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BULAW5916 Taxation Law And Practice 3

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  • Course Code: BULAW5916
  • University: Federation University
  • Country: Australia

Questions:

Purpose

The purpose of this assignment is to enable you to explore and communicate your understanding of relevant aspects of taxation law.

In the future some of you will work as accountants. In the course of doing so, you may have clients who ask for tax advice. They may ask you how transactions they have entered into might be regarded for tax purposes (for example, is a transaction likely to be regarded as income or capital?). You may therefore be faced with clients in real-life situations and be asked to give advice to them about how they should treat these situations for the purpose of their tax returns.

Question 1

ABC Ltd. is an Australian company carrying on a diversified merchandising and financial business, including an agency arrangement with an Indian shipping company. This agency arrangement was documented by a contract which ABC Ltd. and the Indian shipping company signed on 1 August 1985. The period of the contract was for 30 years.

As a result of the reorganisation of the Indian shipping company’s affairs, the agency contract was terminated after it had been in operation for 24 years. ABC Ltd. calculated the profits which it had expected to earn from the agency contract during the subsequent six years, and negotiated a cancellation of the contract in consideration of the payment by the Indian shipping company of $4 million. The Indian shipping company paid this amount, without questioning how it had been calculated.

The contract with the Indian shipping company had provided ABC Ltd. with business which equated to 60% of its profits. When the contract was cancelled, other minor activities of ABC Ltd. which also related to shipping were terminated.

Part 1- Advise the directors of ABC Ltd. of the income tax consequences of the above arrangements. For the purpose of your answer to Part 1, you will be required to mainly refer to case law regarding income tax.

Part 2- What difference would it make if the agency agreement had been entered into on 1 August 1993? For the purposes of your answer to Part 2, you will be required to mainly refer to the Income Tax Assessment Act 1997 where relevant.

Your combined answer to parts 1 and 2 of Question 1 will be marked out of 20 marks.

Question 2

The directors of ABC Ltd. also consult you about some land that the company acquired in January 1995 as a possible site for a future warehouse and sales office. Following an increase in its lease payments, the company decided in February 1997 to erect a building on the land. Construction commenced on 14 April 1997. The building was completed in December 1998 and the company took up residence of the building on 20 January 1999. The land cost $1.33 million and the building cost $5 million.

On 2 January 2020, the company received an offer to buy the land and buildings for $11 million. Given the termination of the agency contract, the company accepted the offer. Contracts were signed on 14 January, and settlement took place on 18 February. A profit of $4.58 million relating to this transaction is included in the company’s profit and loss statement. ABC Ltd. is continuing to operate, but again from leased premises.

With reference mainly to the Income Tax Assessment Act 1997, please advise ABC Ltd. of the tax implications of the above transactions. What is the capital gain or capital loss of the company? Has the company overstated or understated its profit?

 

Answers:

1: 

Part 1: 

There are situations where the taxpayers normally gets the compensation payment where they suffer commercial as well as other type of losses. There are golden rule or principles relating to replacement. The character of a compensation receipt is largely dependent on the type of amount that is received by the taxpayer. This involves the payment which replaces, substitutes or compensate the taxpayer (Barkoczy, 2018). In order to treat loss of revenue items or amounts that might have been received on the income account are normally treated as income in type. While the compensation that is received for loss, destruction or sterilisation of capital assets are normally held as capital in nature. Given that the compensation payment simply replaces the amount which would have been considered as ordinary income given the amount is received will be considered as assessable ordinary income under the “sec 25 ITAA 1997”.

On the other hand if the compensation payment is received that might have been assessed as the statutory income and falling out of the “sec 6-5 ITAA 1997” the amount will be considered as taxable statutory income under the “sec 6-10 and sec 15-30 ITAA 1997” (Minas et al., 2018).

Usually amounts which the taxpayer gets in relation with the cancellation of contracts or the variation of contracts that are of commercial or trading in nature made during the course of carrying the business are treated to be income in nature. They are treated as compensation for the loss of profit within the contracts and consequently presumes the character of income. In other words, compensation which is received as the cancellation of business contract are considered to be paid in substitution of lost income.

Accordingly amounts which is received by the taxpayer for the loss of business income because of cancellation of trading contracts are known as income. The loss or the variation of such type of commercial contracts do not create an impact on the profits producing structure of business. As per the commissioner in “Heavy Minerals Pty Ltd v FCT (1966)”, the high court had make a decision as whether the amounts that is received by taxpayer company as the compensation for cancellation of contracts to sell the rutile were treated as income or capital. The judgement followed that the amount were considered as income (Krever & Sadiq, 2019).

