Rainsmart Pty Ltd (‘Rainsmart’) is an Australian resident company that manufactures and sells weatherproof clothing to the Australian and international market. Rainsmart purchases raw materials from Indonesia and New Zealand and manufactures at their production facility and head office in Sydney. An administration office is located in each of the Australian capital cities, to support sales and customer service. Rainsmart’s turnover is just over $20 million,net assets $12 million and permanent staff total 150 Australia wide as at 30 June 2017.
a) Based on the information provided calculate the net capital gain or loss derived by Rainsmart for the year ended 30 June 2017. Please show all workings and cite relevant legislation. You must cite relevant legislation and cases where relevant and
explain your answers.
You are required to apply a critical thinking approach to answering this part, in that you must explain why the sale would or would not constitute ordinary income or a capital gain or loss. Please refer to the video explaining the steps to critical thinking on ilearn in the section with this assessment as well as the recording of how critical thinking (and problem solving) is used in tax advising in practice.
A. Capital Gain Relating to Office Building
Section 100 to 149 of ITAA97 specifies the regulation regarding general rules for ascertaining capital gain tax liability and special topics. Capital gains are assessable as statutory income and are part of assessable income as per section 102 -5(1) of ITAA 97. Section 104-10 CGT event A applies in case the asset is purchased after 19/9/85 and must have been sold to other entity. In case asset is not sold, though ownership is change even than provision of CGT will be applied. A capital gain is assessed in case capital proceeds exceed the cost of asset; on the contrary capital loss is assessed in case it is less in comparison to cost of asset (Australian Tax Office. Working out your capital gain or loss, 2016.).
Section 108.5 (1) specifies that any kind of property or legal right which is not a property will be considered as asset for CGT purpose. Further, rights relating to personal service and right to bring action for personal service injuries are not deemed to be asset for CGT purpose.
In present case as Rain smart has purchase land after 19/09/85 i.e. in Jan 2000 and disposal of asset (office building) has been made to another entity; the provision of CGT will be applied in present scenario. Building is an asset in accordance with provision of section 108 -5 (1) of ITAA 97 thus the same will be taxed in accordance with specified provision (Australian Taxation Office. Capital gains tax, 2016). Elements which are been required to be included in cost have been specified in section 110-25; section 110-35, section 110-38; section 110-40; section 110-45 of ITAA 97. Thus incidental cost relating to disposal of asset and capital expenditure relating to asset for maintaining or increasing the value of asset is treated as part of cost (Yinger, Bloom and Boersch-Supan, 2016). Thus, in present case all relevant cost of office building has been treated as part of cost of office building.
Computation of capital gain
Capital gain relating to sale of Melbourne office
Selling price of asset $4500000
Cost of asset (Working note -1) $2649000
Capital gain $1851000
(Selling price – total cost of asset)
Three method of calculating capital gain have been specified in ITAA97. In first method which is known as discounting method in which if asset held for more than twelve month than 50% of taxation gain is taxable for individual and trust. However, discounting method is not applied in case company disposes an capital gain tax asset (Jones, 2016). Thus, in present case as it is a company capital gain will be computed in accordance with other method i.e. (Selling price – Cost of asset).
Working note 1
Cost of Melbourne office
AASB 116 specifies the provision relating to Property, plant and equipment. Para 11 to 14 specifies explanation relating to initial and subsequent cost of asset which is to be recognized in books of accounts. As per the specified provision all expenditure made on an asset with are required to prepare the asset for its intended use are included in cost of asset (Vernimmen and et.al; 2014).
Purchase cost $1800000
Cost relating to painting and other expenditure necessarily required $430000
Strip of land $360000
Legal cost $25000
Incidental cost of acquisition and sale of office $34000
Capital Gain on Sale of Shares
Selling price $800000
Cost of shares $12000000
Sale of shares generally triggers capital gain tax; and the same is calculated by reducing cost from selling price (Jacob, 2016). Further, an exemption has been provided that no CGT provision applies on sale of shares between members of same group; whether the shares relate to company outside the group. Thus, in present case of capital gain tax provision will be applied as the company is selling its own shares. Similar description is provided under case of FCT v. Lamesa Holdings BV.
