Determination Of Income And Capital Gains Taxation - Case Study

Question 1

Hilary is a well-known mountain climber. The Daily Terror newspaper offers her $10,000 for her life story, if she will write it. Without the assistance of a ghost writer, she writes a story and assigns all her right, title and interest in the copyright for $10,000 to the Daily Terror. The story is published and she is paid. She has never written a story before. She also sells the manuscript to the Mitchell Library for $5,000 and several photographs that she took while mountain climbing for which she receives $2,000.

Requirement:

Discuss whether or not the three payments are income from personal exertion. Would your answer differ if she wrote the story for her own satisfaction and only decided to sell it later?

Question 2

Your client is a parent who lent $40,000 to her son to provide a short-term housing loan. The agreement is that the son will repay $50,000 at the end of five years. Reconsider this question in light of the following facts. The loan was made to the son without any formal agreement and without any security provided for the sum lent. In addition, the client (the mother) has informed you that she told her son that he need not pay interest. However, the son repaid the full amount after two years and included in his payment an additional amount which was equal to 5% pa on the amount borrowed. Only one cheque was presented for the total amount.

Requirement:

Discuss the effect on the assessable income of the parent.

Question 3

Scott is an accountant who purchased a vacant block of land in Brisbane on 1 October 1980. On 1 September 1986, Scott built a house on the land. At the time, the land was valued at $90,000 and the cost of construction was $60,000. The property has been rented out since construction was completed. On 1 March of the current tax year, Scott sold the property at auction for $800,000.

Requirement:

a) Based on the information above, determine Scott’s net capital gain or net capital loss for the year ended 30 June of the current tax year.

b) How would your answer to (a) differ if Scott sold the property to his daughter for $200,000?

c) How would your answer to (a) differ if the owner of the property was a company instead of an individual?

1. The current case study is based on the determination of Hilary’s income from personal exertion. According to the case study it is understood that Hilary is permanent occupant of Australia and “under ITAA 1997” she shall be held liable to pay tax based on the taxable. As stated in the study, Hillary cannot be regarded as the professional writer however, she had narrated down her story of Mountain climber for the first time (Deutsch 2014). Hence, incomes or revenues derived from the sale of copyright story is assessed as CGT income. According to the case study, Hilary had formed an agreement with the Daily Terror newspaper by assigning her right, title and interest under the copyright for a sum of $10,000. Hilary did not owned the ownership of interest and copyright instead she submitted her ownership and interest under the agreed terms (Brody et al. 2015). As stated under “Section 393-10 of the Income Tax Assessment Act 1997” “Section 393-10 of the Income Tax Assessment Act 1997” the income derived by Hilary from the sale of copyright is classified as ordinary income that is earned for the service provided according to the terms of the agreement.

As evident from the case study, Hilary had transferred the ownership of her story and manuscript along with some photographs to the Daily Terror newspaper. Hilary’s manuscript and her photographs will be considered as her private assets. As held in the case of “Brent v FCT (1971) 125 CLR 418”, Hilary’s disposal of interest and copyright is considered as sale and the income derived from such sales considerations would be assessed as ordinary income (Beshears et al. 2015). Hence, sales proceeds of any such kinds of personal assets must be treated as CGT events. Hilary’s sale of manuscript and photographs to Daily Newspaper must be considered as CGT events. However as stated under “Section 15-2 of the Income Tax Assessment Act 1997”, if Hilary had written the story for her personal contentment and sold the same in the later stages then such transfer of interest and ownership would have been assessed under the CGT events (Chaturvedi 2015). 

2. The current case study is based on the determining the effect on the assessable income of the parents who had lent a sum of $40,000 to her son to assist him with short-term housing loan. As evident from the case study, the son would repay the sum of $50,000 after the end of five-year term (Barkoczy 2016). However, the amount borrowed was repaid by the son within the span of two years with an additional amount of $4000 ($40000 x 5% p.a. x 2 years) for the sum borrowed, nevertheless the parents had not asked for any certain sum of interest. 

Question 2

It is assumed that the parent had sacrificed the amount  for a term of two years and the receipt of additional amount by their son can be assumed as the interest income. As stated under “Section 6 subsection (5) of the Income Tax Assessment Act 1997 in the form of interest income”, the supplementary amount can be considered as assessable income for the parents with taxation purpose (Woellner et al. 2014). It is noteworthy to denote that loan provided to her son did not contained any kind of formal agreement or security sum. Hence, the loan amount can be presented as financial assistance to her son and the parent can declare that additional income does not forms the part of borrowings. As stated under “Section 6 Subsection 5” the additional amount will not be assessed as ordinary income (Taylor and Richardson 2013).