 


The business of the taxpayer was of mining rutile and dealing in rutile. The capital asset of the taxpayer were the mining lease and the plant. Following the cancellation of contract the taxpayer still had these. The taxpayer was still free to mine rutile and to sell it if it can locate buyers.    

Hence the cancelled contracts and the amount of compensation was associated to the matters of revenue or income. It involved the sale of rutile and no the capital matters such as the lease and plants (Jacob, 2018). Nevertheless, if the cancellation or variation payment is associated to the manner in which the business is structured along with the cancellation of business agencies where it do not form the feature of any particular industry the payment might be treated as capital in nature.

As evident in case of ABC Ltd which is carrying the diversified merchandising and financial business with an agency agreement with shipping company. As the part of reorganisation of shipping company’s affairs, the contract between the ABC Ltd and Indian Agency Company was terminated following the 24 years of operation. The case highlights that ABC Ltd computed its profits which it had anticipated to earn from the Indian agency in the subsequent six years and also negotiated a cancellation of contract in exchange of a payment of $4 million. The amount was paid by the Indian Shipping Company to ABC Ltd.

The payment of $4 million that is received by ABC Ltd should be treated as compensation that is paid for the cancellation of agency business contract. As the general rule, the amount of $4 million that is received by ABC Ltd in relation with the cancellation of business contract was made during the course of business (Jones, 2016). The compensation amount that is received by ABC Ltd will be considered as the loss of profit within the contract and eventually takes the character of income because the sum of $4 million that is paid to ABC Ltd is deemed to be received as substitution of lost income.

The reference to the case of “Heavy Minerals Pty Ltd v FCT (1966)” can be made to state that the compensation payment which is received by ABC Ltd were for the cancellation of contracts and will be considered as taxable income under the “sec 25 ITAA 1936” (Deutsch, 2018).

 

Part 2:

A “CGT event C2” under the “sec 104-25 ITAA 1997” involves the cancellation of surrender of contracts. This event is associated with the extinction of a taxpayer’s ownership of an intangible asset (Kenny et al. 2018). The “CGT event C2” takes place where the CGT asset is redeemed or cancelled or it is released, discharged or satisfied. The “CGT event C2” takes place when the asset is abandoned discharged or satisfied. As held in “FCT v McLaurin (1961)” the “CGT event C2” also includes the right of receiving compensation is cancelled or satisfied (Nethercott, 2018). A capital gains normally happens under the “CGT event C2” when the capital proceeds from the ending of ownership of asset goes past the asset cost base.

In alternative situation if the agreement between the ABC Ltd and Indian Agency had been entered in 1st August 1993 and the disposal of the contract would have taken place following that date then a “CGT Event C2” would have happened (Sadiq, 2018). With respect to the “sec 104-25” when the contract was cancelled then a “CGT event C2” would have taken place. By referring to the case of “FCT v McLaurin (1961)” the cancellation of contract has resulted in the right for compensation for ABC Ltd.

 

2: 

When a taxpayer gets any receipt from the usual business proceeds then it will be held as ordinary earnings within the “sec 6-5 ITAA 1997” (Taylor et al., 2018). In an alternative situation a transaction is normally categorized as the extraordinary transaction where the receipt happens out of the normal business proceeds. On the other hand, the isolated transactions happens when the receipt arises from the one-off nature of transaction and it is not undertaken by the taxpayer in the existing business operation. While an extraordinary and the isolated transaction might happen to take the character of capital, it will be considered as the ordinary income given the transaction falls in the following categories;

  1. The transactions becomes business itself
  2. The transaction is falling under the first strands of “FCT v Emporium (1987)”
  3. The transaction is falling under the second strands of “FCT v Emporium (1987)”

As noted in the case of “California Copper Syndicate v Harris (1904)” the principle established suggest that the gain which is derived from the isolated transactions are differentiated between the “mere realisation” or a gain that is the result of carrying the business which leads to ordinary income under the “sec 6-5 ITAA 1997” (Woellner et al., 2019).

The decision made in “FCT v Whitfords Beach Pty Ltd (1982)” the profits that is derived from the isolated transactions or potentially the extraordinary transaction which has portrayed a satisfactory business indicators is held as ordinary earnings from the business activity. The judgement held that extensive amount of land development was regarded as business. additionally in another case of “Stevenson v FCT (1991)” the extensive amount of land development and the sales procedure that was undertaken by the taxpayer was held as carrying the business of land development and the proceeds were treated as ordinary gains from business under the “sec 6-5 ITAA 1997” (Woellner et al. 2017,).

