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1. Identify and analyse relevant issues;
2. explain and apply relevant cases, rulings and legislation

Applicable Legislation and Principles

The key issue in the given scenario is to ascertain the appropriate tax treatment of following three transactions with regards to taxpayer Amber.

1) Sale of boutique chocolate shop with special reference to the potential CGT (Capital Gains Tax) implications.

2) Proceeds from restrictive covenant imposed during sale of business - Capital proceeds or revenue proceeds?

3) The sale of inner city one bedroom apartment with particular reference to inheritance of capital asset and the computation of potential CGT implications that may arise.

Law and Application

In the given section, the transactions enacted by Amber would be analysed in light of relevant legislation, tax rulings and case law to determine the applicable taxes.

The definition of capital assets is highlighted in s. 108-5 ITAA 1997 which includes amongst other assets goodwill along with plant & machinery that may be used in business. However, the same cannot be said about trading stock which as per s. 70-10 ITAA 1997 s used in the business and would be essentially converted into final goods which would be sold to consumers (Coleman, 2015). As a result, s. 118-25 ITAA 1997 states that any capital gains or loss that tends to arise on account of a CGT event would be disregarded if the underlying asset is trading stock. This is because trading stock is part of the business and hence any profit or loss arising from the same would be reflected as assessable income in accordance with s. 6-5 ITAA 1997.

With regards to s. 104-5, whenever there is a disposal of a capital asset, then it corresponds to event A1. In such cases, the capital gains or losses would be derived by subtracting the cost base of the underlying asset from the sales proceeds of the asset (Reuters, 2017). Additionally, for the computation of capital gains that would be subject to 30% CGT, there are namely two methods i.e. Discount Method and Indexation Method. The taxpayer has the choice to use either of the two methods so that the CGT liability can be minimised. The discount method as outlined in s. 115-25 ITAA 1997 provides 50% discount on the capital gains provided the asset has been held in excess of one year. No discount under s. 115-25 can be availed for assets which are held for less than a year (Deutsch, Freizer, Fullerton, Hanley & Snape, 2015).  In case of indexation method, revised cost base is used for the computation of capital gains.

The first critical aspect is that the proceeds that Amber receives with regards to the business assets would be capital proceeds and hence no tax would be applicable on these proceeds. However, for capital gains made on the various assets related to the shop, CGT may be applicable in accordance with the discussion carried out above. With regards to shop, there are different assets which need to be segregated particularly with regards to presence of trading stock (Reuters, 2017).

With regards to goodwill, the proceeds from sale are known and also the cost is given with regards to the shop. As a result, the capital gains can be derived in accordance with s. 104-5 and event A 1 (Deutsch, Freizer, Fullerton, Hanley & Snape, 2015). Further, the discount method would be applied in order to compute the taxable capital gains since the shop was purchased in 2010 and sold in 2018 thus making the resulting capital gains as long term.

Sale of Boutique Chocolate Shop

In relation to the equipment, the capital gains or capital loss would be derived by considering the sale value of equipment and the book value of equipment at the time of sale. This is imperative since depreciation is charged on the equipment and hence the original cost cannot be considered for capital gains computation. Also, discount method would be applied in this case since capital gains are long term.

In relation to the trading stock with the shop, capital gains would be disregarded in line with s.118-25 ITAA 1997 and thus these no capital gains would be levied on the same.

The key issue with regards to restrictive covenant is to determine whether the underlying proceeds would be capital or revenue in nature. This is imperative so that it can be ascertained whether the receipts are revenue or capital. This is essential as revenue receipts would be taxable but the same is not true with regards to capital receipts. A relevant case law is Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 where there was an agreement between parties whereby right to sue was not allowed (Nethercott, Richardson & Devos, 2016). A critical aspect highlighted was that if a payment has been derived with regards to restricting a legitimate right that the taxpayer has, then the underlying proceeds would be capital in nature. The same logic can be extended to restrictive covenant which prohibit the seller of a business from opening a business in certain geography and for certain time and hence restraining the legitimate right the seller has to open a new business. Therefore, the proceeds derived from the same would be capital in nature which has also been supported by tax rulings TR95/35 and TR 94/D33 (ATO, 2018).

In the given case, Amber has received an additional sum of $ 50,000 for signing a separate contract with the buyer of the business whereby she is not allowed to open a similar business within the radius of 20 km from the shop sold for a period extending to 5 years. It is apparent that the restrictive covenant tends to restrict the rights available to Amber with regard to opening shop and hence the proceeds from this contract would be capital in nature on which no tax would be applicable. However, CGT may apply on any capital gains that may be related to the contract.

