Recent changes to the way Capital Gains Tax (CGT) on assets subject to CGT is treated in a bankruptcy may cause some significant issues for bankrupts. The changes and associated implications are discussed in this article.
Background
Prior to 2021 a trustee realising an asset of a bankrupt estate that attracted CGT was not liable for the CGT component of any realisation. The bankrupt was responsible for the capital gain. This practice arose from the interpretation of s106 – 30 of the Income Tax Assessment Act 1936 (ITAA) which considered the asset to still be the bankrupt’s asset even though it vested in the trustee.
In 2021 the Australian Taxation Office (ATO) reviewed the provisions of s160-30 and s254 of the ITAA and determined that a trustee was liable to account for the tax on any gain. It was recognised that the changes could create difficulties for the trustee in calculating the gain without knowing the personal circumstances of the bankrupt during the period of ownership of the asset and identifying any allowable deductions. This is particularly relevant in circumstances where the bankrupt is uncooperative.
The practice adopted by trustees prior to 2021 had been in place for decades. As a consequence, there was concern by trustees about the historical position and the challenges that would be faced in accounting for CGT. In 2022, a Queensland trustee applied to the ATO for a tax ruling as to whether he was liable in his capacity as trustee for CGT on two properties he sold. The ATO determined that he was liable and that s254 of the ITAA applies to trustees in bankruptcy. The trustee appealed the tax ruling which served as a test case for the issue. The appeal decision was handed down in July 2024 and determined that a trustee was liable.
How Is the Capital Gain Calculated
Although the calculation of CGT liability is uncharted water as the process is in its infancy there are some underlying issues that can create problems for bankrupts.
A trustee must register for a separate tax file number for the bankrupt estate where there is likely to be a capital gain on the sale of an asset. Annual tax returns for the bankrupt estate are required to be lodged and capital gains recorded in the year in which they are generated. The trustee receives the benefit of the tax thresholds when the CGT liability is calculated.
The CGT liability does not arise until an income tax assessment is made.
A bankrupt is required to include the capital gain in their income tax return which will also include income from other sources. While they receive a credit for the tax paid by the trustee there will always be a shortfall for the bankrupt, if they have generated any additional income during the year, because the bankrupt does not receive the benefit of the tax-free threshold to which the trustee is entitled.
If the bankrupt does not declare the capital gain in their income tax return the ATO will issue an amended assessment once it receives a tax return from the trustee. If the additional tax payable is significant it could result in the bankrupt needing to declare themselves bankrupt.
General Comments
We note that the timing of the CGT event is critical and where the CGT event occurred prior to the bankruptcy, any debt owing on the CGT will be subject to the bankruptcy and therefore not otherwise payable.
A mortgagee in possession is not subject to the CGT provisions and in some cases, a better result may occur for all parties if the mortgagee takes control of the sale process.
If any of your clients become bankrupt and have an interest in property which is likely to be subject to CGT, we recommend that the bankrupt and/or their advisors liaise with the trustee to assist with the quantification of any allowable deductions.
Please do not hesitate to contact us if you require further information in relation to this topic.
Article by Hillary Orr (Consultant) – Adelaide