Answer to scenario (I)
From the following case study, it is found that Marzena formed a contract to sell a separate block of land for a sales value of $79,000 that was originally purchase for $81,000. Income, which is held for tax, is regarded as assessable income. The profit generated from the sales of land subdivided land is regarded as capital gains and ordinary income in accordance with the situation (Barkoczy 2016)
- Taxation rulings of 92/3
- “Income Tax Assessment Act 1997”
- FC of T v The Myer Emporium Ltd(1987)
- Westfield Ltd v FCT (1991) 21 ATR 1398
Marzena had purchased a vacant land with the intent of building a front office but due to certain restrictions, she undertook the decision of selling the land. The land, which Marzena intends to sell, will be regarded as capital gains and it is subjected to capital gains tax. To assess the taxable income of Marzena the sum received from the sale of land will be treated in the ordinary course of business.
As stated under the “taxation rulings of 92/3” any income generated from the sale of land will be considered as the isolated transactions in relation to the ordinary concepts and usage of land is largely dependent upon the circumstances of Marzena. As defined under the rulings 92/3 it is understood that Marzena had entered into the contract with the purpose of generate profit (Woellner et al. 2014). Hence, the contract entered into by Marzena and the income generated from the ordinary course of business will be taken into the consideration for assessment as assessable income.
As stated under “Income Tax Assessment Act 1997” any income generated from the sale of subdivided piece of land will be regarded as capital gains or ordinary income as per the prevailing situations. Marzena decision of selling the separate piece of land and income generated from that land will be regarded, as ordinary income the original purpose of entering into the contract was to derive profit. Referring to FC of T v The Myer Emporium Ltd (1987) the amount of taxpayer at the time of issuing interest-bearing loan was treated as profit from the transactions (Taylor and Richardson 2013). The basic purpose of entering into such contract was make profit in the due course of taxpayers business.
As evident from the case study that Merzena actual intention was to generate profit from such undertakings. As defined under tax rulings of 92/3 the commissioner of tax had adopted wider approach of characterising the business gains derived from isolated transactions. Referring to the case of “Westfield Ltd v FCT (1991) 21 ATR 1398” the taxpayer is under obligations to contemplate means through which the profit was derived. The taxpayer in the current situation purchased land with the objective of designing and constructing a shopping centre (Thomson and Skali 2016). Hence, it was not held for assessment based on the capital account prior to making the choice of selling the land.
According to the current situation of Marzena the commissioner of taxation will assess the taxpayer for income generated from the sale of land in the form of income in accordance with the ordinary concepts.
Answer to question 2:
The following issue is concerned with the determination of whether government grant received by Toowoomba Pty Ltd would be held for assessment under cash or accrual basis under “taxation rulings of 2006/3 of income tax act 1997”.
- Subsection 29-40 (1)
- Section 6-5 of the income tax assessment act 1997
- Taxation rulings of 2006/3 of income tax
- Taxation rulings 2006/3
- Pipe Coaters Pty Ltd v. FC of T 90 ATC 4413
Toowoomba drilling Pty Ltd must account the income under the cash basis since the size of entity is relatively small and its annual turnover does not exceeds more than $2 million. “Subsection 29-40 (1)” defines that small entity executing the business activities and its turnover does not exceeding more than $2 million must account under cash accounting methods for amount of income that is earned during the accounting year (Cunningham 2016). As it is noticed in the case study that Toowoomba drilling Pty was regarded as the middle size business and its turnover did not exceeded beyond $1.5 million and with the objective of income tax Toowoomba drilling Pty can rightly account for its income under the methods of cash accounting. It is suggested that Toowoomba drilling Pty must opt for cash basis of accounting commencing from the first day of the taxation period.
As defined under the accounting for GST based on cash basis taxable goods made on cash Toowoomba drilling Pty must attribute the GST that is payable for the taxable period under which the considerations for supply is received (Carling 2015). It must be only restricted to the considerations of supply that is received during the taxation period.
Answer to Part II:
Grant that is received as the ordinary income can be assessed under “section 6-5 of the income tax assessment act 1997”. Ordinary income can be defined as those incomes, which is ordinary in concept. As stated under the “taxation rulings of 2006/3 of income tax”, payment received by industries in the form of government grants is to help the organisations to continue or start their business operations (Evans et al. 2014). From the current case study, it is evident that Toowoomba drilling Pty received a grant from government of $55,000 so that it can purchase the machinery to be put into the use of constructing new railway.
“Paragraph 139 of the taxation rulings 2006/3” defines that government paying to new business in order to help them in acquiring depreciating assets would not be held for assessment under the heads of ordinary income and therefore it will held for assessment under the statutory income. Taking into the considerations the fact of the current case study that must be addressed based on the association between the payment received and business activities.
