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## Methods for calculating capital gain

Questions:

Periwinkle Pty Ltd (Periwinkle) is a bathtub manufacturer which sells bathtubs directly to the public. On 1 May 2015, Periwinkle provided one of its employees, Emma, with a car as Emma does a lot of travelling for work purposes. However, Emma's usage of the car is not restricted to work only. Periwinkle purchased the car on that date for \$33,000 (including GST).

For the period 1 May 2015 to 31 March 2016, Emma travelled 10,000 kilometres in the car and incurred expenses of \$550 (including GST) on minor repairs that have been reimbursed by Periwinkle. The car was not used for 10 days when Emma 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 2015, Periwinkle provided Emma with a loan of \$500,000 at an interest rate of 4.45%. Emma 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, Emma purchased a bathtub manufactured by Periwinkle for \$1,300. The bathtub only cost Periwinkle \$700 to manufacture and is sold to the general public for \$2,600.

(a) Advise Periwinkle of its FBT consequences arising out of the above information, including calculation of any FBT liability, for the year ending 31 March 2016. You may assume that Periwinkle would be entitled to input tax credits in relation to any GSTinclusive acquisitions.

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

On subtracting capital gain from the capital expenditure incurred on capital assets, we derive the capital gain. There are three approaches used for calculating capital gain. These are indexing method, discount method and residual method. When the assets are purchased before 21st September and are held for more than 12 months, then the method used is indexing method. When the assets are held for less than 12 months, then the method used is residual method. Discount method is applied 12 months prior to the event of the generation of capital gain.

• Receipt of compensation for injuries
• Purchase value of collectibles being lower than \$500
• Sale proceeds of dwelling house
• Motor vehicles

Long term loss of capital nature

Capital revenue is utilized for setting off capital loss in the long term. Other set offs cannot be used. The capital loss can be taken forward to relevant undefined assessment year and the loss can be set off from the capital revenue (Ato.gov.au).

Capital revenue in both short and long term can be utilized for setting off the loss in the long term.  The capital loss can be taken forward to relevant undefined assessment year and both short term capital profit and long term capital profit can be used for setting off the capital loss incurred on long term basis (Larsson 2014).

## Capital revenue and long-term capital loss

Mr. Dave Solomon lived in a house, which was of two floors. The purchase price of the house was estimated to be \$70,000. He decided to sell the house at \$865,000. The prospective buyer paid an amount of \$85,000 as advance but failed to clear off the remaining amount. As a result, the failure led to the money being forfeited. The amount of \$85,000 was branched under income from other sources.

Calculation of capital gain:

1. i) Revenue from sale \$865,000

There is exemption for such items under CST I.EF family home exemption.

Long Term capital profit                               NIL

1. ii) A pro hart painting was acquired on September 12th 1985 for a price of \$15,000 and the sales generated a turnover value of \$125,000.

Calculation of capital profit

Revenue from sale                                      \$125,000

Less: Index cost

(\$125,000/71.4*123.4)                                \$25,961

Long term capital profit                                \$99,039

iii) A motor cruiser was acquired for \$110,000 in late 2004 and was sold for a value of \$60,000 to broker dealing in boats.

Calculation of capital profit

Revenue from sale                                        \$60,000

Less: Purchase index cost                              \$110,000

Capital loss in short term                                (\$50,000)

iv) Shares of a mining company were sold for a value of \$ 80,000 in the current year on 30 The acquired price of the shares on 10 January of the present year was \$ 75,000. A loan of \$70,000 and interest of \$5,000 was undertaken, in order to pay the acquisition price. Stamp duty worth \$250 and brokerage charges worth \$ 750 was paid.

The law of income tax states that loan interest will not be included in the purchase price, which will lead to loan interest not being included in the computation.

Computation of capital profit

Revenue from sale                                         \$80,000

Less: Acquisition price                                    (\$75,000)

Less: Stamp duty                                            (\$250)

Less: Brokerage charges                                  (\$750)

Capital profit on long term                                 \$4,000

Part a

Calculation of capital profit in the present year:

1. i) Revenue from the sale of house NIL
2. ii) Long term revenue from sale of painting \$99,039

iii) Short term loss from sale of motor boat           \$(50,000)

1. iv) Long term revenue from sale of shares \$4,000

Long term capital profit                                        \$53,039

Mr. Dave incurred a net loss of \$ 10,000 in the previous assessment year. In the present year, the capital profit was \$ 53,039. Henceforth, the approximate net capital profit was fixed at \$ 43,039. The former year’s capital loss was set off against the present year’s capital profit of \$ 53,039. This led to the computation of the net capital profit of \$43,039.

