Hi6028 Taxation Theory | Capital Assessment Answers

1.You are working as a tax consultant in Mayfield, NSW. Your client is an investor and antique collector. You have ascertained that she is not carrying on a business. Your client provides the following information of sales of various assets during the current tax year:

(a) Block of vacant land. On 3 June of the current tax year your client signed a contract to sell a block of vacant land for $320,000. She acquired this land in January 2001 for $100,000 and incurred $20,000 in local council, water and sewerage rates and land taxes during her period of ownership of the land. The contract of sale stipulates that a deposit of $20,000 is payable to her when the contract of sale is signed and the balance is payable on 3 January of the next tax year, when the change of ownership will be registered.

(b) Antique bed. On 12 November of the current tax year your client had an antique four-poster Louis XIV bed stolen from her house. She recently had the bed valued for insurance purposes and the market value at 31 October of the current tax year was $25,000. She purchased the bed for $3,500 on 21 July 1986. Although the furniture was in very good condition, the bed needed alterations to allow for the installation of an innerspring mattress. These alterations significantly increased the value of the bed, and cost $1,500. She paid for the alterations on 29 October 1986. On 13 November of the current tax year she lodged a claim with her insurance company seeking to recover her loss. On 16 January of the current tax year her insurance company advised her that the antique bed had not been a specified item on her insurance policy. Therefore, the maximum amount she would be paid under her household contents policy was $11,000. This amount was paid to her on 21 January of the current tax year.

(c) Painting. Your client acquired a painting by a well-known Australian artist on 2 May 1985 for $2,000. The painting had significantly risen in value due to the death of the artist. She sold the painting for $125,000 at an art auction on 3 April of the current tax year.

(d) Shares. Your client has a substantial share portfolio which she has acquired over many years. She sold the following shares in the relevant year of income:

(i) 1,000 Common Bank Ltd shares acquired in 2001 for $15 per share and sold on 4 July of the current tax year for $47 per share. She incurred $550 in brokerage fees on the sale and $750 in stamp duty costs on purchase.

(ii) 2,500 shares in PHB Iron Ore Ltd. These shares were also acquired in 2001 for $12 per share and sold on 14 February of the current tax year for $25 per share. She incurred $1,000 in brokerage fees on the sale and $1,500 in stamp duty costs on purchase

(iii) 1,200 shares in Young Kids Learning Ltd. These shares were acquired in 2005 for $5 per share and sold on 14 February of the current tax year for $0.50 per share. She incurred $100 in brokerage fees on the sale and $500 in stamp duty costs on purchase.

(iv) 10,000 shares in Share Build Ltd. These shares were acquired on 5 July of the current tax year for $1 per share and sold on 22 January of the current tax year for $2.50 per share. She incurred $900 in brokerage fees on the sale and $1,100 in stamp duty costs on purchase.

(e) Violin. Your client also has an interest in collecting musical instruments. She plays the violin very well and has several violins in her collection, all of which she plays on a regular basis. On 1 May of the current tax year she sold one of these violins for $12,000 to neighbor who is in the Queensland Symphony Orchestra. The violin cost her $5,500 when she acquired it on 1 June 1999.

Your client also has a total of $8,500 in capital losses carried forward from the previous tax year, $1,500 of which are attributable to a loss on the sale of a piece of sculpture which she sold in April of the previous year.

Required:

Based on this information, determine your client’s net capital gain or net capital loss for theyear ended 30 June of the current tax year.

2.Rapid-Heat Pty Ltd (Rapid-Heat) is an Electric Heaters manufacturer which sells Electric Heaters directly to the public. On 1 May 2017, Rapid-Heat provided one of its employees; Jasmine, with a car as Jasmine does a lot of travelling for work purposes. However, Jasmine's usage of the car is not restricted to work only. Rapid-Heat purchased the car on that date for $33,000 (including GST). For the period 1 May 2017 to 31 March 2018, Jasmine travelled 10,000 km in the car and incurred expenses of $550 (including GST) on minor repairs that have been reimbursed by Rapid-Heat. The car was not used for 10 days when Jasmine was interstate and the car was parked at the airport and for another five days when the car was scheduled for annual repairs.

On 1 September 2017, Rapid-Heat provided Jasmine with a loan of $500,000 at an interest rate of 4.25%. Jasmine used $450,000 of the loan to purchase a holiday home and lent the remaining $50,000 to her husband (interest free) to purchase shares in Telstra. Interest on a loan to purchase private assets is not deductible while interest on a loan to purchase income-producing assets is deductible.

