Tax Consequences For Jill’s Transactions In The 2017/18 Income Year

Facts About Jill and Her Transactions

Facts:

Jill is employed full-time as an accountant at a top tier accounting firm. In the 2017/18 year of income, she receives a salary of $100,000 and a bonus of $30,000 for her outstanding dedication in assisting with the training of new graduates at the accounting firm. Jill spends many evenings working past 8pm at the accounting firm and her employer pays for her taxi travel to go home. Jill lives in the suburb of Epping. During the 2017/18 year, Jill also spends $5,000 on a range of contemporary suits, shirts and other ordinary items of clothing that she regularly wears to important client meetings which she is required to attend in the course of her work at the accounting firm. In September 2017, Jill receives an award for “Best Accountant in Sydney” from the Chartered Accountants Association, which includes a cash prize of $3000 and a top-of-the- range coffee machine (valued at $2000).

Jill is very hard-working and in recent years she has been able to supplement her income from the accounting firm, by also undertaking specialist consulting work for a company, CorpCo Ltd (located in Epping) where she works in the early mornings from 7:00 am to 9:00 am, before commuting directly to the accounting firm in Sydney where she is employed full-time. During the 2017/18 year of income, Jill incurs travel expenses of $6,000 in commuting from CorpCo Ltd’s premises in Epping, to the accounting firm in Sydney.

Jill is also very talented at sewing curtains. Her friends are very impressed with the curtains that she has sewn for her home, and several of Jill’s friends suggest that she should consider sewing custom-made curtains and selling them to customers. Jill is very keen on the idea of designing and sewing custom curtains for profit and she is confident of her ability to design and sew the curtains. In October 2017, Jill takes photographs of her various curtain designs, and puts together a glossy catalogue, which she distributes to her friends, colleagues and other potential customers. She keeps meticulous records of her expenses, including travel expenses incurred on her weekend visits to potential customers in their homes to give quotes and take measurements for custom-made curtains. During the 2017/18 year of income, she received and fulfilled four (4) orders for custom-made curtains, and gross receipts from the sale of curtains were $10,000.

Jill has also become quite a collector of rare books. In December 2017, she purchased a set of three (3) rare books for $900. The books are of equal value. In May 2018, she received an offer of $1800 for the set. She negotiates with the buyer to sell each book to them separately.

On 1 July 2017, Jill borrowed $1,200,000 from CashBank Ltd (an Australian resident bank) on an interest only basis at a rate of 5% per annum to partly fund the purchase of an investment property in the Blue Mountains. The balance of the purchase price was paid from Jill’s savings. Jill also paid stamp duty of $50,000 and legal fees of $2,000 in relation to the purchase.

At the time of the purchase, the property was already rented out to tenants who continued to live in the property following the purchase. During the 2017/18 year of income, in relation to the property, Jill received rent of $60,000, and incurred the following expenses: council rates of

$2,500, water rates of $500, and insurance premiums of $1,000.

Unfortunately on 1 June 2018, during a bushfire in the Blue Mountains, caused by a lightning strike during a severe storm, the rental property was destroyed by fire. Jill received compensation of $500,000 from her insurer in August 2018.

Advise Jill regarding the income tax consequences of the above transactions for her, in relation to the 2017/18 income year. In your answer, make sure you consider whether any of the amounts/benefits that Jill receives will be included in her assessable income, and whether any of the expenditures that she incurs will be deductible to her for Australian income tax purposes. Also make sure you apply the HIRAC methodology and refer to any relevant cases, legislative provisions, tax rulings and principles of tax law.

Facts About Jill and Her Transactions

The issues involve: (1) whether the taxpayer be held assessable under the “section 6-5 of the ITAA 1997”; and (2) whether the taxpayer be entitled to claim the allowable deductions under “section 8-1 of the ITAA 1997”.

As per “section 6, ITAA 1936” income from the personal exertion or income obtained from the personal exertion implies income comprising of the wages, salaries, commission, fees, allowance and gratuities received from carrying on of the business. According to “Section 6-5, ITAA 1997” commonly, most part of the income that comes into the taxpayer is treated as income in terms of the ordinary concepts. In “Dean & Anor v FC of T (1997) ATC 4762” retention payment that is given as the consideration to the key employees for agreeing to remain employed for 12 months after buyout was treated as income.