As per s.149-10 ITAA 1997, any capital asset acquired before September 20, 1985 would be considered as pre-CGT asset and the capital gains tax would not be applicable on any capital gains or losses arising from the sale of such asset irrespective of holding period and the quantum of capital gains (Nethercott, Richardson & Devos, 2016). In relation to deceased estates, it is imperative to note that CGT implications before the death of the concerned owner are disregarded.  Also, even though the estate is inherited but the market value at the time of death tends to serve as the cost base of the asset so that any CGT liabilities that may arise from the sale of the asset may be computed. Also, with regards to TR 94/29, in situations where the contract for sale is signed or executed in a given year but proceeds are obtained in the next tax year, the CGT is payable in the same year when the sale contract is executed and the CGT liability ought to be computed in accordance with the contract sale terms as set in the sale contract (Kreyer, 2016). As per Division 118-B main residence exemption is available when the taxpayer tends to use the given house as main residence. In case of deceased estates, this benefit is extended to the taxpayer who has inherited the property  (Hodgson, Mortimer & Butler, 2016).

Proceeds from Restrictive Covenant

Based on the given case facts, it is apparent that Amber has inherited the property from his uncle in October 2013. Since the property was purchased after 1985, hence the given asset is not a pre-CGT asset. However, it is noteworthy that Amber’s uncle purchased the house in 1992 and had resided in the same house till his death. As a result, it may be concluded that Amber’s uncle used the house as main residence. Further, Amber has continued the same since from the time of inheritance, she has resided in the house thereby making it the main residence. As a result, there would not be any capital gains tax on the sale of house in accordance with Division 118-B which provides the main residence exemption.  Besides, the proceeds from the house sale are capital in nature and thereby non-assessable for tax purposes.

Conclusion

Based on the above discussion, it may be concluded that Amber would have to pay capital gains tax on the sale of the chocolate shop but same would pertain only to the equipment and goodwill. Any capital gains or loss on the trading stock would be disregarded. Further, the proceeds from contract enacting the restrictive covenant would be capital in nature and hence non-taxable . However, the capital gains if any on these would have to be computed and CGT may be applicable. In relation to the sale of the inherited one bedroom house, it is apparent that the main residence exemption would apply owing to which no CGT would be applicable on the capital gains or losses derived from the sale of house. Further, the proceeds from house sale are capital and thus non-taxable. 

The objective of the given task is to highlight the tax implications for both the employee (Jamie) and employer (Houses R Us) with regards to the various benefits that have been extended. The key issues would be as follows.

  • Determine whether a given amount is assessable income for Jamie under s. 6-5 or s. 6-10 ITAA 1997.
  • Determine whether Jamie can have any tax deduction with regards to the interest paid on loan amount.
  • Determine whether the given amount spent by the employer would be tax deductible under s.8-1 and other suitable provisions.
  • Determine the FBT (Fringe Benefit Tax) related liability on Jamie and employer with regards to car for personal use and also loan provided at subsidised rate.

Law & Application

The discussion of the various amounts paid to the employee or spent by the employer pertained to Jamie is carried below.

Employee – For Jamie, the above income derived on the basis of the employment contract would be considered as employment salary for her services as a real estate agent. Additionally, there is a 10% commission which is also linked to the given employment only. Hence, both these payments would be considered as ordinary income under s.6(5) ITAA 1997 (Austlii, 2018e). As ordinary income is one of the components of assessable income, hence the given amount would be subject to personal income tax on part of Jamie.

Employer – In accordance with s. 8-1 ITAA 1997, any outgoing or loss which is incurred for production of assessable income is deductible (Barkoczy, 2017). However, ss. 8-1(2) prohibits tax deduction for capital expense, private expenses and expenses for non-assessable income production. The given expenditure in the form of salary and commission would be revenue expenditure for gaining assessable income and hence tax deduction for Houses R Us can be claimed.

In accordance Division 2, Fringe Benefit Tax Assessment Act 1986, if the employer provides a car to the employee for personal use, then it would amount to extension to car fringe benefits. The fringe benefit tax on the same would be payable by the employer in accordance with s. 9 FBTAA 1986. However, no fringe benefit tax or any other tax arises for the employee (Austlii, 2018c).