During the year, Jasmine purchased an Electric Heaters manufactured by Rapid-Heat for $1,300. The Electric Heaters only cost Rapid-Heat $700 to manufacture and is sold to the general public for $2,600.

Required:

(a) Advise Rapid-Heat of its FBT consequences arising out of the above information, including calculation of any FBT liability, for the year ending 31 March 2018. You may assume that Rapid-Heat would be entitled to input tax credits in relation to any GSTinclusive acquisitions.

(b) How would your answer to (a) differ if Jasmine used the $50,000 to purchase the shares herself, instead of lending it to her husband?

1.Issue

A client has sold many of the assets during the given year and requires consultancy in relation to the potential tax treatment of these transactions. The information in relation to these transactions needs analysis considering the applicable tax norms in Australia and relevant tax rulings.

Law

Nature of Proceeds

The first question that needs to be answered is in context of the nature of proceeds that would arise from the transactions highlighted. There are two main choices in the form of capital or revenue receipts based on underlying classification of transactions capital transactions or normal business transaction (Reuters, 2017). In case of transaction being capital, the proceeds would be termed as capital and hence immune from levying of tax burden and only potential tax burden would be as Capital Gains Tax (CGT) on any potential capital gains. In contrast, revenue transactions would result in production of income as per ordinary concepts mentioned in s. 6-5. Thus, the tax treatment of the proceeds is dependent on the underlying nature (Barkoczy, 2017).

Exemption from CGT

A class of asset is referred to as pre-CGT asset and these are defined in s. 149-10 ITAA 1997. The key characteristic of this asset class is that it is exempt from application of CGT (Austlii,  2018a). The necessary condition to be fulfilled by the underlying asset is that it must have been purchased at a time when the capital gains were not taxed. This would essentially refer to time on or before September 20.1985. It is noteworthy that this exemption is independent of various aspects such as asset type, extent to gains, type of ownership and period of holding of underlying asset.

Further, besides the pre-CGT based exemption of CGT, for certain assets there are certain threshold limits below which CGT would not be applied (Reuters, 2017).  An example of this is in the form of collectables asset type where for CGT application, purchase price must exceed $ 500 as outlined in s. 118-10. With regards to personal use asset the threshold limit is $ 10,000 which ought to be exceeded for the application of CGT as outlined in ss. 108-20(1).

CGT computation

The CGT computation process tends to have several steps that are outlined as follows.

First Step: The underlying process of CGT computation initiates with CGT event present. It would be incorrect to assume that asset disposal has to necessarily happen for CGT event to take place as there is vast range of these events as mentioned in s. 104-5. The useful event from the perspective of situation at hand is A1 event which forms the basis of disposal of assets. In order to compute the corresponding capital gains or losses, a critical input required is in the form of cost base.

Step 2: The cost base related to an asset is a sum total of various elements as per s. 110-25 ITAA 1997 with one of the elements being the asset purchase price but it is not limited to that as apparent from the element list mentioned as follows (Austlii,  2018 b).

It is not necessary that all the given assets would comprise of all the elements mentioned above and if some of the elements are absent, then the cost base is computed based on elements that are applicable (Deutsch, et.al., 2015).

Third Step: With the asset cost base computed, using the A! event formula, the potential capital losses or capital gains may be calculated. The CGT is not applicable on these gains as first any capital losses made in the current year or pending from the previous years need to be adjusted with the capital gains realised from the asset sale as per s. 102-5 ITAA 1997. Also, there is a restriction in relation to collectable related capital losses which ought to be compensated against capital gains arising from the same asset class.

Fourth Step: The capital gains derived after the third step are not applied CGT yet. This may be attributed to the application of concessions that can lower the capital gains burden. There are two options available in this regards i.e. Discount method and Indexation method. In the given context, the relevance of the former is higher than the latter and hence the discussion is focused on the discount method as per s. 115-25 ITAA 1997 (Woellner, et. al., 2017). A reduction of 50% on the capital gains derived from step 3 is available provided the asset produces long term capital gains, The presence of holding period greater than one year would ensure the presence of long term capital gains and fulfilment of the applicable condition (Deutsch, et.al., 2015).

Fifth Step: The net capital gains arrived after fourth step is directly levied CGT to reveal the taxation burden on the client.

