Taxation Law

Taxation Law Assignment 1

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Case Study 1

Issues:

What are the assessable incomes sources for the year ended 30 June 2011?

Analysis and Conclusion:

a) $ 27,600 – Income is derived when received. Even though $800 of this amount relates to future performance, it is considered income following the cost method for sole trader (Carden’s Case)

b) $ 1,400 worth – using client’s holiday house in compensation of the tax payer’s performance on client’s mothers, is considered assessable income and it was held in Brown’s case. (Reading 1.69). The shift permission, or opportunity to use that holiday house for one week has sufficient nexus between his job and they way he was rewarded.

c) AHK Bank – Although Brett was posted overseas for 3 months and he received salary in an overseas bank account, he is considered Australian resident for tax purposes. His intension was to help the subsidiary company with those particular projects rather than settling down in HK. His situation satisfies the four rules of the resident definition as per sec 6 (1).

Salary during the year:

9 months + 1 week - 55,500Nov – Salary + bonus - $7,500Dec – Salary - $7000

3 weeks no payment – insurance covered - $70,000

* $4,000 bonus for KPI’s performance 2011 will be declared next financial year. This is because individuals to declare income on cash basis rather than accrual and the company will issue the group certificate or payment summary on 30/06/2011, which will be assessable in 2012 FY.

$ 9,000 received for playing 5 games (Asian Tournament). The question here is to determine whether this activity is a hobby or ordinary source of income carrying on business as professional cricket player. Based on Scott v FCT (1967) 10 AITR 290, this amount could be considered as a gift for his performance playing those games rather than income. However, keeping in mind his history in Australia as professional cricket player and the income he received this financial year for some covenant agreements, there are sufficient agreements to recognize this amount as assessable income.

Cricket Activities

$ 15,000 – as restricted covenants

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$27,000 – I won matches$8,000 – Bonus for great season.$50,000

This scenario deals with the decision whether $ 15,000 paid as restricted covenant should be recognized as capital or ordinary income. This payment is a lump sum payment in compensation of his loyalty to devils during the next 2 seasons. Analyzing the date this money was paid (05-01-2011) and the additional payments during 2011 season, this income could be considered ordinary income of his performance as it was held in case A 14 (1969) 69 ATC 80. In this case, the installment received for the restrictive covenant, was embraced as reward for professional applies performance. This case applies to this question because Brett is accepting this money at the beginning of the season plus additional income if they win. This is sufficient reason to consider this reward as assessable income. We can confirm this appreciation drawing the scenario in which Devil’s wouldn’t win any match, and off course no bonus paid. The $15,000, payment is still in place and in this case that money represents his compensation for his professional performance as a cricket player.

Broken Wrist

$ 6,000 Insurance covered 3 weeks work - $ 2000 * 3

This payment is classified as compensation and damage. The criteria to determine whether it is assessable income or capital nature is based on the way the payment was done. Ordinarily when the compensation is a lump sum payment, the income is considered of capital nature and non-assessable. But, when the compensation is paid periodically, it is assessable income. In Brett’s case insurance paid $2000 weekly, for loss of wages, so $6000 is ordinary income, as it was held in Crommelin v DFC of T98 ATC 4790.

On the other hand, $ 20,000 received following court decision for pain and suffering is classified as Capital, as it was held in FCT v Slaver 84 ATC 4077.

In summary, total assessable income:

1. $ 27,000 – Income from personal performance. 2. $1,400 – Compensation Converted into money for personal performance3. $70,000 – Wages / Salary / bonus as employee4. $9000 – Income received for performance as Cricket Player in Australia5. $6000 – Insurance payment periodically for compensation of loss of

wages.

$ 163,000 Total Assessable income 2011 FY.

Laws:

a) Scott v FCT (1967) 10 AITR 290b) A 14 (1969) 69 ATC 80

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c) Crommelin v DFC of T98 ATC 4790d) FCT v Slaver 84 ATC 4077e) Section 6-5 Ordinary Assessable Incomef) Author Murray (NSW) PTY Ltd v federal commissioner of taxation (1965)114

CLR314

Part – B

Issues Analysis and Conclusion:

This case deals with resident status of James, who decided to travel to London with the intension of trying career development overseas. The residential status of a tax payer must be evaluated annually according to particular circumstance and facts. Fct v Applegate 1979 9 ATR 899.

