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CGT bill - Ralph expert says it's flawed

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Media Release : ·-*-·. . : - _____________________________Investment & Financial Services Association Ltd 29 Nov 99

CGT Bill - Ralph expert says it’s flawed (gE y

The Investment and Financial Services Association today released legal advice on the New Business Tax System (Integrity and other measures) Bill 1999 prepared by one of the key advisers to the Ralph Review.

The advice was prepared by Professor Richard Vann from the Sydney University Law School, who was one of the tax experts assisting the Ralph Review.

Lynn Ralph, IFSA’s CEO, said; O n the basis of advice written by Professor Vann, the Bill has some serious technical flaws. The advice confirms advice already given by KPMG and Price Waterhouse Coopers that the Bill fails to deliver the

Government’s promise of a 50 per cent cut in CGT to all Australian investors. In this regard 3 million Australians with moneys in a managed investment will receive CGT relief as low as 25 per cent.

However, investors who have direct shareholdings and property interest will reap the full 50 per cent relief. This is a most adverse outcome and was not contemplated in the Ralph Review. As those investors who hold managed funds tend to be in the low and middle income bracket e.g. retirees, it is reasonable to conclude that the current provisions favour the better off (who own second houses and have extensive share portfolios). On this basis the CGT relief is highly regressive.

The problem can be solved by way of a simple amendment that would allow managed investments to have the same CGT relief as other investments such as direct holdings in property and shares.

A copy of the advice is attached.

For further information please contact Lynn Ralph (0417 232 958) or Richard Gilbert (0417 247 998)

Level 24, 44 Market Street, Sydney NSW 2000 Ph: 61 2 9299 3022

_____________________Email: Fax: 61 2 9299 3198

^ 9 . NOV. 1999 13=10 C-REEhWOODS S, FREEHIL 61 2 3224117 NO.304 P . 2 / 3

Adverse effect of new CGT rules on individual unitholders in widely held unit trusts Prepared fo r 1FSA by Richard Vann, Consultant to Greenwoods <£ FreehiJls, Professor o f Law, University o f Sydney

The impact o f the new 50H reduction COT regime on unit trusts appears to have a damaging effect on the public unit trust industry which is not warranted by the underlying policy. The problem is not an easy one to explain but is nonetheless real for individual unitholders.

The measures concerned are contained in two bills currently before Parliament, New Business Tax System (Integrity and Other Measures) Bill 1999 and New Business Tax System (Capital Gains Tax Bill) 1999, the second of which amends the first The second bill does not seem to fit completely with the first as it apparently leaves in place references to sections in the first bill that are deleted in the second bill. However, I have been informed by a representative o f IPSA that the problem discussed below is not an unintended consequence that will be fixed

on a later occasion, though It is apparently not intended that this position will continue after the new regime for collective investment vehicles commences on 1 July 2001.

I should add that I have tried to contact the relevant officers in Treasury and the ATO without success, so I do not have the benefit o f discussion with them on this issue. (An ATO officer returned my call but turned out not to be the right person - he is trying to contact the right person who is currently at Parliament House).

The Justification that has apparently been given for the measure is the problem o f double dipping. Presumably this is a reference to the possibility o f non-taxable income and a matching loss under current law if there is no cost base adjustment The following example is used throughout the discussion j>elow. For simplicity it uses a single unitholder in a unit trust with only one asset but the discussion is generally applicable to the position o f unit trusts, especially public unit trusts.

Assume that an Individual unitholder contributes $1,000 to a unit trust which invests it in an asset which rises m value to $1,400 (a $400 nominal capital gain). If Inflation In the meantime would lead to a reduction o f any capital gain to $100, there is a possibility o f a double loss as follows. The original unitholder could sell the unit before the trust sells the asset for $1,400 if there is no discount to the price for tax reasons. The original unitholder would be entitled to indexation o f $300 on the inflation scenario assumed and so only be taxed on a capital gain o f $100 under the previous CGT regime The purchaser of the unit (assumed to be an individual) will have a cost base o f $1,400 In the unit. If the trust now sells the asset for $1,400 and indudes S100 capital gain in its net income after allowing for indexation and distributes the $400 nominal gain to the unitholder, the unitholder will only include $100 in assessable income as a result o f the mist distribution. The unitholder could however sell the unit for $1,000 (being the cash left in the trust after the sale) and so realise overall a capital loss on the unit equal to the amount o f untaxed nominal gain received from the trust (the unitholder has $100 assessable income from the trust distribution, a cost base o f $1,400 and sale price o f $1,000 giving a capital loss of $400). Hence current law in sl04-7Q of the Income Tax Assessment Act 1997 reduces the cost base o f the unitholder by the $300 non-

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assessable distribution. This eliminates the $300 net loss sad leaves the unitholder with the correct outcome

The measures introducing the CGT discount change the current treatment in a number o f ways. I f the unit trust elects to take the discount on the capital gain (which is likely where the indexation calculation gives a higher capital gain than the

50% exclusion) the unitholder is deemed in addition to the capital gain included in the trust distribution to have a capital gain equal to twice that gain and also gets e deduction for an amount o f capital gam included in the trust distribution. This is a mechanism that allows die individual to apply any capital losses that he or she has against the gain and to claim the 50% reduction that the individual is entitled to. The cost base reduction section is adjusted in some case» to take account o f the new system (where companies or superannuation (Unda receive the distribution, or where capital losses are applied by the unitholder against the mist capital gain - $104-70(7A)) but not for the simple example used here.

Assume that the trustee elects to use the discount in our example becaue indexation l* leas beneficial (for example, Indexation would only reduce the gain by $100, not $300 aa above). Trust net income is thus $200 ($400 reduced by 50%) and the trustee again distributes the flail $400 nominal gain. The individual unitholder include· the $200 trust income in assessable income but also takes a deduction o f $200 Further the individual has $400 aa a separate capital gain under the doubling rule above. As a result the individual can claim the 50% reduction for the $400 capital gain and includes only $200 o f it in assessable income. However, the individual ha· received $400 cash o f which only $200 was an assessable

distribution (the $200 trust net Income received). This means that the purchaser o f the unit for $1,400 reduces the cost base to $1,200. If the unitholder then sells the unit for $1,000, there is a $200 capital loss

If the loss on sale occurred in the same year as the distribution it would only go to reduce the $400 capital gain included under the doubling rule by half, this is because capital losses reduce capital gains before the 50% reduction is applied The individual purchaser would thus end up being taxed on $100 capital gain ($400 - $200 " $200 reduced by 50% * $100) even though no gain or loss has actually occurred for that taxpayer and the original unitholder has been taxed on the capital gain.

There should be no cost base adjustment In this case.

When the possibilities o f indexation and 50% exclusion are combined the position is more complicated, but there is no underlying policy reason in the more complex cases why the cost base adjustment should apply.

This document has not analysed the position o f superannuation where similar problems may apply. The whole fcsue requires fu rth er consideration.

I f it is not possible because o f shortness o f time to amend the current legislation before Parliament, the Government should indicate that further amendments will be forthcoming to deal with the problem in due course. If the Government considers that the outcome set out above would not occur under the current bills, it should

state so publicly and indicate how the legislation will operate in this type o f case.

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