Legl602 Taxation Law : Account Assessment Answers
Under a separate agreement with the bank Jones has arranged for a balance of $5,000 to be maintained in the savings account and any balance to be transferred to his mortgage. He has also arranged for any interest on the savings account to be offset against the mortgage interest. For the year ended 30 June 2017 $300 was offset.Jones also runs a small practice providing accounting and taxation services to local businesses. During 2016/17 he billed fees of $35,000 of which $30,000 has been received. An amount of $3,000 was also received from outstanding accounts from the 2014/15 year. One of his clients is Travelco, a local motel. In March 2017 Travelco provided Jones and his wife with free return air tickets to Bali. Equivalent fares would cost $2,000.
Jones’s wife Joan is an IT expert. For several years John and Joan had been developing software for an accounting package for use by small businesses. The system, ‘J-Accounts’, has been licensed and is used by 175 local businesses at a cost of $100 per year [$17,500]. A national software developer ‘Cashbooks’ has agreed to pay the Joneses $25,000 in return for the exclusive rights to use the program for five years after which time a new agreement for a further five years may be signed.
Jones has an interest in history, particularly commercial history. In 2005 he purchased 500 old share certificates from an acquaintance who practised in the area of insolvency and liquidation. The total cost was $500. The certificates related to old companies that had been liquidated during the 1930s depression. They were very elaborate and ornat and Jones thought that framed they could be marketable as a decorative feature to hang in the offices of accountants and solicitors. In February 2017 he happened to mention the matter to Herman, a local decorator and picture framer. Herman suggested that if properly framed, numbered, and if an inscription was added, they could sell for $1000 each. The cost to Jones would be $100 per certificate. Herman agreed to sell the items on a commission basis of 10%.
A local television station runs a quiz show called ‘Who Wants to be Rich?’ Contestants are selected randomly from the local telephone directory. Jones was lucky enough to be selected and he appeared on the show for five nights, answering every question and becoming ‘Grand Champion’. He won $200,000 and a car valued at $30,000.
Required:
Advise John Jones of the tax consequences of the above receipts. You should discuss what amounts would be included in his assessable income or, if any item is not assessable income, why that is so. Your answer should include a discussion of the following:
• Whether particular amounts are ordinary income or statutory income (including capital).
• Under what sections of the Acts the particular amounts are assessable.
• How the quiz show winnings are to be treated.
• What are the tax consequences of the share certificate proposal, if he was to proceed with the plan?
• What case law is relevant to the issues raised?
In your answer you should list relevant ATO Rulings/Determinations and discuss their application.
3: Part A
excess to a local supermarket and now regularly supplies three retailers with sweet potatoes and pumpkin. They don’t keep records as they never intended to make a profit but estimate that in a good month gross receipts could be $500 to $600.
Their neighbours have a citrus orchard and throughout the year vegetables are swapped for oranges and mandarins. This seems like such a good idea Allan and Betty decide to set up a ‘barter’ system in the area. To join the system a person must pay an up-front, one-off fee of $50 to Allan and Betty as a charge for the keeping of administrative records. Thereafter people register their goods or services to be bartered.
Required:
(a) Advise Allan of any income tax consequences of para 1, above.
(b) Citing relevant case law, explain how a hobby is to be distinguished from a business.
(c) Advise Allan and Betty of any income tax implications arising in paras 2 and 3 above.
(d) Advise the participants in the barter scheme of any income tax implications.
On 1 October 2010 Alex purchased a large block of land near the beach at a cost of $250,000 financed by an interest-only loan. Other costs in respect of the land purchase were:
Stamp duty 6,800
Legal costs of conveyance 2,500
Water rates – included in contract 380
Council rates – included in contract 900
Originally Alex’s intention was to hold the land as an investment but in 2016 he decided to take unpaid leave from his employment and build a house on the block. The plan was to engage building contractors and perform unskilled labouring himself. On completion the house would be rented.