James worked six months in Australia and other half in London. So, determining if he was resident of Australia as of 30th of June 2011, we have to apply or discuss the concepts of Australian resident as per Sec 6 (1).

This Section outlines four rules to establish if an individual can be an Australian resident. Resident of Australia, the domicile, 183 days, superfund rules are the four rules that applies to individual to analyze the resident status for tax purpose.

According to the information provided to resolve this case, we have to consider James’s resident status and domicile test, keeping in mind that, James worked half year overseas, the fact ors that determines his residential status are not enough. However he stayed overseas half a year with the intension of settling there with better jobs. This factor leads deeply into the consideration of his place of abode. For this reason we have more to the second rule, the domicile test. This test relies in two sub-tests, domicile and permanent place of abode.

James relinquished the lease of his apartment in Brisbane and signed one year lease of another flat in London. No properties were left in Australia apart from his bank account. His initial job contract for 6 months was rolled over. This scenario is clear enough to determine that his permanent place of abode is London, as it was held in Fct v Applegate 1979 9 ATR 899 and FCT v Jenkins (1982) 12 ATR 745.

James is a no- resident for tax purposes; James income earned in Australia is the only one assessable in Australia at non- resident tax rate. Income earned in London is not assessable in Australia.

Laws:

a) Fct v Applegate 1979 9 ATR 899

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b) Fct v Applegate 1979 9 ATR 899 and FCT v Jenkins (1982) 12 ATR 745

Case Study 2


Legal Costs

This is an interesting situation where we have to identify the real intentions of the tax payer. Although Megan was advised of shop lifting the facts do not explain her real intention. Whether it was mistake or there were clear intentions of stealing products from the shop.

Legal expenses can be claimed as deduction if they are incurred in the course of business activities in contrast, legal expenses related to private nature or capital are not deductible, sec 8-1.

According to the negative limbs, sec 8-1 (2), there are some losses or outgoings that cannot be deducted because their nature for example, megan’s case legal costs is an outgoing of capital, capital nature, private, or domestic nature.

The touta negative limb – specific denial exclusion. Outlines that deductions linked to a penalty are denied sec 26-5. However the information provided does not clarify if there is any fine component included is $12,000 legal costs paid to her barrister.

Bearing in mind that her intention, appointing one of the top barristers was to keep the license to operate her law practice, we could conclude that this cost is 100% legal expenses if she would been continued, she wouldn’t being able to generate income through her law firm. This kind of expenses is deductible under section 8-1. However, the discussion taken place under that happened before that put her on a court dispute.

The main issue here is, she went to court for possible shop lifting issues, and then considering her business activities as lawyer, the sanction or finr could be the suspension of her license to operate her business. At this point the appointment of a lawyer to argue he case becomes more provide or capital nature than business. The dispute was not originated through out the normal course of her business, therefore we can argue that this expense is not deductible, see 26-5 provide that penalties or sanctions due to a breach of the law of the commonwealth is non-deductible.

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Nine Sample

Travel Expenses $10,600

The principle that applies to this case is the deduction of the preliminary expenses. Preliminary expenses are outgoings incurred in the preparation of activities linked to the future income earning operations, book page – 88

Section 8-1 through the positive limbs states that an expense can be deducted to the extent that

a) It is incurred in gaining or producing assessable income orb) It is necessarily incurred in carrying on a profit business activity.

Megan ‘s case is a bit more complicated because even though she had the idea of opening her wine business before undertaking the benchmark trip to France, she had not developed the business plan to open or set up the business. This situation leads the questions about the nature of her travelling expenses to France, are they private nature or preliminary business expenses?

Even though she learn a lot during this trip and two months later she set up a business place, what would happened if the decision of opening the business would be negative.? The expenses was incurred in either scenario is it deductible or not?