CGT computation timing

Whenever capital assets are sold, circumstances may arise that the sale contract may be signed earlier and the cash receipts would be received later. A critical issue that arises in such a scenario is when the contract for sale has been executed in a particular year while the cash receipts for the same are received in the other year. In this scenario, guidance ought to be provided to the taxpayer in relation to the timing of CGT computation as there are two events in separate years (Wilmot, 2014). A useful reference to resolve this issue exists in tax ruling TR 94/29 as it clarifies that the year of cash receipt is not significant since the pivotal factor is the enactment of sale contract for asset which necessitates the deduction of capital gains based on the underlying contract terms (ATO, 1994).

Application

Nature of Proceeds

For the given client, it is known that the transactions that have been sold are not part of business transactions. In the light of this information, it would be inappropriate to treat the receipts as revenue and the appropriate nature of receipts seems to be capital. As the receipts are capital, hence no tax would be levied on these. Hence, the potential tax implications of the given transactions would be in form of any capital gains or capital losses that are extracted on which CGT may be applicable resulting in tax liability for client.

Exemption of CGT

One of the bases for CGT exemption is the classification of the asset as pre-CGT asset. Hence, consideration needs to be provided to the respective purchase date of each of the assets. The same has been done and it has been seen that only painting can be termed as a pre-CGT asset owing to the purchase date falling in a period when no tax on capital gains existed.  The purchase date in all the remaining assets has been in the period when capital gains were taxed. As a result, painting would be exempt from the burden from CGT.

A collectable amongst the given assets is antique bed and hence it is necessary for application of CGT that the minimum price of the bed must be greater than $ 500 which is being complied in this case. A personal use asset also belongs to the list of assets which would be violin. This conclusion has been drawn on the use of the violin by the client for purpose of entertainment quite often.  The necessary condition in case of these assets for application of CGT is that the minimum price must be higher than $ 10,000 but the violin that has been sold fails to satisfy this condition and hence no CGT liability would be levied on the resultant capital gains or capital losses of this transaction.

CGT computation timing

In the transaction involving land, it is apparent that the contract signing has already concluded in the present tax year but the proceeds from the sale would only be available to the client by the next year.  TR 94/29 would be useful in the presented scenario and would lead to the conclusion that the resultant capital gains expected to be derived from land sale should be levied CGT in 2017/2018 only.

Conclusion

A cumulative taxable capital gains of $139,100 have arisen from the list of transactions that client has enacted during the year. Also, it is noteworthy that no CGT would be applicable on painting and violin sale while CGT is applicable for remaining assets.

2.Issue

In wake of the information provided about the various fringe benefits that have been provided to the employee (Jasmine), the consequent Fringe Benefit Tax (FBT) burden on the employer (Rapid Heat) need to be determined.

Law

The applicable law would be Fringe Benefits Tax Assessment Act 1986 and the relevant provisions of this act would provide direction on highlighting the potential tax treatment of these benefits. The requisite discussion in this regards is carried out as follows (Barkoczy, 2017).

Car Fringe Benefit

The extension of these benefits tends to occur in accordance with s. 8 and hence an imperative condition is the permission granted to employee for personal use of car provided by the employer. The professional use of the car is immaterial (Krever, 2017). A three step process ought to be adhered to for computation of FBT related liability on Rapid Heat as exhibited below.

Step 1: The fringe benefit value needs determination as per section 9.

Car base value is computed by making relevant deductions for repairs from the price at which the car is purchased.  In relation to days of private usage, deduction is permissible only if the car is not available for use owing to major repairs related garage stay or the employer not providing permission for personal use by employee (Woellner, et. al., 2017).

Step 2: Car fringe benefits taxable value = Gross up Factor * Value obtained in Step 1

The gross up factor is determined by the type of good and prevailing tax year.

Step 3: FBT levied = Rate of FBT for assessment year * Value obtained in Step 2

Loan Fringe Benefit

As per s. 16, the extension of these benefits to the employee would happen when the employer provides financial loan charging an interest rate lower as compared to the benchmark interest cost (ATO 2018). This rate is given by the Reserve Bank of Australia on an annual basis. A three step process ought to be adhered to for computation of FBT related liability on Rapid Heat as exhibited below (Wilmot, 2014).

Step 1: Consider the savings in the cost related to interest realised by employee in the assessment year taking the days of loan extension into consideration (ATO, 2017).

Step 2: Loan fringe benefits taxable value = Gross up Factor * Value obtained in Step 1

The gross up factor is determined by the type of good and prevailing tax year.

Step 3: FBT levied = Rate of FBT for assessment year * Value obtained in Step 2

As per the deduction rule in s. 18, deductions in FBT liability may be claimed by the employer but only on the loan amount that the employee deploys for generation of assessable income  (Krever, 2017). Also, a key aspect of this deduction is that it cannot be availed by the employer when the proceeds of the loan are utilised by any relative of employee (Barkoczy, 2017).