The following costs were incurred:
• 1 April 2016 Establishment fee for interest-only bank loan 1,500
• 2 April 2016 Development application fee to local Council 4,200
• 20 April 2016 Legal fees arising out of an appeal against the
• Council’s refusal of the development application 16,000
• 15 May 2016 Architectural fees 6,500
• May – July 2016 Building materials 120,000
• Building contractor’s payments 60,000
• Alex’s labour: based on Alex’s time at $25/hr over
• three months 13,000
The house was completed in September 2016 and rented out until 30 June 2017.
Interest paid over the period September 2016 to 30 June 2017 was $14,600. Total interest paid however was $122,500.
On 15 July 2017 Alex obtained a qualified valuer’s appraisal of the property which put the value of the land at $350,000 and the house $350,000. The valuation cost $4,000.
In October 2017 Alex sold the property to his cousin Matthew for $650,000.
Part A:
Part B:
Jai does not have enough funds to complete the sales on both properties, but his bank manager has approved a loan for the shortfall of $150,000 at an interest rate of 5% per annum.
In order to prepare loan documentation, the bank manager needs to know whether Jai will:
a) use the $200,000 cash to pay for his new home and use the borrowed funds of $150,000 to purchase the investment property;
b) use $150,000 of the cash to pay for the investment property and then pay for his new home with the remaining $50,000 cash and the borrowed funds of $150,000; or
c) pay for his new home by using $100,000 of the cash and $100,000 of the borrowed funds; and pay for the investment property by using the remaining $100,000 cash and the balance of the borrowed funds ($50,000).
Answer:
1: Whether John must return on a cash or accrual basis:
John must account for GST on cash basis under section 29-40 of the GST Act 1999 since the amount derived from accounting and taxation services together with development of software is under the threshold limit of $2 million (Barkoczy 2016). The annual turnover of John small business is below the aggregate of $2 million and as defined under section 29-45 of the taxation rulings of 2000/13 the commissioner may permit John to account for GST on cash basis.
Whether the amounts are ordinary or statutory income:
The particular amounts that is derived by John along with his capital will be considered for assessment under the ordinary concepts since such income is generally categorised under income and fits within the common law theory of income. The receipt of salary by John represents income from personal exertion. Furthermore, income from carrying on the business of software development will be considered as ordinary income according to the concept of common law.
Assessable acts:
Under section 6-5 (1) of the Income Tax Assessment Act 1997, the income derived by John from his personal exertion and income from carrying on the business will be assessable as ordinary income (Chaturvedi 2015).
Treatment of winning from Quiz:
As defined under the Goods and Service tax rulings 2002/3 winning from quiz is subjected to GST. The winning from Quiz by John will be considered as the taxable supply under section 9-5 of the GST act 1999. John has not only received cash prizes but was also provided with car, which represents a supply of considerations as well. John will be required to declare the amount cash in his tax return along the value of car received by him (Faccio and Xu 2015).
Tax consequences of share certificate:
The proposal of selling share certificate will be treated as capital gains asset. Capital gains tax is applicable on share or units on the occurrence of CGT event. The profits that will be derived by John from the sale of shares will form the part of the business of share trading and it will included in the ordinary income instead of considering it as capital gains (King 2016). The disposal of share must be ascertained in the determination of profit and loss on the disposal under subsections 25 (1) and 51 (1) of the Income tax assessment act 1997.
Relevant case law:
Referring to case of Commercial and General Acceptance Ltd v. FC of T (1997) John disposal of the shares will be considered as revenue asset but will not be regarded as trading stock. The gross receipts from the sale of shares is capital in nature but the profit derived by him is treated as income according to the ordinary concepts and will be therefore assessable under subsection 25 (1).
2: As defined under taxation rulings of TD 2015/25 Bit coin is referred as the type of digital currency under which an encryption techniques are used so that it regulate the generation of currency and verify the transfer of currency (Millar and Moon 2016). The tax implication are as follows;
- Bit coin is not regarded as foreign currency and division 775 is not applicable. Transactions involving bit coin leads to same tax consequences as other barter transactions.
- ATO considers bit coin as an asset for the purpose of capital gains tax.
3: Part A
A:
From the existing situation, it is found that Alan and Betty were living and working in Melbourne. They sold their Melbourne house and bought a home in central Victoria. As defined under the Australian taxation office a person can usually claim exemption for their main house for the purpose of capital gains tax (Russell 2016). To claim exemption, the property should be dwelling in nature and that individual should have dwelled in it. As noticed in the current scenario, Alan and Betty were using their Melbourne house for dwelling before selling off their Melbourne home and purchasing a home in central Victoria.