Sale of Inner City One-Bedroom Apartment

Employee – It is apparent that the employer has provided a Toyota Kluger to Jamie and the same is not only used for work purposes but also on weekends and for personal purposes. Also, the operating expenses are paid by the employer only and hence no deduction in this regards would be provided for the employee. Besides, no tax burden on account of car fringe benefit is levied on to the employee Jamie.

Employer – The employer would have to pay FBT on the car fringe benefit which are computed in accordance with s. 9 as per the following formula can be used (Austlii, 2018b)

Base value of the car would be $ 48,000 while the additional data depending upon availability of private usage can be filled in to determine value of car fringe benefit. Further, this can be used to determine the grossed up taxable value on which FBT would be applied.

Also, deduction for the running cost of the car would be deductible under s. 8-1 to the extent the car is used for business purpose (Austlii, 2018d).

In accordance with FBTAA 1986, portable electronic devices such as laptop, mobile which are provided to the employee with regards to fulfilling the work requirements are exempt from any FBT (Sadiq, et. al., 2015).

Employee – For the employee Jamie, mobile and laptop have been provided to assist in work. The FBT would not arise on Jamie and also the amount of these devices would not contribute to assessable income as these have not been derived on account of any salary sacrificing arrangement.

Employer – For the employer, no FBT implications would arise on providing mobile and laptop to Jamie since these are exempt from FBT. Further, the expenditure incurred under mobile and laptop would be capital and not revenue and therefore deduction under s.8-1 will not be available for the employer for capital expenses pertaining to laptop and mobile. However, decline in value for these depreciating assets may be charged by the company during the useful life of these assets and this would be a deductible expense.

Employee –As per TR 92/15, for assessable income to be produced, it is essential that the employee must gain some economic profit (Sadiq, et. al., 2015). However, in the given scenario Jamie has been merely obtained reimbursement for the subscription of a magazine which is related to his profession. Since, there is no expense or benefit derived on part of Jamie, hence no tax implications would arise for him on account of the given transaction.

Employer – With regards to the employer, there has been an expense in the form of subscription fee. Also, it is related that this is with regards to assessable income production. Owing to sufficient nexus between the expense and the assessable income production, deduction for this expense would be given to employer as per s. 8-1 ITAA 1997 (Barkoczy, 2017).

As per TR 92/15, allowance is defined as a payment whose quantum is predefined and is provided to meet an estimated expense irrespective of the fact whether any expense has been made on the same or not.

CGT Implications of Pre-CGT Assets

Employee – The entertainment allowance to the extent of $ 2000 per year would be assessable income for the employee considering that he will receive $ 2,000 from the employer irrespective of whether any expense on entertainment has been incurred or not. Therefore, economic benefit would be derived on which income tax would be payable.

Employer – The entertainment allowance would be a business related revenue expense with sufficient link to production of assessable income and hence tax deduction under s.8-1 is permissible for the employer.

One of the components of assessable income is statutory income as per s. 6-10 ITAA 1997. The various non-cash benefits that may be derived would be considered as statutory income if the same can be linked to income production activity. This is in accordance with s. 21A  ITAA 1997 highlights that even though the non –cash benefit may not be convertible to cash but it would be assumed to be cash convertible and contribute to assessable income (Austlii, 2018a).

Employee – It is apparent that the home entertainment system has been presented to Jamie owing to the ensuring that he had the highest sales of all employees during the six month period. Clearly, this is linked to his job and hence the value of the home entertainment system would be assumed as statutory income and therefore would contribute to assessable income of the employee Jamie.

Employer – The underlying expense of the home entertainment system would be an expense related to employee benefits which are imperative in order to produce assessable income and hence general tax deduction under s. 8-1 is permissible for the employer.

One of the key benefits that employers provide to their employee is in the form of personal loans which are either provided at zero interest or at substantially low interest rate. This may pave the way for extension of loan fringe benefits (Austlii, 2018c).  As per division 4, Part III FBTAA 1986, if the employer provides loan to employees at a rate which is lower than the corresponding rate that is prescribed by the RBA (Reserve Bank of Australia), then loan fringe benefit has been extended to the taxpayer. For the year 2017/2018, the benchmark interest rate decided by RBA is 5.25% p.a. as highlighted in TD 2017/3. As a result, extension of loan below this rate would result in interest savings for the employee which essentially highlights the quantum of loan fringe benefit on which then the FBT liability for the employer would be computed.

