LAW3130 Revenue Law and Practice-Capital Gain Tax

Application

The Income Tax Assessment Act of 1997 in section 4-1 provides that every individual, business or entity is required to pay tax on the taxable income. The taxable income is calculated by reducing allowable deductions under section 8-1 of the Income Tax Assessment Act 1997 from the assessable income as per section 4-15 of the Income Tax Assessment Act 1997. The tax law provides that assessable Income include both ordinary income and statutory income (Vann 2016). The income according to the ordinary concept is an ordinary income as per section 6-5 of the Income Tax Assessment Act 1997. The section 6-10 of the Income Tax Assessment Act 1997 state that income that are not ordinary income are statutory income. In both the section 6-5 and 6-10 of Income Tax Assessment Act 1997 it is provided that in case of resident taxpayer income received from all the sources are taxable. Therefore, it can be said that the income derived from the selling of lands should be included in the assessment income as per the above sections (Smith et al. 2016).

The income received from sale of capital asset is a statutory income. Therefore, is it necessary to determine the nature of asset so that the nature of income can be properly classified. In this case, it is necessary to determine whether the block of land sold is a capital asset. If it is found that the block of land qualifies to be capital asset in that case the income derived from the sale of land will be regarded as a statutory income under section 6-10 of Income Tax Assessment Act 1997 (King 2016).  

The capital gain or loss arises in case of capital gain tax event as per section 100-20 of the Income Tax Assessment Act 1997. The disposal of capital gain tax asset give rise to Capital gain tax event. There are certain examples of capital gain tax assets given under section 100-25 of the Income Tax Assessment Act 1997. This example of capital gain tax assets includes building, land or shares. Based on the above discussion it can be said that CGT event includes selling of land provided that land is not held as inventory for the purpose of business. The intention for the purchase of land should be ascertained in order to determine whether the income from the sale of land is a capital income or the statutory income. In this case it is provided that the land was purchased for developing building and selling it for profit. The land was regarded as inventory in this business therefore; income derived from the sale of land should be regarded as an ordinary income (Russell 2016).

Conclusion

Based on the above discussion it can be said that the company is engaged in the business of land development so the land held by the business is to be treated as inventory and not capital asset. The income derived from sale of land should be taxable as it is an assessable income. In addition to this as the land is not regarded as the capital asset so the income derived from sale of land should be included as ordinary income.

Issue

The company is engaged in the business of underground drilling and has entered into a contract with government of Queensland. The project involves construction of major infrastructure related to Railways. The construction project required an equipment that the government has agreed to finance provided the contractor works exclusively for the project for 3 years. However, if the contractor violates the terms of the agreement then the amount that the government has financed for the equipment will have to be repaid by the company. In this case, two issues needs to be determined. The first issues to ascertain whether cash accounting or accrual accounting is suitable for the business. The second issue is to determine whether the funding received from the government should be included ordinary income or statutory income.

Law

The rules and regulations that have been applied in order to determine the issues highlighted above are:

• The taxation Ruling 98/1;
• The Taxation Ruling 2006/3;

Application

The Taxation Ruling 98/1 deals with the type of accounting that an entity should follow for the purpose of tax. The para 16 of the Taxation Ruling 98/1 provides that there are primarily two methods of accounting for the purpose of section 6-5(2) and (3) of the Income Tax Assessment Act 1997. The cash accounting method and the accrual accounting method are the two methods of accounting that is provided in this ruling (Mahar et al. 2016). The taxation ruling 98/1 in para 18 states that cash or receipt method of accounting is appropriate for income received from employment, non-business income and business income that is related to personal skill and knowledge. In the Para 20 of the taxation ruling it is provided that income derived from business should be accounted on accrual basis for the purpose of tax. Based on the above taxation ruling it can be said that the business should apply are running or accrual method of accounting for the purpose of tax (Amendment 2016).

The rules and regulations relating to the government payment to the business are provided in the Taxation Ruling in 2006/3. In the Para 10 of the ruling it is provided that the payment that has been made by the government to the  business for continuing the operation should be included in the assessable income in the year of receipt (Peiros and Smyth 2017). If the business sacrifices profit or sales part of share, in return of the fund received from the government then in such case the amount should not be included in the assessable income. The business in this case has received funding from the government but has not sacrificed profit or sold part of shares. Therefore, in this case the funding received from the government for the equipment should be included as a statutory income.