Allan in this context is a practicing locum doctor. As defined under the principle of locum doctor of Australian Medical Association standard tax instalment deductions must be made from the pay of locum. As noticed in the current case study, Allan had received fees from service rendered to wine makers dog for snakebite. Subsection 221 A (1) of the Australian Medical Association defines that Payment that is received by the locum as salary or wages falling within the subsection shall be treated for tax instalment deductions (Saad 2014).
B: For the purpose of taxation, it is vital to understand the difference between the hobby and business. Given a person undertakes the activities of carrying on the business it are vital to understand whether the actions of the person form the part of hobby or business. Unlike hobby, business consists of reporting requirement such as declaring the revenue that is earned and claiming business related expenditure (Tanzi 2014). As held in the case of Evans v. Federal Commissioner of Taxation 89 ATC 4540 the taxpayer had followed the interest of horse racing by stating betty as a hobby and the hobby of the taxpayer ultimate led to excess of his loss from the previous year.
The federal court passed its judgement by stating that the activities of Evans does not forms the part of business and his winning from horse would not be treated for tax (Tanzi 2014). The facts derived from the current scenario represents that the taxpayer had not carried out the activities of business of betting and he did not followed any system of betting however placed betting in conformity with the guiding principles.
C: The current situation is based on the determination of whether or not the activities of Allan and Betty represented hobby or business. From the current case study, it is understood that Allan and Betty possessed few hectors of land and commenced plantation of vegetables. They undertook the course on organic farming and found excess surplus in production. It is noticed that Betty on every Sunday opened a stall and sold surplus production in local supermarket regularly. The taxation rulings of TR 97/11 states that a person carrying on the activities which has the character of primary production under ITAA 1997 (Taylor and Richardson 2013). Subsection 995-1 of ITAA 1997 defines the activities of Allan and Betty as business since it was repetitive and possessed regularity since the excess production were sold in the local market to local supplier.
The activities of both Allan and Betty do not possess the intention of generating all their income from primary production activity since they were engaged in their occupation and profession. However, the activities of production represent business and income generated from such activities attracts tax liability.
D: Barter system consists of directly exchanging goods and service from other goods and service without referring to money. From the current case study, it is found that Allan and Betty undertook the decision of Barter system and indulged in the activities of barter. On one instance Suzie decided to render service of hairdressing at her home for exchange of 15 to 20 barts were credited for goods and service with equal value (Woellner et al. 2013). As stated under the taxation rulings of 2668 barter transactions will be treated for tax and shall be deductible for income tax purpose to the similar degree as cash or credit transactions. As evident both Allan and Betty were the member of trade exchange and performed the activities of taxable supply, which attracts tax liability together with GST. As a general rule the Barter transactions will be held taxable for the purpose of taxation together with GST.
Part B:1
From the current case study, Alex sold the land for $650,000 and generated income from the activities of selling. As defined under sub-section 15.15 Alex had bought the land before 20 September 1985 with the objective of selling and the profit derived from sales would be considered as assessable income (Taylor and Richardson 2013). When the taxpayer sold the property the provision of the ruling mentioned under section 15-15 is deemed to have been acquired by Alex with the intention of making profit. The amount generated by Abby will be considered taxable under section 15-15 of the ITAA 1997.
