG is about $98,000 total, which is split between partner and I, and then reduced by 50% due to ownership - and that is what I budgetted for with the ATO and our finances.

He is getting a bit narky with me for sending back more queries and wants to meet next week. Obviously the issue for us is the depreciating assets included in the purchase price (which reduces that by $45872) so our cost base is less than what we actually paid.


Capital works deductions (which I gather is what we have claimed in our tax returns - )this might be OK)

I will go through and digest all this information above. The property was purchased before the 1997 date mentioned above - does that change anything?

If the accountants calculations are correct, then what really bugs me is the incorrect tax advice received in 2004 before we first put it on the market. So I am taking that up with them too, negligence too maybe! I have their advice in writing which totally supports my calculations.

Thankyou once again people and Depreciator, I will keep your kind offer in mind! I cant let it go!

 

[depreciator]

If you were supposed to apportion the cost base notionally between building, land and equipment, why was this section necessary to be passed in the first place? And why is there no similar section for plant and equipment?[/QUOTE]

Therein lies the conumdrum. The legislation is pretty definite about what you must do, but it's much harder to learn what you don't have to do, because this is often not stated. I would back the accountants on this forum against any in the country - and I talk to a huge number of them.

Pushka, this is odd:

Purchase Price is $275,000
Less cost of depreciating assets included in purchase price $45872 = $229128

What sort of place was this? A $275K rental property with $45K worth of Assets? And why is their value being deducted from the cost base?

 

[Pushka]

Hi Scott
It is a serviced apartment in a Hotel group, so it comes furnished with things like chairs, crockery, bedding etc. It is in Noosa. I dont know enough about all this to know why it has been deducted from the cost base. Maybe because it has been depreciated? That is my problem you see, I have to rely on the accountant to do it properly because I dont understand this at all; yet it was the accountant (the original one) who gave me the bum steer in the first place. So if the accountant says something I dont have the knowledge to push back or counter argue.

 

[depreciator]

I reckon with what Dale and MRY have posted, you now have the knowledge. My accountant (who isn't as clever as Dale, MRY, Coastymike et al) just did the CG calcs for a property I sold and depreciation claimed on the Assets didn't come into it. Maybe your accountant needs to point you to where it says they do - he won't find anything. I wonder how many clients he's had over the years who have paid too much CGT?
Scott

 

[Brenda Irwin]

I have printed out this thread and will be handing it to my tax accountant next week. Thanks so much guys. I know you hate repeating yourselves but hopefully this time my accountant will listen.

 

[Pushka]

After the rocket email I just sent my accountants, I am thinking they will sack me as a client! So, any accountants in SA who really know their stuff?

 

[coastymike]

I'm going to stir up a hornets nest here but Section 110.45 (6) says that " Expenditure does not form part of the cost base to the extent that:

(b) you could have deducted it for an income year under any of these Divisions (about capital works):

(i) Division 43 of this Act"

Ok that is the Division 43 capital allowance out of the way. However Section 110.45 2 says "Expenditure (except expenditure excluded by subsection (1B)) does not form part of the cost base to the extent that you have deducted or can deduct it for an income year," This would include the written down value of plant & equipment sold as part of the building (division 40 deductions)

Let's run through an example excluding Division 43 :

Purchase Price Land & Buildings & Equipment $1,000,000
Depreciation deduction on p&e $ 100,000
WDV of p&e $ 100,000
Sale Price $1,500,000

If you looked at it on the surface you would say the capital gain is $500K. However you are really selling two separate assets, the land & buildings & equipment. Most accountants use a reasonable apportionment as the contract rarely specifies the sale price of each item so we assume the sale price of the plant & equipment was $100K. Therefore $100K sale price and wdv of $100K results in no balancing adjustment for the p&e.

This therefore means that the sale price for the land & buildings was $1,400,000. $1,500,000 - $100K for p&e. The breakup of the components of the cost base are therefore

$200K p&e
$800K land and buildings

As you have sold the land and buildings for $1,400,000 then the gain would be $600K on sale.

Note i'm throwing this up for discussion. Want to get other people's thoughts before revealing the answer

 

[DaleGG]

Hi

Yes, it could make a massive amount of difference.

The section of the law requiring the building write off costs to be added back only applies to properties bought after this date; or to additions made after this date.

Properties acquired pre this date are exempt from this section of the tax act.

Have fun and good luck with your meeting

Dale

I will go through and digest all this information above. The property was purchased before the 1997 date mentioned above - does that change anything?

 

[Mry]

I will go through and digest all this information above. The property was purchased before the 1997 date mentioned above - does that change anything?

Ooooops! Dale is right. Thats a big boo-boo by your accountant. That should wipe another 26888 off the capital gain.

 

[Pushka]

You are both kidding me! That is just disgraceful!!!!!!!!!!

