Capital Proceeds

The capital proceeds of a CGT event are the amounts receivable on disposal of CGT asset. It is generally understood that a capital gain is the difference between the amount paid for a CGT asset, and the capital proceeds.

Capital proceeds are the subject of Div 116 of the Tax Assessment Act 1997.

On this page
Definition of capital proceeds
6 rules for modifying capital proceeds
Market value substitution rule (Sec 116.30)
Apportionment rule (Sec 116.40)
Examples of capital proceeds apportionment
Non-receipt rule (Sec 116.45)
Repaid rule (Sec 116.50)
Assumption of liability rule (Sec 116.55)
Misappropriation rule (Sec 116.60)
Div 116 – further rules
CGT on earnout rights
Questions
What happens when a business sale price includes performance instalments?
What if capital proceeds are stolen?
What happens if there’s no sale price?
What if some of the sale proceeds are paid back?
What if more than one CGT asset is included in the sale?
What happens if the asset is sold with liabilities attached?

Definition of capital proceeds

There is no detailed definition of ‘capital proceeds’ in the Income Tax Assessment Act.

Sec 995.1 defines “capital proceeds” as having the meaning given by Division 116.

Division 116 refers to the phrase without explanation (and not-so-helpfully links back to the ‘definition’ in Sec 995.1).

The Tax Office website, however has published a nice friendly definition. It describes capital proceeds as “Whatever you receive as a result of a capital gains tax (CGT) event.”

As with the concept of “cost base” and “reduced cost base”, the determination of “capital proceeds” is modified according to various tax rules.

There are 6 general rules set out in Division 116 which affect the calculation of “capital proceeds”, and then a further number of rules applying to specific kinds of transactions.

This is a simplified summary:

6 rules for modifying capital proceeds

1. Market value substitution rule (Sec 116.30)

This rule says that if you do not receive any capital proceeds, or if part of the proceeds cannot be valued, then for CGT purposes it is assumed you received the market value of the CGT asset at the time of disposal.

Market value can also be substituted if the capital proceeds are determined by parties to the CGT event who are not acting at arms length.

Gifts fall into this category. For example a block of land gifted to another person. For capital gains tax purposes the “value” of the disposal, i.e. the capital proceeds, is the market value of the land on the date it was transferred as a gift.

Determining market value is generally the work of a professional valuer, although the Tax Office has stated that in principle “The acceptability of a valuation for tax purposes usually depends on the valuation process undertaken rather than who conducted it.”

To be legally sound, a valuation should be conducted by a valuer with appropriate qualities, including:

  • independence
  • appropriate qualifications
  • relevant experience
  • personal integrity and competence

The valuation should be appropriately documented.

The market value the Tax Office wants to see is the value based on the ‘highest and best use’ of the asset as recognised in the market. They have set out some guidelines for who may undertake a market valuation here.

2. Apportionment rule (Sec 116.40)

This rule applies to proceeds that are attributable to more than one CGT event, or a payment that includes compensation for a CGT event and something else.

The capital proceeds are required to be apportioned in a manner which is “reasonably attributable” to each CGT event.

Practical examples of a required apportionment are numerous, but can include the sale of a rental property which contains depreciated assets and the sale of residential property whose area exceeds the 2 hectare main residence exemption.

Examples of capital proceeds apportionment

The principle of apportionment is logical as a process of matching capital proceeds to the asset being sold. However the legislation provides no guidance as to how the apportionment should be done.

An example provided in the legislation is the sale of land and a boat. There are two CGT events, to each of which must be reasonably attributed a share of the sale proceeds. However the example is silent as to how best this should be done.

Another example is that of proceeds of the sale of land bundled with advice. Again, no guidance is included for the basis of attribution.

In the absence of specific case references to section 160.40, we looked to published Tax Office material for guidance.

CGT Determination TD 9 provides a heavy hint: despite an independent valuation not being “mandatory”, and it being possibly challenged by the Tax Office, taxpayers are expected to “take whatever steps are appropriate” to determine a basis of apportioning composite assets, and need to be able to justify the method used.

Tax Determination 98/4 considers the operation of sec 116.40 in the apportionment of the sale price of a capital asset which contains or has attached depreciated property. Once again justifiable assessments of market value are considered the proper basis for the reasonable attribution of capital proceeds, as is required by sec 116.40.

