A separate asset regime of general application is supplementary to the operation of the inclusion and deduction provisions in the law. It is not the purpose of the regime to bring amounts to tax or allow amounts as a deduction. Rather, its purpose is to elaborate the meaning of concepts used in the inclusion and deduction provisions. The main areas that can be dealt with in a separate asset regime are timing and calculation matters.
The timing rules identify the tax year in which the inclusion and deduction provisions apply to an asset, and the calculation rules provide for the determination of the taxable or deductible amount. Depending on the asset, the taxable amount may be a gain calculated by subtracting the cost base of the asset from the consideration received for the asset, and the deductible amount may be a loss calculated by subtracting the consideration received for the asset from the cost base of the asset. In other cases, such as inventory, the taxable amount may be the consideration received, and the deductible amount may be the cost of the asset. In either case, the asset regime should provide for the determination of the cost base of, and consideration received for, assets.
ISSUES RELATING TO TAXATION OF ASSETS
1.Timing Rules for Realization of Gain or Loss
Ordinarily, gains or losses arising in relation to assets are taxed not as they accrue, but rather in the tax year in which the taxpayer realizes the gain or loss. In most cases, a gain or loss is realized at the time the taxpayer ceases to own the asset.
The disposal rules may also provide for gain or loss recognition where an asset that is outside the tax system is brought within the tax system, or vice versa. This can occur because a change in the taxpayer’s circumstances changes the tax status of assets held by the taxpayer. For example, a nonresident taxpayer may become a resident taxpayer. If the new country of tax residence taxes worldwide income, then the change in residence may bring assets held by the taxpayer at the time of the change within the tax system of the new country residence (these assets previously being foreign assets of a nonresident).
Alternatively, a resident taxpayer may become a nonresident taxpayer. The effect of the change may be to take some assets held by the taxpayer at the time of the change outside the tax system of the taxpayer’s former country of tax residence (these assets now being foreign assets of a nonresident). A similar situation can arise where an exempt person becomes a taxpayer, or vice versa. This can happen as a result of a change either in the taxpayer’s circumstances or in the law.
2. Cost Base
The basic rule is that the cost base of an asset is the consideration given for the acquisition of the asset. This should include any borrowed funds used to acquire the asset. Where the taxpayer has given consideration in kind for the asset, the market value of the in-kind consideration at the time of the acquisition should be included in the cost base of the asset. The cost base of an asset should include any ancillary costs incurred in the acquisition of the asset, such as legal and registration fees relating to transfer of the ownership of the asset, transfer taxes, agent’s fees, installation costs, and start-up expenses to make the asset operational.
The cost base of an asset should also include any capital expenditures incurred to improve the asset and expenses incurred in respect of initial repairs. When there is a partial disposal of an asset, it is necessary to provide rules to apportion part of the cost of the original asset to the part of the asset sold. For this purpose, the cost of the original asset should be apportioned by reference to the market values of the respective parts of the asset at the time the asset was originally acquired. It may be difficult to apply this rule when an asset was acquired without contemplation of part disposal.
3. Non-Arm’s-Length Transfers
In the absence of prophylactic measures to control the amount of cost and consideration for tax purposes, related parties may choose transfer prices in the hope of achieving a variety of tax objectives—minimizing recognition of gain to defer taxes, inflating gains to absorb losses that were carried forward, value shifting to transfer gains to a lower bracket or exempt taxpayer, and so forth. Objectives unrelated to taxation, too, may also influence transfer values. For example, taxpayers may wish to shift value to improve their balance sheet for the purpose of obtaining debt finance. To prevent manipulation of transfer prices, rules for determining the deemed market value consideration are needed for non-arm’s-length transactions. In broad terms, an arm’s-length transaction is a transaction in which the parties act completely independently of each other and seek to put their own interest first.
4. Nonrecognition Rules
There may be situations in which a taxpayer has realized a gain or a loss on disposal of an asset, but recognition of the gain is deferred until a later event occurs. Similar deferral may apply when property changes its tax status. In some jurisdictions, these nonrecognition rules are referred to as providing rollover treatment. The tax position of a taxpayer or asset is rolled over into another taxpayer or asset, as the case may be.
One country attempted to broaden its tax base by introducing measures on a prospective basis so that they applied only to assets acquired after a certain date.This approach is not recommended because it creates arbitrary differences in the treatment of assets depending on when they are acquired. These differences encourage taxpayers to enter into transactions to shift value from taxed to untaxed assets. Further, this approach creates a lock-in effect in that persons holding assets acquired before the relevant date are encouraged to hold onto them.