2: Computation of Capital Gains Tax of Land
|
Particulars |
Amount ($) |
|
Selling price (A) |
650000 |
|
less: cost of selling (B) |
18500 |
|
Adjusted selling price (A+B=C) |
631500 |
|
Purchase price (D) |
250000 |
|
Add: Cost of purchase and ownership (E) |
36280 |
|
Adjusted purchase price of asset (D+E=F) |
286280 |
|
Capital gains/(loss) |
345220 |
|
CGT under Old regime |
|
|
Indexed capital gains/ (loss) |
345220 |
|
Tax payable under the old regime (marginal tax rate x indexation factor x capital gain) |
154812 |
Assumptions:
The following amounts that are included because they form the direct cost of the property are as follows;
Amount included
- Stamp duty
- Legal cost of conveyance
- Water and council rates
- Establishment fee for interest on bank loan
- Development application fee that was paid to the local council
- Architectural fees
- Building materials
- Abby’s labour hour
The following cost are excluded since they do not form the part of direct cost to land
Amount Excluded:
- Legal fees arising out of appeal against the council
- Valuation cost
Computation of Capital Gains of Property
|
Particulars |
Amount ($) |
|
Sale price (A) |
$650000 |
|
less Cost of selling (B) |
$6,700 |
|
Adjusted sale price (A+B=C) |
$643,300 |
|
Purchase price |
$0 |
|
add Cost of purchase and ownership |
$354,180 |
|
Adjusted purchase price of asset |
$604,180 |
|
Capital gain/loss |
$39,120 |
3: Assuming cost base 600,000:
|
Particulars |
Amount ($) |
|
Selling Price (A) |
700000 |
|
Less: Cost of Selling (B) |
2500 |
|
Adjusted Selling price (A+B=C) |
697500 |
|
Cost Base of asset |
600000 |
|
Add: Cost of Purchase and Ownership |
16080 |
|
Adjusted Purchase Price (D+E=F) |
616080 |
|
Capital gains / (loss) |
81420 |
|
Capital gains tax (Old regime) |
|
|
Indexed Capital gains/loss |
81420 |
|
Tax payable under the old regime (marginal tax rate x indexation factor x capital gain) |
26869 |
4: Part A
Negative gearing can be defined as the practice of investing the borrowed sum of money in a way to result in loss, which can be claimed as tax deductions. Tax concession for investment housing comprises of 50 per cent discount from individual tax rates on capital gains which will enable the investor to subtract losses incurred on rental property investment. Negative gearing is usually used for rental property investment since housing is supposed to be a safe investment to borrow against however it is used to invest in agriculture and shares (Yinger, Bloom and Boersch 2016). Negative gearing and capital gains tax concession for property investors creates a negative impact on the economy. It generally leads to higher inflation and interest rates due to the boom in asset price, which may prompt the reserve bank to set interest rates higher than the usual rates. Another reason against the negative gearing is that it leads to the problems of higher household debts and could lead to probable economic turndown.
Part B:
Jai must take the advantage of the negative gearing by using $150,000 of the cash in order to pay off the investment property and then use the remaining fund of 50,000 cash for his new home from the borrowed funds of $150,000. The reason for choosing this options is that it will provide Jai with Tax concession for investment housing comprises of 50 per cent discount from individual tax rates on capital gains which will enable the investor to subtract losses incurred on rental property investment.
Reference:
Auerbach, A.J. and Hassett, K., 2015. Capital taxation in the twenty-first century. The American Economic Review, 105(5), pp.38-42.
Barkoczy, S., 2016. Foundations of Taxation Law 2016. OUP Catalogue.
Chaturvedi, K.N., 2015. 014_Income-Tax Law.
Faccio, M. and Xu, J., 2015. Taxes and capital structure. Journal of Financial and Quantitative Analysis, 50(03), pp.277-300.
King, A., 2016. Mid market focus: The new attribution tax regime for MITs: Part 2. Taxation in Australia, 51(1), p.12.
Millar, R. and Moon, L., 2016. Designing a Simple and Fraud-Proof Tax System: Australia.
Russell, T., 2016. Trust beneficiaries and exemptions from CGT: reflections on the Oswal litigation. Taxation in Australia, 51(6), p.296.
Saad, N., 2014. Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, pp.1069-1075.
Tanzi, V., 2014. Inflation, indexation and interest income taxation. PSL Quarterly Review, 29(116).
Taylor, G., and Richardson, G. 2013. The determinants of thinly capitalized tax avoidance structures: Evidence from Australian firms. Journal of International Accounting, Auditing and Taxation, 22(1), 12-25.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2013. Australian taxation law. CCH Australia.
Yinger, J., Bloom, H.S. and Boersch-Supan, A., 2016. Property taxes and house values: The theory and estimation of intrajurisdictional property tax capitalization. Elsevier.
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