Capital Gain on Sale of Painting
Section 24 of ITAA97 specifies the provision regarding situation when asset are lost or destroyed. It has been provided in sub-section 1 that in case the entire asset is lost or destructed it will deemed as disposal of asset whether or not any sum has been received as compensation. Thus, computation of capital loss in present case will be done in following manner:
Sellin100000g Price Nil
Cost of acquisition
1st Painting $100000
2nd Painting $70000
However, as compensation has been received than loss will be
reduced to same extent; thus compensation in present case is $160000
$110000 and $50000 for second painting
Capital loss $10000
Total capital loss of Rain smart for the year ended on 30th June 2017
Capital gain from sale of office building $1851000
Capital gain from sale of own shares 0.00
Capital gain from sale of painting -$10000
Total capital gain $1841000
(As capital loss from one asset can be set off against capital gain of another
asset in same year. (Harding, 2013))
B Applicable Provision
The specified asset is CGT as per provision of section 108-5 (1) of ITAA 97. If a block of land is subdivided, each part land will be registered with a separate title. For the purpose of capital gain, the original piece of land is divided into separate assets (Australian Taxation Office. Subdividing land, 2016). Mere sub division of land does not in itself result into capital gain, if the ownership is retained by the original owner. No capital gain or capital loss arises at the time of subdividing land. For this purpose case study of Scottish Australian Mining Co Ltd v FC of T (1950) 81 CLR 188 can be considered. Capital gain arises only when there is a clear intention by the owner of selling the subdivided land (Gitman, Juchau and Flanagan 2015). For calculating the capital gain or capital loss, the date on which a person acquires the land and further sub divided it is to be considered. The cost of original land is sub divided into the number of sub divisions on reasonable basis.
The profit which arises from the sale of subdivided land may be treated as capital gain or ordinary income, depending upon the situation. If a block of land is subdivided and sell the blocks which are newly created than the profit is treated as a capital gain and is subjected to the tax provisions. Same is cited under provisions of Federal Commissioner of Taxation v. Whitfords Beach Pty. Ltd. However, as per views of Faccio and Xu, (2015) if the sole intention of subdividing the land is to create profit or gain in the normal course of business than the profit will be treated as ordinary income.
Relevance to the Present Case
According to the taxation ruling, TR 92/3, Rain smart’s sale of constructed premises of 20 subdivided lands will be treated as capital gain. Since, the land was not acquired for the sole intention of making profit and the profit does not arises in the normal course of business; the gain will not be treated as ordinary income. Moreover, as far is capital gain is concerned, it will only arise when the subdivided land is sold and a transaction arises on the part of Rain smart (Clark, 2014). Distinction between income and capital receipts have been specified in Sec26 (a) and section 25A of ITAA36; thus in accordance with provision of specified section the receipts which will be received on sale will be treated as capital receipts. Thus the difference between the cost of acquiring the land and the proceeds from its sale will be considered as the capital gain (Nicola, 2016). The cost at which the land was acquired will be divided rationally amongst the 20 sub divided land.
The assumption on which the above conclusion is drawn is that since the purchase of the land by Rain smart is for the use of proceeds from sale of shares, the purchase will be treated as an investment.
In accordance with above provision it can be concluded that capital gain provision will be applied when blocks of land will be sold as the activity is not in ordinary course of business for Rain smart Ltd.
Clark, J. (2014). Capital gains tax: historical trends and forecasting frameworks. Economic Round-up. (2), P.35.
Faccio, M. & Xu, J. (2015). Taxes and capital structure. Journal of Financial and Quantitative Analysis. 50(3). Pp.277-300.
Gitman, L.J., Juchau, R. & Flanagan, J. (2015). Principles of managerial finance. Pearson Higher Education AU.
Harding, M. (2013). Taxation of dividend, interest, and capital gain income.
Jacob, M. (2016). Tax regimes and capital gains realizations. European Accounting Review. Pp.1-21.
Jones, D. (2016). Capital gains tax: The rise of market value?. Taxation in Australia. 51(2), P67.
Vernimmen, P. & et.al. (2014). Corporate finance: theory and practice. John Wiley & Sons.
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.
Australian Tax Office. Capital gains tax. (2016) [PDF]. Available through < https://www.ato.gov.au/General/Capital-gains-tax>. [Accessed on 8th October 2017].
Australian Tax Office. Subdividing land. (2016) [PDF]. Available through < https://www.ato.gov.au/General/Property/Land---vacant-land-and-subdividing/Subdividing-land/> [Accessed on 8th October 2017].
Australian Tax Office. Working out your capital gain or loss. (2016) [PDF]. Available through < https://www.ato.gov.au/General/Capital-gains-tax/Working-out-your-capital-gain-or-loss/>. [Accessed on 8th October 2017].
Nicola Webber. Real Commercial, Commercial News. (2016) [Online].Available through < https://www.realcommercial.com.au/news/capital-gains-tax-means-commercial-property>. [Accessed on 8th October 2017].