The loan provided to her son was to assist her in acquiring house and it was entirely based on short-term. In the current case, if the son decides to claim deduction for the supplementary amount made to her parent, then the parent will also have to declare the supplementary sum received from her son in her assessable income (Cao et al. 2015). Therefore, the additional amount will then be treated as the interest income.  

3. A: Net Capital gains under normal situation:

The current study is based on the determination of net capital gains or net capital loss for the year ended 30 June in the existing taxation year. Scott is presumed to be the Australian inhabitant and did not indulged in any kind of trading of real estate. The land and building will be considered as his private assets it will not be regarded as trading stocks (Saad 2014). The net capital gain or loss arising out of the disposal of land by Scott is computed on the below stated assumptions;

Scott acquired the land prior to 20^th September 1985. This constitute as the pre-CGT asset and it will be exempted from the CGT taxation.

The construction building was made following 20^th September 1985, and it will be considered as Post-CGT asset (Tanzi 2014). The Capital Gains Tax will be computed based under the proportionate selling price of the building. The selling price of the building stands $320000 [$800000 x $60000/($60000+$90000)].

As evident that building was constructed prior to 20^th September 1999, in order to determine the cost base of the building indexation method is put into the use (Auerbach and Hassett 2015). However, Scott can also make the use of discounted method of CGT computation. Under such circumstances, it is suggested that Scott must compute the CGT based on both the indexation method and discounted method.

Question 3

Under the above stated both the methods will help in lowering the amount of tax for Scott (Highfield and Warren 2015).

Below stated computations represents the net capital gains or loss based on the sale of rental property are as follows;

From the above stated computation, it is Scott will be paying lesser amount of tax if he applies the discounted method determining capital gains tax (Barros, Teo and Hinchliffe 2016). Therefore, the net amount of capital gains on the disposal of rental property of Scott for the current year stands $130000. 

b) As evident from the study that, it Scott undertakes the decision of selling the property to his daughter at a lesser price, then the considerations for sales based on taxation purpose will be determined according to the market value of the property (Jacob 2016).

Since the property was sold at auction, the selling price at the auction will be considered as the market price of the building. Under such circumstances, the net amount of capital gain derived from the sale of property to his daughter will be similar to that stated above. 

c) If Scott decides to sell the property to any company, then under such circumstances the company has to work out the net capital gains based under the indexation method. Hence, the net amount of capital gains for such sales will be $222945. 

Reference List:

Auerbach, A.J. and Hassett, K., 2015. Capital taxation in the twenty-first century. The American Economic Review, 105(5), pp.38-42.

Barkoczy, S., 2016. Foundations of Taxation Law 2016. OUP Catalogue.

Barros, C., Teo, E.J. and Hinchliffe, S., 2016. Clash of the deeming provisions: Pre-CGT concessions, tax consolidation and policy in the federal court. In Australian Tax Forum (Vol. 31, No. 3, p. 509). Tax Institute.

Beshears, J., Choi, J.J., Hurwitz, J., Laibson, D. and Madrian, B.C., 2015. Liquidity in retirement savings systems: an international comparison. The American economic review, 105(5), pp.420-425.

Brody, E., Breen, O.B., McGregor-Lowndes, M. and Turnour, M., 2014. 5 An Unrelated Income Tax for Australia?. Performance Management in Nonprofit Organizations: Global Perspectives, 17, p.87.

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Deutsch, R.L., 2014. Australian Tax Handbook 2006.

Highfield, R. and Warren, N., 2015. Does the Australian Higher Education Loan Program (HELP) undermine personal income tax integrity?. eJournal of Tax Research, 13(1), p.202.

Jacob, M., 2016. Tax regimes and capital gains realizations. European Accounting Review, pp.1-21.

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Saad, N., 2014. Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, pp.1069-1075.

Tanzi, V., 2014. Inflation, indexation and interest income taxation. PSL Quarterly Review, 29(116).

Taylor, G. and Richardson, G., 2013. The determinants of thinly capitalized tax avoidance structures: Evidence from Australian firms. Journal of International Accounting, Auditing and Taxation, 22(1), pp.12-25.

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Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2014. Taxation of consolidated groups. In Australian Taxation Law 2014 (pp. 951-996). CCH.