Conclusion

Based on the above discussion it can be said that as per the taxation ruling 98/1 the business should follow earning or accrual method of accounting. On the other hand, the Taxation Ruling 2006/3 provides that if the business receives funding from the government then the amount should be included in the assessable income as a statutory income.

 Evaluation of CGT Small business concession

In this report, an attempt is made to examine the concession given to the small business for capital gains. The report discusses the types of capital gain that are allowed to be small businesses. The conditions that needs to be satisfied is also discussed in the report. The small business has played an important part in the Australian economy by contributing heavily in employment and economic growth (Geljic, et al. 2016). It is estimated that 49% of the private sector employment is provided by the small business. In an estimated can be said that small business constitutes 97% of the private sector business. It is clear that small business is an important constituent Australian economy. The main aim of the report is to evaluate the contribution of the small business concession.

Capital Gain tax introduction and implementation

In the organization for economic development and cooperation (OECD), Australia is an important member. Australia was the last member to adopt the capital gain with the introduction of Income Tax Assessment act 1936 Part IIIA. From 20 September 1985, the capital gain tax become effective and it was dealt in from section 160A to 160 ZZU. It should be noted the capital gains made on disposal or transfers of assets was not taxed before the introduction of capital gain tax (Tucker 2016). On the other hand, the income received from ordinary activity was taxed at the normal rate. In order to remove the disparity in the taxation system the capital gain tax was introduced.

The disposal of assets that have been acquired on or after 20 September 1985 are subject to capital gain tax. In case of assets that are purchased before 20 September 1985 are exempted from tax and is commonly known as pre capital gain tax assets (Holland 2016). There are no separate rate of tax that is applied for capital gain. The Income tax Assessment 1997 under section 6-5 and 6-10 state that an individual, trust or other entity is required to pay tax on all the ordinary or statutory income. The marginal tax rate is applied to all the income received from capital gain and it is regarded as the statutory income (Tran?Nam et al. 2016).  The disposal of shares, real estate or interest in a trust is regarded as the capital gain tax event under section 100-20 of the Income Tax assessment Act 1997.

Therefore, it can be said that tax rate that is applied on the profit earned from the disposal of capital asset is known as capital gain tax. In the organization for economic development and cooperation the law related to the capital gain tax is already applied by all the member countries. On comparing the law, it has been found that there are mainly two approach for taxing the capital gain that are followed by the member countries of the OECD. One of the approach is that the capital gain tax is regarded as ordinary income. In this case, normal personal income tax rate is applied in the capital gain for calculating the tax payable. In the second approach, the capital gain is not included in the ordinary income. In this case, a different tax rate is applied on the capital gains for calculating the tax payable (Woellner et al., 2016). On analyzing the tax rates of organization for economic cooperation and development countries it can be seen that the tax rate of Australian one of the highest. This means the tax rate applied on the capital gain of Australia is higher than most of the countries.

The purpose of the Capital gain tax legislation

The new amended form of capital gain tax was announced on 21 September 1999. The CGT legislations was adopted because of the following reasons:

• It was felt that there is a need for better asset management so that natural resources can be allocated properly.
• It was seen that economic efficiency of the resources was reduced due to the application of existing capital gain tax structure.

The reasons highlighted above made it necessary to change the existing capital gain tax structure. In order to make the capital gain structure of Australia in line with other countries the system of indexation and averaging was abolished. This has helped in reducing the complexity of the system and hence help the taxpayer. It can be seen that burden of tax for small business are higher (Somers and Martins 2016). The high tax rate of Australia has reduced the savings of the small business. This in fact has reduced the investment capability of the small business because of reduction in savings. This has negatively affected the economy of Australia.