## Calculation of capital profit and loss in the short term

Part b

Net capital profit is described as the summation of the capital profit and the preceding year. The capital loss can be offset against such profit amount. As a result, the net capital profit will be the summation of the capital profit and deducted from it is the capital loss. It is advocated that a capital profit is not differentiated from the total income of the assesse and the capital profit is needed to be treated for tax for the year in which such profit is raised (Fisher 2015).

Mr. Dave has generated a net capital profit of \$43,039 and the amount can be used for proving fund to the superannuation fund. He is required to possess requisite vouchers like documents of purchase amount, stamp duty, interest paid on loan and all other legal fees. He is required to maintain documents like brokerage charges paid and documents on maintenance charges incurred on assets.

Part c

Net loss on capital assets is relating to the loss on the turnover of capital in the present as well as the last few years. The capital loss can set off against the capital profit of the previous years. The person being assessed does not have the power to ignore the set off of capital loss against capita profit, though he can decide on which capital profit, the capital loss can be set off (Brown, 2013). If Mr. Dave suffers a net loss on the sale of capital assets and does not have enough funds to provide to the superannuation fund, he has certain measures to adopt. He could either borrow funds or sell further more assets to create some funds. In this way, he could generate enough funds and supply necessary funds to the superannuation funds. This is one of the methods, by which a person can overcome a situation of net loss and supply necessary funds to the superannuation fund. He can then buy a house on rent in the city and derive the benefit of tax free amount from his fund after getting to the age of 60.

Periwinkle Pty Ltd is a company that makes bathtub and sells it to customers directly. The company has an employee named Emma who is provided with a car by the company because of the extensive work activities undertaken by her. However, the car is not only for work related purpose. It is only applicable for private use. The acquired value of the car was \$33,000.

The car was used from the 1st of May 2015 till the 31st of March 2016. The car covered distance of 10,000 kilometers. The company reimbursed Emma with an amount of \$ 5500 for repair charges. For 10 days, the car was unused as it was left at the airport and a period of 5 days also depicted the car not being in use as it was it was getting repaired at the garage.

Loan worth \$ 500,000 was provided to Emma by the company. She used \$450,000 in acquiring a house while the remaining balance was passed over by her to her husband for acquiring shares in Telstra.

## Calculation of capital profit and loss in the long-term

A bathtub was also sold to Emma for a value of \$1300. The cost of manufacturing  of the bathtub was \$700. It was ultimately sold to the public for a value of \$2600.

The fringe benefit tax is levied on the employer for the benefit provided by the employer to the employee. The tax is levied based on the benefits in kind provided by the employer to the employee.

Some items are excluded for such tax. These include:

• Taxation treatment, which do not include borrowed funds.
• House benefit provided by the employer in remote places
• Car benefit provided by the employer, which is provided work related purpose
• If the amount provided by the employer is lower than \$300
• Reimbursement provided for work related purpose
• Benefit provided in the case of shifting of employees to different locations.

The scope of  liability of fringe benefits tax covers fund provided for acquisition of car, car facility provided, different type of allowances, fund provided for acquisition of house and allowances provided for houses, fund provided for the airline, fund provided for car parking, benefit provided for travelling and transport. The fringe benefits tax labels a car to be an engine that is capable of taking a weight of 1 ton or is capable of holding in nine passengers. If the car does not fall under this definition, then the fringe benefit tax will be liable on the employer and if the car is not utilized for more than 3 months, then the tax will be deemed to be not applicable on the employer (Hopkins 2015).

In the given case, Emma had used the car for personal needs and thus the employer was liable to pay the fringe benefit tax. The car was not exclusively used for official purposes. It is observed that if car was founded to be with the employer, then the car would have treated as used only for official use. However, it is inferred that the car was found to be in the possession of Emma. Therefore, it can be said that car was being used for private purposes. However, if the car is at the garage for repair purposes, then that is not considered to be in personal possession.

