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Smith and Jones have been involved in property development for many years. Eight years ago Smith and Jones purchased two properties in an area where there was extensive real estate development. For six years the properties were used for sheep grazing and the properties were improved for that purpose.  

Owing to drought conditions, the sheep grazing proved to be unpro?table. Furthermore there was an imminent zoning change whereby the properties could only be disposed of in 20-hectare lots instead of 5-hectare lots. Smith and Jones therefore quickly arranged to subdivide the land up into 5-hectare blocks and sold the whole property to one purchaser. At the 30th of June the amount is still unpaid. The Commissioner assessed Smith and Jones on the gross receipts in s 6-5 of ITAA 1997.

Discuss whether the sale of the property should be assessable under s 6-5 of the ITAA 1997 and what amounts are to be included in the year ending 30.06.2016. In your response ensure you state the appropriate legislation, tax rulings or common law cases to support your answer.

Jenna is single and an Australian resident for tax purposes. She is 32 years of age and an experienced orthodontist. On 1 July 2015 she acquired “SmilesRG8” dentistry clinic in Sydney. Jenna has been operating as a sole trader but employs three orthodontists and six assistants in addition to nursing and administrative staff.  She provide you the following records for the 2016 income year.

Receipts ($):   

2, 400,000 Cash from Dentistry Fees (see note 1 & 3)

8,000 Bad debts recovered

Payments ($):   

500,000 Staff Salaries and Wages (see note 2 & 4)

15,000 Motor Vehicle Operating Expenses: fuel, repairs, registration and insurance

20,000 Fringe benefits tax

3,000 Jenna’s travelling expenses from home to work and return  

2,000 Legal fees for the renewal of lease of the office building

1,500 Debt collection expenses paid to a solicitor

500 Council rates on business premises

200,000 Purchase of Dental Supplies

 55,000 Rent and Council Rates – Rented Premises  

20,000 Provision for doubtful debts (see Note 5)

Notes and Additional Information

  1.  Outstanding Consulting Fees – On 30.06.2016 $55,000
  2.  Outstanding Wages Owing to Staff – On 30.06.2016    $12,000
  3.  On 1/2/ 2016 Jenna discovered that an employee had stolen $1,000 cash in respect of money received from fees.
  4.  Staff salaries include $10,000 paid to Jenna’s niece Tamara for casual reception duties. The Commissioner considers $5,000 to be a reasonable commercial rate for this task.
  5.  Jenna is owed $10,000 by a debtor who is bankrupt. It is very unlikely that she will recover any money from the debtor, and Jenna does not take any action to recover the money.
  6.  Plant Equipment and Motor Vehicles acquired during the financial year includes:

Computers $100,000 acquired on 1 July 2015

Equipment and Furniture $150,000 acquired on 1 July 2015

 Security System $30,000 acquired on 15 July 2015

Alfa Julietta (Car) $60,000 acquired on 1 July 2015

  1.  Jenna wishes to minimise her tax liability for the income year.
  2.  Assume Jenna does not qualify as a SBE.

Complete a Statement of Taxable Income for the year ending 30.06.2016 with appropriate schedules. Ensure you support your calculations and your arguments with appropriate legislation and common law cases.

Case Study 1: Taxation Implications of the Sale of Property

Issue

In this case, smith and Jones is engage in the business of property development. They used the block of land for sheep grazing. Then as it became unprofitable, they subdivided and sold the land. The issue here is to determine whether the sale of the property should be accessible under section 6-5 of the Income Tax Assessment Act 1997.

The laws and regulations that have been applied for determining the issue are:

  • Division 70 of the Income Tax Assessment Act 1997;
  • section 995-1 of the Income Tax Assessment Act 1997;
  • Ferguson v FC of T (1979);
  • section 70-10 of the Income Tax Assessment Act 1997;
  • FC of T v St Hubert’s Island Pty Limited 78;
  • Taxation Ruling 92/3;
  • section 25(1) of the Income Tax Assessment Act 1936;

The income tax consequences for dealing with the property or land is subject to assessment under different portion of the tax law. The two issue that are considered while determining the tax regime applicable for the sale of property or land are the nature of the transaction and the profile of the taxpayer. The general rule is that if the land disposed is regarded as the item of trading stock or revenue asset then on sale of such assets will be regarded as ordinary income. On the other hand, if the land disposed is regarded as capital asset then the income will be subject to capital gain tax.

The Division 70 of the Income Tax Assessment Act 1997, states that if the property sold is a part of the business related to the development of property then the property will be regarded as trading stock. Therefore, the issue is to determine whether the activity related to the property development business. The term business is defined under section 995-1 of the Income Tax Assessment Act 1997 and includes profession, trade etc. In the case of Ferguson v FC of T (1979) it was held that whether a business is been carried out in the matter of fact. The trading stock is defined under section 70-10 of the Income Tax Assessment Act 1997; it states that the meaning of trading stock includes anything that is manufactured, purchased or acquired and is held in the ordinary course of business. In the case of FC of T v St Hubert’s Island Pty Limited 78, it was held that land would be considered as a part of the trading stock only if it was acquired for the purpose of resale. Therefore, it is necessary to determine the purpose of purchasing the land.  In this case, Smith and Jones is engaged in the business of property development. On considering the nature of business, the block of land would be regarded as inventory. However, on analyzing this case it can be seen that the particular block of land was used for grazing sheep and the land was improved for that purpose. Therefore, it can be said that this particular block of land cannot be regarded as land that was originally acquired as a trading stock.