The court stated that nexus is not effected by the lump sum or the one-off receipts for performing the particular task. In “Brent v FCT (1971) 125 CLR 418” reward given to the wife of train robber for the purpose of providing exclusive media rights of publishing her life story would be treated as income.

As per “section 15-2, ITAA 1997” the taxable income of the person should include the value of the allowance, gratuities, compensation and benefits provided to the person in relation to any employment or the services rendered by an individual.

According to “section 8-1, ITAA 1997” cost incurred for acquiring the ordinary items of clothing such as suits are not regarded as deductible expenditure. As held in “Mansfield v FC of T (1996) ATC 4001” the taxpayer was denied deduction on the ordinary articles of apparel irrespective of fact that such expenses were necessary to make her appearance suitable in a particular job or profession.

Mere prize is not treated as income however will be held as income if the prize holds appropriate association with the income producing activities of the taxpayer. As held in “Kelly v FCT (1985) 85 ATC 4283” award received by the professional footballer for being the best and fairest player was treated as income. The sum was assessable as income since it was relevant to his employment by the club and associated to the employee’s skill.

As per the legislative response of “section 25-100 ITAA 1997” permits the taxpayer with the deductions relating to the cost of travel between the workplaces. Travel should be directly related between the income generating activities are performed and none of the place is the assessor home. The court in “FCT v Wiener (1978) ATC 4006” allowed the taxpayer with deduction for traveling between schools as the taxpayer was travelling in the performance of her duties.

Assessable Income and Deductions

The legislative definition of business defined in section 995-1 refers to the profession, trade, employment, vocation or calling but does not comprises of occupation in capacity of employee. It becomes vital to ascertain when the hobby or recreational activities turns out to be a business. Whether the profit making intention is present or not is not necessary to preclude that there is a business activity. The court in “Thomas v FCT (1972) ATC 4094” expressed that whether the commercial approach has been undertaken is greater than the recreational activity. In “FCT v JR Walker (1985)” small operations might be treated as business if other sufficient characteristics are present.

Under “section 108-15 (1)” set of collectables are the one that is owned by the taxpayer as the set and it is disposed ordinarily as the set. As per “section 108-15 (2) of the ITAA 1997” set of collectables are considered as the single collectable and each of the disposal is treated as the part the collectables.

As per “section 110-25 of the ITAA 1997” the cost base of the property includes the cost of ownership. There is certain expenditure for which a taxpayer is not allowed to claim deductions this includes the acquisition and costs of disposing the property. A taxpayer is not allowed to claim deduction for the expenses that are occurred in acquiring or disposing the rental property. However, these expenses would be treated as the part of the property cost base for the purpose of CGT.

The court in “Adelaide Fruit and Produce Exchange Co Ltd v FCT (1932)” held that rent refers to the price that is paid using another person’s property. An individual taxpayer must include the rental income in their assessable income rent since it constitutes an ordinary income under “section 6-5 of the ITAA 1997”. However, “section 8-1” allows the taxpayer to claim deductions for the rental expenses incurred when the property is let out for rent.

A CGT event C1 happens under “section 104-20 (1) of the ITAA 1997” if the CGT asset that is owned by the taxpayer is lost or destroyed. It is necessary to determine the time of the event when the compensation is first received by the taxpayer. A taxpayer either makes capital gains or loss from the receipt of such compensation.

Jill is full time employed in the top tier accounting firm and received a salary of $100,000 with the bonus of $80,000. Citing “section 6, ITAA 1936” the salary would be treated as income from the personal exertion. With reference to “Dean & Anor v FC of T (1997) ATC 4762” the salary income would be treated as ordinary income with in the ordinary concepts of “Section 6-5, ITAA 1997”.

Applicable Case Law and Legislative Provisions

Jill received the bonus of $30,000 for helping the new graduates at the accounting firm. Citing the case of “Brent v FCT (1971) 125 CLR 418” the sum of $30,000 constitutes the reward for the services and holds the sufficient nexus with the income producing activities. Therefore, the sum of $30,000 will be treated as assessable income under “section 6-5 of the ITAA 1997”.