In the given case, the car was found to be in the garage for 5 days, which depicts that the car was not in personal custody of Emma. However, the period if 10 days, when the car was at the airport, then it can be said that car was in personal custody of Emma. This period will be considered for calculation of days. If the keys of the car would have been in the custody of the employer, then those number of days will b excluded from the calculation of days. However, this is not the case.

The methodology involving the calculation of fringe benefit tax are : i) Cost based method, ii) statutory formula.

The given question states:

Price of the car                   \$33,000

Number of days                   (335-5 days = 330 days)

In the given case, the car was found to be in the garage for 5 days, which depicts that the car was not in personal custody of Emma. However, the period if 10 days, when the car was at the airport, then it can be said that car was in personal custody of Emma. This period will be considered for calculation of days. If the keys of the car would have been in the custody of the employer, then those number of days will b excluded from the calculation of days. However, this is not the case.

20/100*330/365* \$33,000= \$5,967

Less: payment for repair = \$550

Assessed tax value= \$5417

The fringe benefit tax arises when the employer gives loan, which has interest at a lower rate in comparison to the existing standard rate. It also includes loans, which do not carry any interest.

In the case of Emma, the interest on loan was lower at 4.45 in comparison to the standard rate of 5.95.

Therefore the fringe tax would be computed by:

\$500,000* 1.5/100 = \$7500.

The loan amount was \$500,000 and the tax was \$7500. It was seen that Emma used the loan amount for acquiring a house and gave the balance to her husband to acquire shares of Telstra.

If amount of loan was utilized by Emma for acquiring house and shares, then the calculation    would be in the form as described below:

1. i) Tax value not including interest: 500,000*1.5= 7,500
2. ii) Tax value containing interest: 5.95*500,000= 29,750

iii) Payment of interest on loan, if equivalent to tax value:  10/100*29,750= 2,975

1. iv) Assessment of real life scenario if interest charged on loan was borne by the employee: \$500,000*10/100*4.45= \$2,225
2. v) Finding the difference, \$2,225- \$2,975= =\$750

Tax value fixed = 7500-750= \$6,750.

In the given case the acquisition value of the bathtub for Emma was valued at \$1300 and the   value of sale proceeds from bathtub was fixed at \$2600. Therefore, for fringe tax benefit, the value calculated was \$ 2600-\$1300= \$1300. This was the debt waiver fringe tax benefit for the employer.

Reference List

Brown, C., 2013. Australia-taxation of trusts–the problem of aligning concepts of income. Asia-Pacific Tax Bulletin, 19(5).

Capital gains tax | Australian Taxation Office. [online] Ato.gov.au.

Fisher, R., 2015. Judicial dissent in taxation cases: The incidence of dissent and factors contributing to dissent. eJournal of Tax Research, 13(2), p.470.

Hopkins, B.R., 2015. The law of tax-exempt organizations. John Wiley & Sons.

Kenny, P.L., 2012, October. Assessing the impact of team based learning and the examination performance of undergraduate taxation law students. InAustralasian Tax Teachers Association National Conference Paper Series.

Lang, M., 2014. Introduction to the law of double taxation conventions. Linde Verlag GmbH.

Lang, M., Pistone, P., Schuch, J. and Staringer, C. eds., 2015. Introduction to European tax law on direct taxation. Linde Verlag GmbH.

Larsson, J.Å., 2014. Loopholes in Bell inequality tests of local realism.Journal of Physics A: Mathematical and Theoretical, 47(42), p.424003.

Levy, J., 2015. Ajay K. Mehrotra. Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877–1929. The American Historical Review, 120(3), pp.1034-1035.

Mason, A.T. and Stephenson, G., 2015. American constitutional law: introductory essays and selected cases. Routledge.

McDaniel, P.R., 2015. Federal Wealth Transfer Taxation (Doctoral dissertation, Pepperdine University).

Palmer, T., 2013. UQ Library Guides: Taxation Law: Get started.

Santucci, G., 2014. Understanding taxation law and Australian tax law [Book Review]. Ethos: Official Publication of the Law Society of the Australian Capital Territory, (233), p.42.

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