Australian Taxation Law: Computation Of Tax Essay.

Issue 1: Taxation Treatment of Hilary's Book Rights and Manuscript/Photographs

Discuss about the Essay for Australian Taxation Law of Computation of Tax.

The given case pertains to Hilary who is a famous mountain climber. Due to her fame, a local newspaper offers her $ 10,000 for writing her story in the form of a book.  Hilary gives acceptance to this offer and thereby completes the book despite having no experience in this regard. The rights for the book are sold to the newspaper for a net consideration of $ 10,000 while the manuscript and some expedition photographs are sold to Mitchell Library for a consideration of $ 5,000 and $ 2,000 respectively. In this background, the aim is to opine on the appropriate taxation treatment being accorded to the money that Hilary had managed to obtain.

Rule

In the context of taxation, the task of differentiating between capital receipts and revenue receipts is pivotal since revenue receipts are taxed while capital receipts are tax free. The common source of revenue receipts is business activity or engaging in some employment while capital receipts are derived when any given asset of capital nature is sold. In case of capital receipts, the taxpayer may need to pay tax on the capital gains realised (Section 10-5, ITAA 1997) (Barkoczy, 2015). The revenue receipts are government by Section 6-5, ITAA 1997 which defines the concept of ordinary income. The revenue receipts may be treated as income from personal exertion but for this it is imperative that the same must be earned though any activity which is of business nature and preferably of repetitive nature (Sadiq et. al, 2015).

A relevant case that could provide some insight into the given case is the Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418. The case revolved around a contract that was enacted with the appellant who happened to be the wife of a famous robber. The contract was with regards to divulging the details about her personal life with the husband to a newspaper for a hefty consideration which was to be paid in instalments. The appellant narrated her story to couple of journalists from the newspaper over a period of five days. Further, the book was completed by the journalists with mere suggestions from appellant which were not held in high regard. At the end, she was requested to put her signature on all pages of the book to authenticate the same. Due to only part payment being received and consideration of payments as capital receipts, there was difference in opinion with the tax authorities (CCH, 2012).

Issue 2: Treatment of Interest Income Received by Mother from Son

The court after taking cognizance of the facts declared that the payment would constitute as capital receipts only. The court reasoned that the appellant has not contributed in book writing but has merely provided the information about her life through the medium of interview. The other activities such as giving suggestions for the book, providing with some photos, tokens etc. were secondary and relatively insignificant as compared to the information she had. Hence, by sharing the details about her life, she has given her secret away and since the copyright was given to newspaper, thus, the information now become the exclusive property of the newspaper (Gupta, 2009). Thus, the contract essentially involved the transfer on an intangible asset (i.e information) from the appellant to the newspaper. Thus, no tax was levied in that case but it would attract CGT in the present world (Woellner, 2013).

Application

Taking the above case as the reference, it is evident that the newspaper’s offer to Hilary is not on account of quality writing but only because she has the secret information about her life which is an asset since it has commercial value. This is because she is a famous mountain climber and hence people would be interested in reading about her personal life. While Hillary did write the book, but this is incidental to the information possessed by her. This is apparent from the fact that had the topic not been her own life, the newspaper would not have approached her as she is not a writer. Hence, the copyright transfer in this case is essentially transfer of information about Hilary’s personal life and not her writing. Further in case of manuscript and photographs also, it is not the writing or photography skills that are being sought after since Hilary does not have these as her professions.

Conclusion

Based on the above, it may be concluded that all the income in actuality are capital receipts and would be only subject to capital gains tax in line with Section 10-5, ITAA 1997.

 (b) The classification of income would not undergo a change even under the case when Hilary is not approached by the newspaper and instead writes for her own satisfaction only. In this case also, the real asset is the detail about Hilary’s personal life that is contained in the book. The content otherwise does not hold any literary value since Hilary is not a writer and hence writing would be just a medium through which she would propagate the information copyright from herself to the eventual buyer (Gilders et. al., 2015).

Issue 3: N/A

In this case, son has approached mother for borrowing a sum of $ 40,000. The son intends to return the money in five years and would pay a 5% interest. However, the mother does not want any interest payment and communicates this to son at the time of extension of loan facility. The son manages to pay the entire debt within two years only. He gives a combined cheque which totals $ 44,000 where, the incremental amount of $ 4,000 is the interest at the rate of 5% for a period of two years. The core issue is to discuss the relevant taxation norms and thereby opine on the assessibility of the interest received by the mother.

Rule

The ordinary income is defined in accordance with Section 6-5, ITAA 1997. As per this section, interest payment is one of the components of ordinary income. However, namely two types of interest payments would be derived as ordinary income (Barkoczy, 2015).

• Interest income derived from any security that pays interest such as bond, bank account
• Business income when the taxpayer runs a business that engages in money lending

It is possible that a given individual may indulge in casual lending to help a particular individual or without any profit motive. In order to distinguish casual lending from business lending, the nature of the transactions needs to be compared with the transactions of those who actually own such a business. Isolated transactions that are executed in a manner alike to actual business would lead to deriving of ordinary income (Woellner, 2013). Also, the interest may be derived on a regular basis or a lump sum basis in order to be qualified as a component of ordinary income (Sadiq et. al, 2015).