The main reason for revising the law was to safeguard the interests of small business. The legislation extended and rationalized the capital gain tax concession given to small business. In the new legislation, the provisions were merged and the cost of compliance was reduced. The treasury commented that the main purpose of the capital gain tax small business concession was to provide excess found in the hands of the small business so that they can invested the fund for expansion (James and Maples 2016). This will help in in the growth of Australian economy, as more individuals will be willing to invest in small business. This legislation ensure that individual will be encouraged to invest by providing small business concession to the owner at the time of disposal or acquisition of business or at the time of terminating the business. The capital gain tax concession will also support in promoting the culture of investment and savings. It was found that the heavy burden of tax falls on individual and small business so this legislation aims to reduce the tax burden (Russell 2016).

CGT small business concession legislation

The Income Tax Assessment Act 1997 division 152 deals with capital gain tax concession for small business. The law provides that if the small business fulfills the conditions prevailing the concession then the capital gain tax can be eliminated or reduced. There are four types of capital gain tax concessions that a small business can avail this are:

• The roll over relief for capital gain tax;
• In case of retirement the exemption is received for the payment of capital gain tax;
• The fifty percent reduction is allowed for capital gain tax if the active acid test satisfied;
• If the business is held for more than 15 years then full capital gain tax exemption is available;

The basic conditions need to be fulfilled in order to get the concessional treatment for the capital gains made by small business (Dâmaso and Martins 2016).

Rollover of CGT tax

  The small business taxpayer is allowed to delay the payment of capital gain tax arising from the sale of active assets. The taxpayer can only get this relief if the asset is replaced within the limited time. There is no requirement that replace assets should be used for the same purpose. That means assets replaced can be put to use for another purpose (Long et al. 2016). In addition to this, the assets replaced can also be used in another business. In case of sale of share or transfer of interest in the trust, the small business should be the controlling entity of the company or the trust just prior to the CGT event. If the taxpayer selects the rollover concession then to the extent of cost base of the replace assets the capital gain rollover can be applied. The extent the capital gain does not exceed the cost base of the replace assets the rollover should be ignored (Barros et al., 2016).

Small business Retirement exemption

The taxpayer can disregard the capital gain arising from the small business if the proceed is used for the purpose of retirement. There is a limit of $500000 that can be claimed as retirement exemption in the taxpayer's lifetime. The capital gain arising from the small business can be disregarded to the extent the exemption is available. It should be noted that in order to avail this concession the age of the taxpayer should be 55 years or more. However, if the taxpayer is young then the amount received from capital gain should be utilized for superannuation fund, saving account related to retirement or unauthorized deposit fund. In addition to the 50%, deduction available to the small business a taxpayer can apply for further retirement exemption (Bloch and Bhattacharya 2016). That means taxpayer can apply the general 50% discount and then the retirement exemption in order to calculate the capital gain tax payable. Therefore, against the threshold limit of $500000 only 25% of the capital gain is adjusted. It should be noted that this exemption is available to an individual carrying on the business as a sole proprietor or partner. The requirements provides that  there can be one or more controlling interest in case of trusts. The exemption is not available if the company or trust does not have the controlling individual (Crawford and Botchwey 2016).

In order to make an eligible termination payment the person is not required to actually retire for availing the small business construction. The Eligible termination payment is the amount that is selected for the retirement exemption and the amount is not regarded as perquisites (Bird et al. 2016). In the case of a company in order to qualify for eligible termination payment, it is necessary that the person receive termination from office as per ATO ID 2002/493.

50% reduction by the small business

The small business entity that is unable to qualify for 15 years exemption however has satisfied the basic conditions is eligible for 50% reduction of the capital gain. This concession is in addition to the general discount available. The small business can reduce the total capital gain by 75% that means capital gain tax will have to be paid only on the 25% of the original capital gains made (Robson and Laurin 2017). In this case, the taxpayer can initially apply the 50% general discount and then further reduction of 50% can be applied as small business concession. In addition to this, the unapplied capital losses and the current losses can be applied against the current year capital gain by the taxpayer. The capital gain can be further reduced by applying the small business roll over or retirement exemption. The taxpayer can select the manner in which the exemption will be applied.