Following the decision held in softwood pulp and paper Ltd VS Fc (Page. 88)Megan’s’ travelling expenses are not considerable deductible. At the time the trip was underway she was not sure about opening her wine business. Also the business case has not been drawn at that time, However, there could be an option to apply for this deduction under section 40-880, expenses incurred in relation to establishing a business. This deduction could be allowed over five years as expenses incurred in relation to cost in relation to a proposed business, Book Page 88.

20/01/2011 lease contract on a shop, which generated $2000 legal costs.

Taking in to consideration provisions of section 8 -1 this expense is not considered as capital because it is not related to the income earning structure of the business. This is a specific legal expenses incurred in the ordinary course of the business, as is was held in the case 671 (1956) 7 TBRD, costs of preparing lease documents are deductible under section 25-20

24/01/2011, $800 bank loan set up costs section 25-25 include borrowing expenses are deductible. Because this expense is more than $100, it must be apportioned over the period of the loan to a maximum of 5 years. This particular case has loan term of 4 years. The calculation for this deduction is:

31/01/2011 – Leasing wine tasting machine $200 per month

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Lease payments of equipment used to earn assessable income are generally deductible

Total leasing expenses 30/06/2011 = $1,200

04/02/2011 – Completion of the fit-out of the shop

Cost$10,000 – effective life 8 Years.

This expense is claimable 100% during the financial year this outflow is an asset acquisition which allows the business the claim depreciation expenses throughout its span of life, Book Page 130.

According to section 40-25 we can deduct an amount equal to the decline in value for an income year of depreciating asset that the tax payer held any time during the year.

Following the diminishing value method as per section 40-72, the depreciation expenses for this equipment is

Shop opened – 04/02/2011Sales as of 30/06/2011 $150,000Interest Expenses $2,800Lease Costs $12,000 (Shop)Lease Cost $1,200 (Machine)

Under section 8-1, interest expenses and the lease expense are deductible on long and the purpose of the loan and lease is 100% business

Fence:

03//03/2011 –Fence damaged $1,800Employee Contribution $500

The discussion here is whether the net expense is deductible under the allowable deduction provision. The nature of the expenses is included in the general provision of section 8-1, However, the outflow of this money was not incurred generating business income it was generated by an employees accident while parking it could be assured that the car park is part of the business facility that generates income and the risk of this kind of accident is 100% business nature. No matter who was driving the car, an employee, a client or Megan, the fence have to be repaired and it is considered business expense. For example lets assume a non-client of the firm damaged the fence and he/she derived out without assuming any responsibility. After repairing the fence the business is allowed to claim this deduction, this situation could have similarities with deductions for losses by embefflement, section 25-45.

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Reception Desk

a) Written down value old desk $ 120 – 30/11/2010b) Second hand desk $ 1,200 (1/12/2010)

Delivery & installation $ 350Total Cost $ 1,550

c) Repair surface of new desk $ 600 (01/12/2011).

1) Disposal of a depreciating asset.

Assuring the termination value of the old desk $0, under section 40 – 285 (2), Megan can claim a deduction of $ 120. In other words, this asset is written off from book with $ 0 termination section 40-300 value (balancing adjustment event).

2) Cost of second hand desk. Under the uniform capital allowances system the cost of a depreciating asset consists of two elements. First and second element costs.First element cost $ 1,200 – Money paid for the assetSecond element cost 350 – Delivery and Installation

Total Costs $1,550 - 01/12/2010

Depreciation expense, as per section 40-72, is calculated as follows:

$ 1,550 * 212 * 200% = $297 365 6

3) Repair of surface desk $ 600 – 01/12/2011

Section 25-10 allows a deduction for expenses, incurred for repairs of a depreciating asset; this expense is claimed 100% if the asset is used only for business purpose. Taxation ruling TR 97/23 clarifies that to obtain a deduction for repair under section 25-10, the repair must not be one of the follows:

Replacement of the entity Substantial improvement Terminal Repair

Megan’s case her business reception surface desk was repaired after one year of use. This repair is considered a minor improvement rather than substantial repair. Therefore the deduction of $ 600 as repair is available in 2012 financial year. Because the payment was done after 30/06/2011, Megan cannot claim this deduction in 2011 FY.