On numerous occasion the employer of Jill pays her the taxi expenses for returning home. Under “section 15-2, ITAA 1997” the expenses paid by her employer will treated as fringe benefit which is paid to her in relation to employment or the services rendered by an individual.    

Jill reported the expense of $5,000 on the contemporary suits. The expenses incurred by Jill was for the ordinary items of clothing. Citing “Mansfield v FC of T (1996) ATC 4001” the clothing items is not a compulsory clothing and hence not deductible under “section 8-1, ITAA 1997”.  

Jill later reports receipt of $3000 for being the best accountant with coffee machine of $2,000. Citing the event of “Kelly v FCT (1985) 85 ATC 4283” the cash award will be treated as taxable income since it was relevant to her employment by the club and associated to the employee’s skill.

Later Jill reports the travel expense of $6,000 for commuting from Corp Co Ltd premises to her accounting firm. Citing the legislative response of “section 25-100 ITAA 1997” the expenses incurred by Jill was for traveling between two work places with none of the places being her home. Referring the court decision in “FCT v Wiener (1978) ATC 4006” Jill will be allowed to claim deductions since it was incurred in generating the taxable income.

Later events suggest that Jill is talented in sewing curtains and considers sewing custom made sewing curtains for the purpose of selling them to customers. Jill began sewing curtains and puts it in her glossy catalogue. She fulfilled 4 orders of curtains and received the sum of $10,000. Referring to “Thomas v FCT (1972) ATC 4094” Jill undertook the commercial approach which is more than the recreational activity. Citing the event of “FCT v JR Walker (1985)” the activities of Jill constitute small operations of business since it holds sufficient characteristics of carrying of business.

Jill reported the sale of three set of rare books for $900. Referring to “section 108-15 (2) of the ITAA 1997” the three set of books is an item of collectables. The disposal of collectables under “section 108-15 (2) of the ITAA 1997” will be considered for capital gains purpose with any capital gains shall be included in the assessable income.

Jill incurred an expense on stamp duty and legal fees while acquiring the investment property. With reference to the “section 110-25 of the ITAA 1997” the legal expenses and stamp duty forms the cost base of property which is non-deductible. The expenses would be treated as the part of the property cost base for the purpose of CGT.

The rental income received by Jill be will included for assessment under “section 6-5, ITAA 1997” as income under ordinary concepts. However, Jill will be allowed to claim deduction under “section 8-1” for insurance premiums, council and water rates because it was incurred in the derivation of assessable income.

The rental property of Jill was however destroyed by bushfire. She received a compensation of $500,000. The receipt compensation results in CGT event C1 under “section 104-20 (1) of the ITAA 1997” since the asset was destroyed. The compensation received was less than the cost base of rental property and hence results in loss.

Conclusion:

Conclusively the taxpayer will be held assessable under “section 6-5 of the ITAA 1997” while she will be allowed to claim deductions under the positive limbs of “section 8-1 of the ITAA 1997”.

References:

Barkoczy, Stephen, Foundations Of Taxation Law 2014

Brokelind, Ce?cile, Principles Of Law 2014.

Coleman, Cynthia and Kerrie Sadiq, Principles Of Taxation Law 2013

Graetz, Michael J, Deborah H Schenk and Anne Alstott, Federal Income Taxation 2015.

Grange, Janet, Geralyn A Jover-Ledesma and Gary L Maydew, 2014 Principles Of Business Taxation

James, Simon, The Economics Of Taxation 2015

Jover-Ledesma, Geralyn, Principles Of Business Taxation 2015 (Cch Incorporated, 2014)

Kenny, Paul, Australian Tax 2013 (LexisNexis Butterworths, 2013)

Krever, Richard E, Australian Taxation Law Cases 2013 (Thomson Reuters, 2013)

Morgan, Annette, Colleen Mortimer and Dale Pinto, A Practical Introduction To Australian Taxation Law (CCH Australia, 2013)

Sadiq, Kerrie, Principles Of Taxation Law 2014

Woellner, R. H, Australian Taxation Law Select 2013 (CCH Australia, 2013)