The land may not be originally purchased for resale but it can be subsequently held for that purpose. The Taxation Ruling 92/3 provide guidance in determining whether income from isolated transaction should be included in the assessable income under section 25(1) of the Income Tax Assessment Act 1936. The Para 6 of taxation ruling states that income from isolated transaction should be regarded as ordinary income if the intention was to make profit from the transaction and the transaction was actually entered into and profit was made in the ordinary course of the business activity. The Para 7 of the ruling states that the intention of making profit from the transaction should be based on facts and not subjective intention. The Para 8, of the ruling states that the objective of making profit is not required to be the sole intention of entering into the transaction. Therefore, it is not necessary it is not necessary to intend to make profit at the time of acquiring the property. The para 13 of the ruling provides that there are certain conditions that are considered in determining whether isolated transaction should be included as an ordinary income. In this case, the land was originally purchased with the intention of using it for gazing sheep’s. As the business became unprofitable, the land was divided into blocks and was sold for making profit. Therefore, the profit earned by the business from the isolated transaction should be included as ordinary income under section 6-5 of the Income Tax Assessment Act 1997.

Conclusion

Based on the Taxation Ruling 92/3, it can be said that the transaction of selling land should be regarded as the isolated transaction. Therefore, income derived from this transaction should be regarded as ordinary income under section 6-5 of the Income Tax Assessment Act 1997.

Statement showing Taxable income

Particulars

Reference

Amount

Amount

Assessable Income

Income from dentistry fees

 $ 2,400,000.00

Outstanding consulting fees

 $      12,000.00

Fees stolen by employee

 $        1,000.00

Total fees received

Section 6-5 of ITAA 97

 $ 2,413,000.00

Bad debt recovered

Note 2

 $        8,000.00

Total Assessable income

 $ 2,421,000.00

Allowable deduction

Salaries and Wages

 $      50,000.00

Outstanding salary

 $      12,000.00

Unreasonable salary disallowed

 $      (5,000.00)

Net salary and wages

 $      57,000.00

Legal fees

Section 8-1 of ITAA 97

 $        2,000.00

Motor vehicle expenses

Division 28

 $      15,000.00

Legal expenses

Section 8-1 of ITAA 97

 $        1,500.00

Rates and Taxes

Section 25-75 of ITAA 97

 $           500.00

Cost of supplies

Section 8-1 of ITAA 97

 $    200,000.00

Bad debt

Section 8-1 of ITAA 97

 $      10,000.00

Depreciation

 $      50,000.00

Total Allowable deduction

 $ 2,765,000.00

Taxable Income

 $  (344,000.00)


Notes

1.

The Taxation Ruling 98/1 deals in determining whether the income should be computed based on receipt basis or earning basis. The Para 18 states that income derived by an employee should be recognized on cash basis. On the other hand, Para 20 state that earning method is appropriate for income derived by business. Therefore, in this case the accrual method of accounting is followed for determining the taxable income.

2.

The Taxation Ruling 92/18 provide that bad debt is allowed as deduction if the income was previously included in the assessable income. The ruling further provides that the bad debt is not allowed as deduction from the assessable income if the cash basis of accounting is followed. Therefore, it can be said that if bad debt is allowed as deduction then recovery of bad days should be taxable.

3.

The travelling between the home and workplace is regarded as private travel. In general, deductions cannot be claimed for the expenses incurred.

4.

The deduction is allowed for car expenses under Division 28 of the Income Tax Assessment Act 1997. The car expenses can be allowed as deduction under two methods as per section 28-12 of the Income Tax Assessment Act 1997. In this case, the expenses related to motor vehicle has been allowed as deduction.

5.

The section 25-75 of the Income Tax Assessment Act 1997 states that an entity can deduct the amount that has been paid as rates and Taxes on the premises that is used for the purpose of business.

6.

The effective useful life of the assets are not provided it is assumed that the effective life of the assets is 10 years for the purpose calculating depreciation.

References

DZHUMASHEV, RATBEK and EMIN GAHRAMANOV, "A Growth Model With Income Tax Evasion: Some Implications For Australia*" (2010) 86 Economic Record

Freebairn, John, "Who Pays The Australian Corporate Income Tax?" (2015) 48 Australian Economic Review

Goerke, Laszlo, "Income Tax Buyouts And Income Tax Evasion" (2014) 22 International Tax and Public Finance

Legal Database - View: Rulings: TR 98/1 (2017) Ato.gov.au https://www.ato.gov.au/law/view/document?DocID=TXR/TR981/NAT/ATO/00001&PiT=99991231235958

Okello, Andrew, "Managing Income Tax Compliance Through Self-Assessment" (2014) 14 IMF Working Papers

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