An extraordinary or the isolated transactions would meet the first strand of “FCT v Myer Emporium Ltd (1987)” when the below stated tests are met;

  1. There was a business operation that was carried on by the taxpayer or commercial transaction
  2. The taxpayer entered in the transaction with the motive of earning profit from that transaction
  3. The profit derived that is derived was by the means which was consistent with the original intention (Jones et al., 2015).

On meeting the first strand of “FCT v Myer Emporium Ltd (1987)” the gain will be treated as ordinary income (Coleman et al., 2015). While the second strand of Myer states that if the proceeds that is derived from the transaction will be treated as ordinary income if the taxpayer sold the right of income from the asset without selling any underlying asset.

 


In the current situation it is noticed that the directors of ABC Ltd has acquired a land in January 1995 for building future warehouse and sales office. An offer to sell the land and building was received by ABC Ltd from the Indian Agency for selling the building for $11 million. Upon the sale ABC Ltd realised a profit of $4.58 million associated to the transaction which it has included in the profit and loss statement.

With the regard the “sec 6-5 ITAA 1997” the sum of $4.58 million that is received by ABC Ltd will be considered as the gains from extraordinary business transaction (Miller & Oats, 2016). By referring to the case facts of “California Copper Syndicate v Harris (1904)” the profits which is made by ABC Ltd will be considered as a gain derived from the isolated transaction.

By citing “FCT v Whitfords Beach Pty Ltd (1982)” the profits that is received from the isolated transactions by ABC Ltd because the transaction has exhibited an adequate characteristics of business (Lukashova, 2016). The taxpayer has developed the land in an enterprising manner and shows that the profit is the product of extensive land development. The sales proceeds that are undertaken by ABC Ltd will be considered as the ordinary income from the activity.

To further consolidate the above given statement the sum of $4.58 million that is received by ABC Ltd has exhibited an extraordinary or the isolated transaction since it satisfies the first strand of “Myer Emporium v FCT (1987)” since it meets the following requirements;

  1. There was a business operation was carried on by the ABC Ltd
  2. When ABC Ltd entered in the transaction there was a profit making intention when entering in the transaction
  3. The profit which was made by ABC Ltd was consistent with the original intention of making profit.

As the above stated first strand is satisfied the profit will be regarded as ordinary income under “sec 6-5 ITAA 1997”. Conclusively the company has made a capital from selling the building and ABC Ltd has understated the profit. 

 

References:

Barkoczy, S. (2018). Foundations of taxation law 2018.

Krever, R., & Sadiq, K. (2019). Non-residents and capital gains tax in Australia. Canadian Tax Journal/Revue fiscale canadienne, 67(1).

Jacob, M. (2018). Tax regimes and capital gains realizations. European Accounting Review, 27(1), 1-21.

Jones, D. (2016). Capital gains tax: The rise of market value?. Taxation in Australia, 51(2), 67.

Deutsch, R. (2018). Australian Tax Handbook 2018. [Place Of Publication Not Identified]: Thomson Reuters Australia.

Kenny, P., Blissenden, M., & Villios, S. (2018). Australian Tax 2018.

Nethercott, L. (2018). Australian Taxation Study Manual 2018. Other: Oxford University Press.

Sadiq, K. (2018). Australian taxation law cases 2018. Pyrmont, NSW: Thomson Reuters. law 2018.

Taylor, C., Walpole, M., Burton, M., Ciro, T., & Murray, I. (2018). Understanding taxation law 2018.

Woellner, R., Barkoczy, S., & Murphy, S. (2019). Australian taxation law.

Woellner, R., Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2017). Australian taxation law 2017.

Jones, S. M., Rhoades-Catanach, S. C., & Lemler, B. (2015). Principles of taxation for business and investment planning. Issues in Accounting education, 25(3), 599-600.

Coleman, C., Hanegbi, R., Hart, G., Jogarajan, S., Krever, R., McLaren, J., ... & Sadiq, K. (2015). Principles of taxation law. THE AUSTRALIAN TAFE TEACHER.

Miller, A., & Oats, L. (2016). Principles of international taxation. Bloomsbury Publishing.

Lukashova, I. V. (2016). Principles of Taxation of Residential Property. Taxes and Taxation, (4), 359-363.

Minas, J., Lim, Y., & Evans, C. (2018, August). The impact of tax rate changes on capital gains realisations: evidence from Australia. In Australian Tax Forum (Vol. 33, No. 4).

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