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If the date of the repair is wrong – 01/12/2010 rather than 01/12/2011, the repair becomes initial repair, which means this expense has to be considered part of the cost, second element costs. In this case the calculation in point of changes.

Summary Megan’s Case

1) Amounts that can be claimed as deduction -> 30/06/2011

Expense Deductible Non-Deductible

Legal Costs $ 12,000Travel Expenses trip to France $10,600Lease legal costs $2,000Bank loan costs $86Leasing wine T machine $1700Depreciation Fit –out $1000Interest Expenses $2800Lease shop/rent $12000Write off old desk $170Dep. New Desk $297

Repair desk $ 600Available for 2012FY

TotalRepair Fence

$19,503$1,800

$ 22,600

$21,303

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2) Amount assessable to Megan:

Income from sales $ 150,000

Less: deductions $21,303

$128,697Add: Employee contribution $500

Total Assessable Income $ 129,197

Laws:a) Section 8-1 b) Softwood Pulp and Paper Ltd v FCT (1976)7 ATR 101c) Section 25-10

Case Study 3 - Capital Gain


House

a) 22-01-85 Purchase $72,000b) July/2011 Extra rooms $ 34,000c) 10-05-2011 sold price $ 279,000d) Real Estate cost $ 6,300

This is CGT event A1 as per S 104-10. But this operation is exempted under the following section:

1) Asset acquired prior to 20/09/85.2) Main residence, S 118 – 110.

Rental Property

a) 5-01-1987 $ 92,000 – Purchasedb) Legal Costs $800c) Stamp Duty $2,400d) Sold: 15-05-2011 $140,000

Real Estate fees $4,300 Legal Fees $1,050

e) Interest Costs $23,000f) Repairs $ 5,600

Cost base

1st Element $92,000

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2nd Element $ 8,550

Total Costs - $ 100,550

Because, this property was acquired pre 21/09/1999 and the CGT event happened after 21/09/1999 the tax payer has the choice of using the discount method or frozen in taxation method to evaluate the capital gain.

The discount method applies to this case because the property was held for more than 12 months, section 115-25.

CGT Comparison

Discount In taxationCapital Proceeds $140,000 $140,000Less: Cost Base (100,550)Less: Indexed Cost base

(152,431)

$ 100,550 * (123.40) 81.40Capital gain/loss $ 39,450 $(12,431)Less 50% discount (19,725)

Capital gain or loss $ 19,725 $(12,431)

The indexation method gives better result to the tax payer. This capital loss is carried forward to apply future capital gain events. Interest cost and repairs are not included as part of the cost, third element, because the property was acquired before 20-0801991. However, the tax payer can claim these expenses as rental property expense in the year they were incurred.

Block of Land

Land Purchased 05/09/1992 $ 20,000Legal fees and stamp duty $1300

Total Costs $ 21,300

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3/03/1994 – Mary Died

- Market Value $ 30,000

20/06/2011 – Sell Contract $90,000

- Legal fees $ 535- Agency fees 1,800

Greg becomes owner of the property when his aunty passes away 03/03/1994 – Market value $ 30,000. Because Greg acquired this asset before 21/09/1999, and sold it after this date, both the discount method and indexation method are available to evaluate capital gain.

CGT Comparison

Discount IndexationProceeds $ 90,000 $90,000Less: Cost base $33,635

Indexed Cost base$33,635* (123.4)

110.4$37,596

Capital gain/loss $56,365 $52,404

Less 50% Discount $28,183

Total gain/loss $28,183 $52,404

The discount method gives better tax planning to Greg. It would have to pay tax on capital gain of $ 28,183, rather than Tax on $ 52,404.

- Car-Purchase 14/07/2009 $ 16000

Sell 10/05/2011 $26000Repairs $4000

This situation is considered as business transaction. Greg is carrying on a business of buying and selling cars. Subdivision 118 – A states that selling

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trading stock is on exemption for CGT. After selling the Car Greg had a net profit of $ 6,000, which should be declared as Part A ordinary net income of his business.