A ‘private’ opinion from the Tax Office

A 2019 private advice published by the tax office provides a clear summary of its stance on valuations. The scenario being considered was the necessary apportionment of capital proceeds between a building, being a CGT asset, and the land on which it stood which was a pre-CGT asset.

The conclusion drawn in the Advice is that a market valuation at the point of sale is required. Although not a mandated requirement, it is only a market valuation which can provide sufficient evidence for an apportionment.

The Tax Office considered that rates notices were not sufficiently indicative of the market value of the assets at the time of disposal, and CPI adjustments as a basis of estimate are not sufficiently accurate. Furthermore insurance costs and land tax relate to the building and the land respectively, and so neither provide a basis for apportionment.

A similar conclusion was reached in this 2018 private advice. CGT Determination TD 9 is referenced with approval, and the central opinion confirmed; an independent valuation is not mandatory, but the onus is on the taxpayer to substantiate the basis of apportionment used.

3. Non-receipt rule (Sec 116.45)

The general rules treat you as having received an amount when you are entitled to receive it.

The non-receipt rule modifies the general rule by allowing the capital proceeds to be reduced if you did not receive part, provided that:

  • the non-payment is not a result of anything done by you (or your associate); and
  • you have taken “reasonable steps” to collect the unpaid amount.

Any later recoveries are added back.

4. Repaid rule (Sec 116.50)

If any part of the capital proceeds are repaid, or if you make compensation which can be reasonably regarded as a repayment, then the repayment can be deducted from the capital proceeds.

The repayment can include property.

The reduction cannot include any tax deductible (sections 8.1 and 8.5) portion.

An example of a repayment which would reduce the capital proceeds is provided in sec 116.50. It is when a damages payment is ordered by the court for a misrepresentation made by the vendor in a sale contract.

The amount of the damages payment made by the vendor to the purchaser is considered to be a repayment of the capital proceeds of the sale.

5. Assumption of liability rule (Sec 116.55)

This rule increases the value of capital proceeds by the amount of liabilities which are secured over the CGT asset.

For example the sale of land where the buyer accepts responsibility for the the value of an attached mortgage.

6. Misappropriation rule (Sec 116.60)

The general rules treat you as having received an amount when you are entitled to receive it.

However this rule allows an adjustment of the capital proceeds amount if your employee or agent misappropriates all or part of that amount. Any later recoveries are added back.

Div 116 – further rules dealing with capital proceeds

Not all of these rules apply to every type of CGT event. Section 116-25 ITAA 1997 sets out a table showing which rules can apply to each CGT event.

Division 116 also contains a further number of specific rules:

Sec 116.65 and 116.70 includes payments for the granting, renewing or extending an option when the asset under option is created or disposed of.

Sec 116.75 includes payments on the termination of a lease made by the lessor to lessee to compensate for improvements made to the leased property

Sec 116.80: the fall in the market value of a personal use asset or collectable is disregarded from the CGT event of the ownership vehicle being a company or trust

Secs 116.85 and 116.95 concern rolled-over assets and the residency of CFCs. You didn’t really come here for this, did you? Thought so. But if you really want more, call your accountant. She’s a full bottle.

Sec 116.100 enables a valuation of gifted property (under Div 30) to be used as the capital proceeds, provided the valuation is within 90 days of the CGT event.

Sec 116.115 – the market value of an exploration benefit is treated as zero under a CGT event in respect of a farm-in, farm-out arrangement.

Sec 116.120 – Disposals of assets involving look-through earnout rights.

CGT on earnout rights and arrangements

Earnout rights (for these purposes) are the rights of a seller of a business to get more from the sale on some performance basis of the business after it has been sold. It is a form of payment by instalments.

Until the law was amended in 2015 the earnout rights were viewed as a separate CGT asset i.e. separate from the business itself being sold. This meant it was difficult to accurately calculate the final capital gain/ loss at the time of sale, because the future payments at that point are only a contingency.

The law was therefore changed so that the receipt of later-year earnout payments now simply triggers a re-calculation of the capital gain/ loss at the point of sale, and an amended tax return is lodged without penalty to re-calculate the tax for that year.  The tax return for the year of sale is initially completed with the non-contingent components of the sale proceeds included.

There is a 5 year limitation on the period of future benefits, and a number of other qualifying conditions and safeguards associated with these measures.

For further information see:

Earnout arrangements on or after 24 April 2015
Earnout Arrangements

 

This page was last modified 2020-05-20