Small business 15 years concession

This small business is not required to pay capital gain tax in case an asset is sold that has been continuously held for 15 years prior to capital gain tax event. In order to apply for this concession it is necessary that the entity should be an individual. In addition to this, the entity should be incapacitated or retiring in order to use this concession. In case the entity is, a trust or company there should be a controlling individual throughout the time of control or ownership (Abor 2017).  If this condition are satisfied then the entity is allowed to apply for this capital gain tax concession. The requirement provides that the assets sold should be active for the purpose of this concession. The assets is considered active if at least the assets is put to use for half of the period of ownership.

This rule has been slightly modified in case of 15-year exemption. The requirement provides that capital gain tax should be activated for at least 15 years before the capital gain tax event. The requirement for capital gain tax exemption is that the assets should be held continuously held for 15 years before the capital gain tax event. If the above condition are satisfied then the entity is allowed to apply for 15 years small business concession. In case of assets that are acquired under subdivision 124B, the rollover relief or subdivision 126A special treatment is given to the capital gain tax assets in case of breakdown of marriage (Yates and Yanotti 2016).

It is provided that the ownership period of the assets continues in case of involuntary disposal of asset. In case of assets that are replaced it is regarded as the assets have been purchased at the time of original assets for purpose of this exemption. In case the small business entity qualified for the 15 year exemption then the capital gain tax is completely exempted and should not be taken under section 102-5(1). In case the trust or company qualifies for the 15-year examination then they are not required to pay the capital gain tax. It is necessary that the trust or company should distribute the concession receive from capital gain tax exemption among the beneficiary or the shareholders within the time limit of 2 years from the capital gain tax event (Chung 2016).

The good tax system and the evaluation of the CGT concession

The capital gain tax small business concession is evaluated based on the effective tax system. The evaluation is conducted based on the principles of efficiency, equity and simplicity of the taxation system (Mahar et al. 2016).

Equity

The equity is a concept that relates to fairness and justice. The two concepts of equity are the horizontal equity and vertical equity. In the concept of horizontal equity, the equal treatment is necessary for all in the same economic circumstances. This means irrespective of the organization structure of business the legal system should treat all the business in the same manner. In case of vertical equity, it is necessary to have some degree of fairness and justice between the relationships of two income groups (Smulders et al. 2016). This requires that people with higher income should pay higher taxes. Therefore, it can be said that in order to be equitable the individual's from same income group should pay the same level of tax and the individual from higher income group should pay higher taxes. The application of this will ensure that both the vertical and horizontal equity is maintained. The introduction of the capital gain tax was to promote equity in the system of taxation. The primary aim of the capital gain tax system is to improve the integrity of the taxation system rather than raising revenue (Carpentier and Suret 2016).

Efficiency

The efficiency of the system means by applying the minimum amount of resources the maximum amount of output can be obtained. The inefficiency associated with the collection of tax cannot be completely removed but this can be reduced to a tolerable level. The efficient system of taxation minimizes the distortions associated with the collection of revenue. This in turn helps in maintaining an equitable tax burden for all groups of taxpayers. The complexity of the rules associated with the capital gain tax small business concession increases the cost of compliance as the efficiency of the system is increased (Burchardt et al. 2016).

Simplicity

The taxation system is considered simple if the rules and regulations are less difficult and easy to understand. The simplicity of the system decreases the cost of compliance and administration. There was the research conducted by the ATO on the compliance cost of the capital gain tax (Davis 2016). The research have identified factors that increases the cost of compliance. The study found that the main reason for increase in cost is the complexity of the rules relating to the small business concession and the changes that are made frequently. It was found that no sufficient steps were taken to reduce the complexity of the taxation system. Therefore, it can be said that compliance with the capital gain tax small business construction is not a process that is considered simple (Stewart and Thomas 2016).

Conclusion

Based on the above discussion it can be said that capital gain tax has substantially increased the simplicity, equity and efficiency of the taxation system of Australia. The capital gain tax small business concession was implemented with the aim to increase equity in the taxation system. It should be noted that complexity of the taxation system still exists therefore proper steps should be taken to increase the simplicity and efficiency by reducing the existing complexity of the taxation system. The overall analysis have shown that capital gain tax concession have contributed heavily in the economic development of Australia by encouraging individuals to invest in small business entity. The capital gain tax has also promoted equity in the system but necessary amendment is required for the further improvement of the system.

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