The business activities of Toowoomba drilling Pty constitutes as to whether the government grants would be held for assessment under the heads of ordinary income or statutory income. The grants that is received by Toowoomba does not forms the part of ordinary course of business enterprise and the funds provided must be used in the construction of depreciating assets. Referring to the case of “Pipe Coaters Pty Ltd v. FC of T 90 ATC 4413” the sum received by Toowoomba will be considered as subsidy that has increase the capital of payee and cannot be regarded as the product of incident of ordinary income (Evans, Minas and Lim 2015). The income funding constitute statutory in nature and it will be derived in the income year 2017.
Part B: Small Capital Gains Tax
The current study is based on the critical evaluation of the small business capital gains tax concession defied under “division 152” of the income tax assessment act 1997. The Income Tax Assessment Act is defined as the most complex constituted of legislation of tax (Yates and Yanotti 2016). The small business capital gains tax concession was created so that it offer relief in the areas of capital gains to small business. A widespread research has represented that small business capital gains tax concession offers huge sigh of relief to small business those are rich in assets and appears to be deep-rooted into the system of income tax in Australia. It is noteworthy to denote that taxpayers of small business concurrently gets concession in the areas of retirement and roll over reliefs. It appears challenging to validate the small business capital gains tax concession because they presently spread further than the provision of retirement and roll over relief.
The small business capital gains tax concession has largely penetrated through the four principles of tax policy that is economic effectiveness, equity, simplicity and fiscal adequacy. The explanatory memorandum, which escorted the legislation of tax, lays down the best equivocal foundations such kinds of organisation (Miller and Oats 2016). In addition to this, it is debatable to define the theory of small business since there appears to be easy way of drawing the limit with no kinds of rule to provide justification of doing so. In general due to the current prevailing problems, there is yet a requirement for official evaluation on the procedure to justify the small business concession.
The justification of policy regarding the small business capital gains tax concession is evaluated based on the standpoint of four better accepted procedure of deciding tax criteria. These policies are economic effectiveness, equity, simplicity and fiscal adequacy. As opined by Cave and Williams (2015), in order to maximise the communal wellbeing the above stated tax policies are put into use as an ideal theory of tax. It is worth mentioning that the earlier regime faced criticism by Brander and Hellmann (2014), for being very multifaceted. Numerous treasurers have expressed their opinion that the process of concession reformation may provide assistance to small business by encouraging investment through constant lending of support. This forms one of one the major contributor of economy. As defined under division 152 the improved series of concession provides 15-year exemptions to business assets while sub-division 152B lessens the percentage of active asset to 50 per cent. In addition to this, sub-division 152-C brings forward the exemption in retirement whereas sub-division 152-D and Sub-division 152-E has presented capital gains tax rollover (Lignier, Evans and Tran 2014).
In the year 2005, following the application of division 152 the board of taxation received numerous submissions, which brought forward several irregularities. To provide more familiar environment of tax to small business the board of taxation made subsequent recommendations (Schenk, Thuronyi and Cui 2015). The recommendations comprised of increasing the incentives of small business in order to increase their capital and increase their return by reducing the cost of compliance and lessening down the intricacy.
According to Brander, Du and Hellmann (2014), in order to widen the scope of division 152 it was subjected to series of amendments. As defined under division 152, to reduce the capital gains from CGT event a taxpayer is necessarily required to satisfy the basic circumstances revolving the implementation of small business capital gains tax concessions. A small business enterprise is necessarily required to meet the conditions of $6 million test which is notified under para 152-10 of ITAA-1997. Additionally, as stated under sub-division if the CGT assets that are disposed by the enterprises are the part of enterprise or trust then the enterprise is bound to satisfy the concession stakeholder test (Freebairn 2016). On meeting the above stated criterion, the four generous small business capital gains tax concessions the ITAA 1997 will be applicable.
As stated by Lynch and Goeringer (2014), the multifaceted rules of division 152 continous pose significant amount of challenge for small business along with the tax practitioners to uphold the eligibility. As the size of concession is large and in depth examination of the study provides a critique based on the criterion of vital policy of tax. As reviewed by Jacob (2016), the above stated tax criterion forms the most vital part in the formulation of rule in the existing procedure of tax reformation. Several research have stated that administration of tax must be assessed depending upon the reference of simplicity, efficiency and equity.
As defined, division 152 possess rationale that is based on the foundations of economic efficiency equity, and simplicity because their core purpose is to assist the small business with the help of CGT relief and encouraged economic growth. Another objective was to provide small business with concession and enhancing the business delivery at the same time by streamlining the concession (Mehrotra and Ott 2015). However, division 152 has been critiqued based on the foundations of fiscal policy. Other rationale that included the concession was based on the importance of small business to the economy. This comprised of addressing the failures in market and making sure that small business sustains themselves in the events that looms to break them up.
According to Kopczuk (2017), the owners should control small business because they contributes significant amount of capital in business. The principle of decision-making system must rest with the owners and managers. For practical reasons qualitative definition of small business is regarded as unsuitable since the objective and measurable criteria is necessary in the legislation. Using the quantitative measures brings forward the problems of determining the parameters of sales, profit and number of workforce. It is worth mentioning that different parameters will provide different outcome for small business. There is no such apparent manner of executing work when the business is small. One of the dilemmas, which is experienced by the Australian business, is quantitative measures based on the turnover and value of assets.