Employee – Jamie has obtained loan amount to the extent of $ 100,000 from the employer to build his first home. The interest rate levied on the loan amount is 4% p.a. which clearly implies that loan fringe benefits have been extended to Jamie. However, in this regards no tax implications would arise for Jamie. But, Jamie is paying interest on the home loan taken from the employer and hence it needs to be ascertained if tax deduction can be availed by Jamie in regards to the interest paid. Considering that the house being constructed is first time home, hence it is likely that the same would be used for residence purpose and not for renting. As a result, if the house does not produce any assessable income through rent, then interest payments made by Jamie cannot be deducted under s. 8-1 ITAA 1997 (Austlii, 2018 d).

Employer – With regards to the employer, it is apparent that the interest rate charged to the employee is lesser than 5.25% p.a. which provides evidence of extension of loan fringe benefits. The amount of these benefits would be equal to the interest savings that employee would receive during the year. This would then be multiplied with the suitable gross up factor for ascertaining the taxable value of loan fringe benefits on which FBT rate would be levied to determine the FBT liability for the employer. Also, deduction of the interest would not be available for the employer since Jamie is not using the same for production of taxable income.

Conclusion

Based on the above discussion, the following conclusion may be drawn.

  • Base salary and 10% commission is assessable income under s. 6-5 for Jamie. Deduction under s. 8-1 can be availed by taxpayer on the complete amount.
  • Car provided by employer for personal use would result in FBT on employer with deductions under s. 8-1 for operating expenses for business use only. No tax implication for employee.
  • The mobile phone derive and laptop are FBT exempt devices and hence no tax implication for employee. The employer can claim decline in value of these assets as tax deductions.
  • Annual subscription reimbursement would be tax deductible expense under s.8-1 for employer with no tax implication for employee.
  • Entertainment allowance leads to assessable income for taxpayer Jamie with corresponding s. 8-1 deduction for the employer.
  • Home entertainment system cost would be assessable income for employee since it is a type of statutory income and tax deductible for employer under aegis of s. 8-1 ITAA 1997.
  • Loan fringe benefits have been extended to employee and hence FBT would be charged on employer. No tax implication for Jamie, the employee. The interest paid on the loan to employee cannot be deducted for tax purposes by Jamie considering that the house is expected to be used for his own residential purpose rather than income generation.

References  

ATO, (2018) TR 95/35.Income Tax : Capital gains: treatment of compensation receipts. Retrieved from https://law.ato.gov.au/atolaw/view.htm?locid=txr/tr9535/nat/ato 

Austlii, (2018 a) Income Tax Assessment Act 1936- SECT 21 A. Retrieved from https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s21a.html

Austlii, (2018 b) Fringe Benefits Tax Assessment Act 1986- SECT 9 Taxable Value of Car Fringe Benefits – Statutory Formula. Retrieved from https://www7.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/fbtaa1986312/s9.html 

Austlii, (2018 d) Income Tax Assessment Act 1997-SEC 8.1. Retrieved from https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s8.1.html 

Austlii, (2018 e) Income Tax Assessment Act 1997-SEC 6.10. Retrieved from https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s6.10.html  

Austlii, (2018c) Fringe Benefits Tax Assessment Act 1986. Retrieved from https://classic.austlii.edu.au/au/legis/cth/consol_act/fbtaa1986312/ 

Barkoczy, S. (2017) Foundation of Taxation Law 2017 (9th ed.). North Ryde: CCH Publications.

Coleman, C. (2015) Australian Tax Analysis (4th ed.). Sydney: Thomson Reuters (Professional) Australia.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., & Snape, T. (2015) Australian tax handbook.  (8th ed.). Pymont: Thomson Reuters.  

Hodgson, H., Mortimer, C. & Butler, J. (2016) Tax Questions and Answers 2016 (6th ed.). Sydney: Thomson Reuters.

Krever, R. (2016) Australian Taxation Law Cases 2017 (2nd ed.). Brisbane: THOMSON LAWBOOK Company.

Nethercott, L., Richardson, G., & Devos, K. (2016)  Australian Taxation Study Manual 2016. (8th ed.). Sydney: Oxford University Press.

Reuters, T. (2017) Australian Tax Legislation 2017 (4th ed.). Sydney. THOMSON REUTERS.

Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., & Ting, A. (2015) Principles of Taxation Law 2015 (7th ed.). Pymont: Thomson Reuters.

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