Also, certain payments may be gifts and not income. In order to ascertain a particular payment as gift, following conditions need to be satisfied as per TR 2005/13 (ATO, 2013).

• There must be transfer of the ownership of the gift.
• This transfer should be done on a voluntary basis.
• The pivotal force which motivated the transfer should be benefaction.
• In lieu of the transfer, the transferor should not have any expectation for return favours.

For payments that are gifts, no tax burden would result as these are exempted from tax (Gilders et. al., 2015).

From the given information, it is evident that there is no money lending business being operated by the mother. This can be definitively concluded from the non-commercial in which lending has been done. There was absolute no legal documentation or any kind of collateral was also not demanded. Further, the mother had no desire for earning interest income which makes it beyond doubt that the lending is not commercial. While $ 40,000 would be capital receipts but the extra $ 4,000 will be gift as explained below.

The $ 4,000 through the medium of cheque has been extended to his mother. The borrower did not need to pay any interest as instructed by her mother but he still has made this payment. Hence, this is due to affection towards her mother. Further, by giving this payment, the son does not have future expectations about any favours.

Conclusion

It is apparent that the $ 4,000 which is received by mother as interest is gift and hence is not assessable income.

Capital gains are derived when a capital asset is liquidated at a price that is greater than the cost base of the underlying asset. For capital assets whose holding period is greater than one year, any capital gains derived would be classified as long term capital gains. In case of these gains, the taxpayer (in case of individuals) would have two methods (i.e. Discount method and Indexation method) to compute the capital gains that would attract tax burden in the form of CGT (Woellner, 2013).

Selling price derived from the property = $ 800,000

It is known that the land was purchased in 1980 when CGT did not exist, hence the land as a capital asset would not attract any CGT liabilities irrespective of the gains made on land. However, the house was constructed only in 1986, whereby the house would be subject to CGT (Sadiq et. al., 2015).

Clearly there are two capital assets with one being free from CGT burden and the other covered under CGT.

Total cost of the property in 1986 when construction was done = $ 90000 + $ 60000 = $ 150,000

Percentage contribution to property value by house = (60000/150000)*100 = 40%

Thus, selling price of the house = 40% of selling price of property = (40/100) * 800000 = $ 320,000

Further, the only given cost for the house is the construction cost as no maintenance or repair cost has been given.

Hence, capital gains for the house = 320000 – 60000 = $ 240,000

Taxable capital gains (Discount method) = 0.5*240000 = $ 120,000

The other viable alternative method is the indexation method.

Indexation Method

In this method, the construction cost of the house is indexed for inflation.

Indexation factor = CPI for 1999/CPI for 1986 = 68.72/43.2 = 1.59

Thus, indexed cost base = 60000*1.59 = $ 95,400

Hence, capital gains on which CGT would apply = 320000 – 95400 = $ 224,600

Based on the computation carried out above, it is apparent that Scott in a bid to lower the tax liability would prefer the discount method and hence the taxable capital gains would be $ 120,000.

Instead of selling the property to an outsider, Scott now sells it to his daughter. The price in this case is considerably lower than the assumed market price of $ 800,000. The relevant legislation in such cases is the Section 116-30(2) ITAA 1997 as per which in transactions between there is a personal relation between the buyer and seller, in such cases capital gains are computed taking into cognizance the higher of the market value and the selling price (Austlii, 2016). Hence, the capital gains would still be $ 120,000 as previously.

The ownership has been altered from an individual owner to a company. Since companies cannot use discount method for computation of taxable capital gains, hence the indexation method must be used (Barkoczy, 2015). The taxable component of the capital gains as per this method arrives at $ 224,600.

References

ATO 2013, Taxation Ruling:TR 2005/13, Australian Taxation Office, Available online from https://www.ato.gov.au/law/view/document?DocID=TXR/TR200513/NAT/ATO/00001 (Accessed on August 23, 2016)

Austlii 2016, INCOME TAX ASSESSMENT ACT 1997 - SECT 116.30, Austlii Website, Available online from https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s116.30.html (Accessed on August 23, 2016)

Barkoczy, S. 2015. Australian tax casebook. CCH Publications, Sydney

CCH 2012, Australian Master Tax Guide 2012, 50^th eds., Wolters Kluwer , Sydney

Gilders, F, Taylor, J, Walpole, M, Burton, M. & Ciro, T 2015, Understanding taxation law 2015, 8th eds.,  LexisNexis/Butterworths.

Gupta, R. 2009. Receipts from Personal Exertion: Mere Gifts or Gross Income?, Auckland University o Technology, Available online from https://aut.researchgateway.ac.nz/bitstream/handle/10292/735/GuptaR.pdf?sequence=5 (Accessed on August 23, 2016)

Sadiq, K, Coleman, C, Hanegbi, R, Jogarajan, S, Krever, R, Obst, W, and Ting, A 2015 , Principles of Taxation Law 2015, 8th eds., Thomson Reuters, Pymont

Woellner, R 2013, Australian taxation law 2012, 6^th eds., CCH Australia, North Ryde