Internal expense fringe benefit

Employers are not liable to compensate the employee personal expenses. In case, compensation for the same is provided, then there is extension of expense fringe benefit.  It may so happen that the manufacturer a product may provide the same product at a steep discount to the employee for personal use and hence such benefit would be internal expense fringe benefit. A three step process ought to be adhered to for computation of FBT related liability on Rapid Heat as exhibited below (Deutsch, et.al., 2015).

Step 2: Expense fringe benefits taxable value = Gross up Factor * Value obtained in Step 1

The gross up factor is determined by the type of good and prevailing tax year.

Step 3: FBT levied = Rate of FBT for assessment year * Value obtained in Step 2

Application

• Using the above law outlined, the given information of the benefits provided to the employee would be used to work out the potential FBT liability for Rapid Heat.

Car fringe benefit

Since, Jasmine has been allowed to use the car provided by Rapid Heat for personal use, hence car fringe benefits are present. Besides, no deduction may be availed for minor repairs and airport parking stay since during these periods, it would be assumed that car is available for use.

Loan fringe benefit

Loan fringe benefits have been indeed extended as the employer is charging 4.25% p.a. However, the benchmark interest rate for the given assessment year is 5.25% p.a. Hence, the employee is enjoying the benefit of interest savings on lower interest related cost by employer.

No deduction would be permitted for employer on the loan amount that Jasmine’s husband is using for stock investment. However, on the remainder amount, if rent income is produced by the holiday home that Jasmine has bought, then employer can claim FBT deductions.

Internal expense fringe benefit

The original price at which Rapid Heat sells electric heater is $ 2,600. 50% of this amount is contributed by employer even though Jasmine wants to purchase heater for personal use.

• There is a change in the proceeds utilisation since the investment done in husband’s name earlier is now done in name of Jasmine. This implies that the ownership of Telstra shares is with Jasmine. As a result, the income on these shares is also derived by Jasmine. Rapid Heat in this case can make extra claims to the following extent.

Conclusion

In line with the computation carried out above, the FBT payable on part of Rapid Heat has been determined in relation to the various fringe benefits. Also, possible FBT deductions may be available to Rapid Heat based on how the loan proceeds are used and whether the holiday home yields rental income or not. 

References  

ATO, (1994) Taxation Ruling –TR 94/29 [Online]. Available at: Income tax: capital gains tax consequences of a contract for the sale of land falling through. https://www.ato.gov.au/law/view/document?DocID=TXR/TR9429/NAT/ATO/00001&PiT=99991231235958 (Accessed: 29 September 2018)

ATO, (1999) Taxation Determination –TD 1999/40 [Online]. https://law.ato.gov.au/atolaw/view.htm?locid=%27TXD/TD199940/NAT/ATO%27 (Accessed: 29 September 2018)

ATO, (2018) Fringe Benefits Tax- A Guide For Employers. https://law.ato.gov.au/atolaw/view.htm?DocID=SAV%2FFBTGEMP%2F00010 (Accessed: 29 September 2018)

ATO, (2018) Loan Fringe Benefits https://www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/Types-of-fringe-benefits/Loan-fringe-benefits/ (Accessed: 29 September 2018)

Austlii, (2018 a) Income Tax Assessment Act 1997- SECT 149.10 [Online]. Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s149.10.html (Accessed: 29 September 2018)

Austlii, (2018 b) Income Tax Assessment Act 1997- SECT 110.25.General Rules About Cost Base [Online]. Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s104.5.html (Accessed: 29 September 2018)

Barkoczy, S. (2017) Core Tax Legislation and Study Guide 2017. 2^nd ed.   Sydney: Oxford University Press Australia.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., and Snape, T. (2015) Australian tax handbook.  8th ed. Pymont: Thomson Reuters.

Krever, R. (2017) Australian Taxation Law Cases 2017. 2^nd ed. Brisbane: THOMSON LAWBOOK Company.

Reuters, T. (2017) Australian Tax Legislation (2017). 4^th ed. Sydney. THOMSON REUTERS.

Wilmot, C. (2014) FBT Compliance guide. 6^th  ed. North Ryde: CCH Australia Limited.

Woellner, R., Barkoczy, S., Murphy, S. and Pinto, D. (2017). Australian Taxation Law Select Legislation and Commentary Curtin 2017. 2^nd ed. Sydney: Oxford University Press Australia.