Last year I wrote an article highlighting why it is in your interest to have the assets you owned on October 1, 2001 valued for capital gains tax (CGT) purposes. ("How you value an asset affects the amount of CGT you will pay" on October 26, 2002.)
I pointed out that the main reason for having your assets valued is that it gives you greater choice of methods to determine an asset's "base cost". This choice will enable you to use the most favourable method to calculate the base cost of the asset, thereby limiting the CGT you will have to pay when you sell the asset. The base cost of an asset is the value that you may deduct from the proceeds of its sale in order to determine your capital gain.
However, the three methods I discussed in the article excluded cases where the asset is a financial instrument and the weighted average method has been used to determine the base cost.
Financial instruments, such as shares, are regarded as "identical assets", because one ordinary share in a company is exactly the same as another, except for the number on the certificate.
There are special rules in the CGT legislation for determining the base cost of these so-called "identical assets".
For example, if you bought shares in Company A on two occasions, these identical assets will have different base costs depending on when you bought them. And if you now sell some of your holding in Company A, you need to decide which shares, with which base cost, you are now selling.
There are a few ways of determining the base cost of these shares:
- The "specific identification" method. Using this method you must identify which particular asset, among the group that appear the same, is being disposed of, in relation to when it was acquired; or
- The first-in-first-out method. Here, regardless of which specific asset is being sold, the base cost is determined on the basis that the longest-held asset in the group is disposed of first.
If you choose to use either of these methods, you must apply the rules set out in my previous article to determine the base cost for the asset held on October 1, 2001, and the consequent capital gain or loss amount.
There is, however, a further option - namely, the weighted average method - but it may only be used for the following assets:
- Financial instruments (for example, shares) listed on a recognised stock exchange, and that have been listed from the date you acquired them. In other words, this method cannot be used if the company listed while you held the shares; or
- Units in a unit portfolio which are not listed on a recognised stock exchange, but whose prices are regularly published in the newspapers (for example, units in a unit trust); or
- Coins, that is platinum or gold where the prices are regularly published (for example, Krugerrands).
Be aware that if you elect to use the weighted average method for a particular type of asset, you must use this method for all assets of that type until they have all been disposed of. Thus, if you choose the weighted average method for your listed shares, you must use it for all your listed shares.
It is therefore important that you choose your method of valuation carefully.