Furniture

Purchase: 2/12/2009 $12,000Interest $2600Sold 10/05/2011 $15,500

This transaction is a CGT event which is not exempted because the total cost of the asset is > $ 10,000.Under Section 180-20(2) furniture is a personal asset but section 118 – 10 provider the exemption for personal use assets acquired for < $ 10,000. Because this asset was acquired and disposed after 21/09/1999, and Greg held them for more than 12 months, discount capital gain applies.

Capital gain calculations

Cost Element $ 12,000Cost element $2600Total Cost base $14,600 ……………………… (1)

Proceeds $ 15,500 ……………………… (2)

CGT = ((1) – (2)CGT = $ 15,500 -14,600 = $900

50% discount = $450Total discounted capital gain $450

Carried forward losses

CF Capital losses

2008 Collections $ 2,0002010 Shares $ 4,000Total CFL $ 6,000 —> to be applied to any capital gain during 2011 FY. Carried forward capital losses from collectables can only be applied to capital gain from collectables, sec 108 – 10.

Summary total Capital gain – CGT Gain/loss

1) House Nil - Exempted2) Rental Property (12,431) – Loss3) Block Land 56,365 - Gain before discount

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4) Car Nil – Exempted5) Furniture 900 – Gain before discount

Total gain/loss $ 44,834Less: losses CF Previous year (2010) (4000)

Total $40,834

Less:

Discount CGTBlock land (28,183)

Discount CGTFurniture (450)Net Capital Gain $ 16,2012011 FY

Note: Capital Losses carried forward = $2,000 from collectable in 2008.

Case Study 4


Shares:

03/07/2011 - $ 800 – Dividend Cheque.

Under section 44 dividends are derived when they are paid. So, this operation has to be considered as income in the next financial year 2012 (01/07/2011 – 30/06/2012).

Personal Care:

$1200 - Expenses personal make-up to attend business functions. Even though Tammy has to be well presented when attending theses business meeting, these expenses are considered private nature, as it was held on Mansfield v Fct 96 ATC 4001. Also, by definition, expenses of a private or domestic nature would not be incurred in gaining assessable income. These kinds of expenses are no deductible following the provisions of the second negative limb. So, Tammy’s make-up expenses would be considered non-deductible.

Car

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Old Car Volkswagen Golf (VW) – 80% business use

Car accident 5/10/2010 – Repair $11000 (20-10-2010)

Insurance payment 24/11/2010 $ 10,000 (Repairs Cost)

Cost VW $ 32,000

Written down value 30/06/2010 - $ 20,160

Depreciation method – 22.5% diminishing value.

New Car: Toyota – Cost $38,000 (04/01/2011) Trading VW - $ 18,500 Payment – $19,500

a) Repair Expenses

$ 11,000 paid by Tammy – (20-10-2010) (10,000) Insurance Payment – (24/11/2010) 1000 net repair Expense

80% business use - $ 800 deductible.

b) Depreciation expenses old car as of (04/01/2011)$ 20,160 * 22.5% * (188)

365Depreciation = $ 2,336 business use 80% = $ 1,869

Written down value = $ 20,160 – $2,336= $17,824

c) Depreciation expenses new car as of 30/06/11

$ 38000 * 25% * (177) = $4,607 365

* Business use 80% = $ 3,685

Written down value as of 30/06/2011

$ 38,000 - $ 4,607 = $ 33,393

d) Capital Gain/loss selling old car as part of trading new car.

CGT = Proceeds – written down value (04/01/2011)

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= $ 18,500 - $ 17,824= $676

50% discount = $338Total discounted CGT $ 338Net CGT business use 80% = $270

Summary Tanny’s tax consequences

1) Shares: $800 dividend is not derived income for 2011 FY. This income is assessable income in 2012 FY.

2) Make up expense: $1,200 is not deductible because it is consider private or domestic nature.

3) Car: a) Net repair expenses business use (80%) - $800 included in business deduction.

b) Total Depreciation business use (80%) 2011 FY

1) VW $ 1,8692) Toyota $ 3,685

TOTAL $ 5,554

VW written down value 04/01/2011 - $ 17,824Toyota written down value 30/06/2011 - $ 33,393

d) Capital gain disposal VW – Business Percentage

$270

Reference:

1. Taxation Law Study Book2. Lecture notes and Text book.

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Taxation Law