 

[coastymike]

The cost base of an asset is reduced by any amount that you can claim as a deduction. (Sections 110-40 and 110-45) However, this reduction does not apply if:

- the asset is a property you acquired before 13 May 1997;

- the deduction you claimed was for the Special Building Writeoff; and

- the expenditure was incurred before 1 July 1999.

This is explained on page 59 of the ATO Guide to Capital Gains Tax 2006 which can be obtained from http://www.ato.gov.au/content/downloads/NAT4151a-06.pdf.

Note that if you were calculating a capital loss then the reduced cost base must be used. In these cases the reduced cost base excludes the special building write off regardless of when the asset was purchased or construction commenced. However you have made a capital gain and not a capital loss and therefore the cost base is relevant in your case and you do not use the reduced cost base.

 

[coastymike]

Ok I won't leave everyone in suspense any longer. I will go through the legislation and the provisions in order in my next post and the logic behind the following ruling :

Taxation Determination TD 98/24

Income tax: capital gains: what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets?

 

[Pushka]

Hey CM, I have just read through the PDF. Why cant they give an example of a situation like mine - ie, purchased before 13th May '97!

Ok, so the Apartment was purchased in 1996. There have been no structural improvements made at all (it was only 2 years old when we bought it). We have claimed depreciation on the building, and items therein since then, and which were there when we bought it. So I am presuming that we do not need to exclude from the Cost base, the amount of capital works deductions we have claimed because:
1. We acquired the property before 13 May 97
AND
2. The expenditure that gave rise to the deductions was not incurred after 30 June 1999 (ie there was no capital works done after purchase?)

Or am I interpreting 2. incorrectly?

Also, is there a similar provision (date cut off) for depreciating assets? ie the contents? I cant seem to find this anywhere! Because this is another area that seems to have inflated our CG, in this case by $45,000

You guys are fabulous! <hugs>

 

[coastymike]

Pushka,

You don't need to exclude your Division 43 (special building write-off) from the cost base. So taking the special building write-off from the cost base in your case would be incorrect. Print out page 58-59 and take that along to your meeting and ask why the cost base has been reduced by the amount of the special building write-off.

The treatment of the depreciating assets sold as part of the property is covered by the ruling. I don't have all the details so don't know how your accountant has apportioned the sales proceeds and it is therefore difficult to comment on that part of the calculation. You can download the Taxation Determination from http://law.ato.gov.au/pdf/td98-024.pdf

 

[Pushka]

Pushka,

The treatment of the depreciating assets sold as part of the property is covered by the ruling. I don't have all the details so don't know how your accountant has apportioned the sales proceeds and it is therefore difficult to comment on that part of the calculation. You can download the Taxation Determination from http://law.ato.gov.au/pdf/td98-024.pdf

So are you also saying that the depreciable assets, if acquired before May13 1997, should not be used to reduce the purchase costs?

We provided him with a depreciation schedule when we acquired the property so I gather he would be using that.

 

[coastymike]

Read the ruling it goes through the implications. Basically the logic is as follows:

The capital gains provisions treat each asset that you can claim depreciation on as a separate asset to the property. (Section 108-60)

These depreciable assets are no longer subject to the capital gains provisions. (Section 118-24)

When you acquire a number of assets at the same time for a combined purchase price, that purchase price is apportioned between all of these assets on a reasonable basis. (Section 112-30)

The amount you determined to be the cost of these depreciable assets for the purpose of claiming deductions for depreciation must be deducted from the cost base of the property.

Note. The sale proceeds (before deducting costs) are also apportioned on a reasonable basis between the property and the depreciable assets that were sold with the property. (Section 116-40 and Taxation Determination TD 98/24)

You use this apportioned amount to determine whether there should be a balancing adjustment to your depreciation claim due to the sale of depreciable assets.

The apportioned sales proceeds amount to the CGT asset (land and buildings excluding depreciating assets which are not CGT assets) is then used to determine the capital gain.

 

[Pushka]

Ok, thanks. He may have got that bit right, but the buildings write off wrong because of the date of purchase, and that no further expenditure on capital works has occurred since purchase.

I am (obviously) not an accountant, how many other people has he made this mistake with? And why should I be responsible for querying his calculations, he should know better!
Thankyou to you all

 

[coastymike]

Pushka,

Agreed. It should be part of the internal controls for the practice. We have excel spreadsheets which we use for our working papers and included in the capital gains worksheet are headings such as

Special Building Write Off Add-Back

1. Was the property acquired before 13 May 1997. Yes. Go to 2. No. Addback special building write-off

2. etc. etc.

When I review the working papers I then make sure these questions have been answered and calculations done correctly. In my view that is what is the difference between a good practice and an exceptional practice. Internal controls and review processes. Mind you it makes our practice expensive for a section of the population. A section I don't really want to do work for.