Prior to 1st July 2007, a large number of small business tax concessions have made the adoption of distinct parameters that was solely responsible for the creation of complexity and uncertainty. For example, the previous systems of simplified tax usually needed an average turnover of $1 million STS with depreciating test of assets comprising of $3 million (Storey 2016). In contrast to this, the small business concessions were offered with different test. In the year 2005, the federal government established a taskforce, which was aimed at lessening the regulatory weight from small business. Subsequently, under the framework of commonwealth taxation a small business enterprise was established that could harmonise the definition of small business for numerous tax concession. The STS depreciating asset was test was detached and the $2 million aggregate turnover was substituted with $1million turnover test. This signified that large size business would qualify for SBE having lower value of depreciating asset.
As stated by (Cavusgil et al. 2014) the average turnover test must be raised to $5 million. Locating parameters holds the complications of manipulation because owners of business have to restructure their business in order to gain the access of small business concession. Overall it is found that there is no such concession on small business and there is hardly any kind of suitable concession on the parameters. A large number of parameters is required to appropriately identify the small business to prevent manipulation but with large volume of parameters, there is higher greater degree of complexity.
As evident from the above stated argument that small business is vital for economic growth because is assists in employment creation, generation of wealth and contributes significantly in the innovation. As opinion by Kotey and Sorensen (2014), it is reviewed that only small portion of small business creates employment opportunities. This creates the way for impossible difficulties of tax concession. According to Lewis, Richard and Corliss (2014), the regime of Australia’s SBE small business, concession is applied only on the small business. Under such types of regimes, small businesses that hardly experiences growth will gain the benefit of such scheme. In addition to this, business that functions under the lifestyle and hobbies will also gain the benefit of tax concession. As evident from the above stated discussion, the small business capital gains tax concession will lead to restructuring and manipulation of small business in order to qualify themselves to gain undue advantage of tax, which ultimately leads to tax avoidance. It is worth mentioning that tax concession at targeted size is regarded as dull toll and hardly focuses on creation of employment.
Factors such as innovations appear to be more appropriate since these businesses are more probably to achieve growth. As noted by James, Sawyer and Wallschutzky (2015), recognising these types of business is not an easy job as difficulties exists in the success or failures of the business. As reviewed by Valadkhani, Chen and Kotey (2014) if the procedure of targeting is not adequate then there will be problems of allocation of resources. This will ultimately give way for lower productivity and this will force the small business to make over their investment made in CGT assets for the purpose of tax instead of opting of efficiency.
With the prevailing power of monopoly, small business may face market failures. Making an entry into the market will be hard because the size of firms is comparatively smaller with lower capital (McKeehan and Zodrow 2016). Numerous survey have argued that tax concession as small business capital gains tax is required for encouraging investment in small firms. Furthermore, this will help in lessening the spill over effects in the economy arising out of innovative acts of small firms. As stated by Henrekson, M. and Sanandaji (2016), the issue of investment forms wider concern and defined a principle where tax concession are warranted to correct the market failures.
According to Kotey and Sorensen (2014), tax concession have restricted role to play in dealing with market failure. Although the difficulties of small firms are sufficient to warrant the government actions however, OECD recommends that non-tax measures should be targeted instead of measures of levy. Small business capital gains tax relief are capped depending upon the size of firm because tax concession may limit the growth of small business. Designing a simple system of tax will better serve the needs of business and economy. As opinion by Wallschutzky (2015), retirement or death of owners might lead to closure of business and employment loss. Therefore, small business capital gains tax forms vital for small business upon the death of owner. An argument put forward by (Storey 2016), there is a benefit from inter-generational succession but studies suggest that there is no concrete evidence to support this. Survey suggest that small family business or publicly traded firms that have appointed their male child as CEO have not turned out to be fruitful.
The above discussion states that there are four types of CGT concession are prevalent in Australia. Nevertheless, such CGT concession may result in asset being acquired for tax planning rather than using it for optimal business purpose. As opinion by Kopczuk (2017), offering relief from capital assets to small business appears to be more likely of resulting in distortion and demands for additional relief.
To evaluate the small business tax concession in terms of their impact on the horizontal and vertical equity is evaluated as this assists in determination of a person’s capability to pay. Studies have suggested that horizontal equity holds the subject of central significance and the Australian tax enquiries have provided their support in this matter. Taking into the considerations the Australian progressive rate of marginal income tax system, vertical equity is observed as the subject of central significance (Kotey and Sorensen 2014). There are certain polices that favours some kinds of small business that has substantial amount of active assets and gains high amount of CGT benefits. This results in huge amount of inequity inthe tax system of small business capital gains.
The probability of breach in vertical equity is high since the higher income group and wealthier taxpayer’s controls significant number of small business. Persons that generates high income from the small business will be able to gain benefit from small business concession because of the top marginal income tax rate of 49 per cent for the income year ending 30 June 2016 (Storey 2016). Research have pointed out that concessions will additionally provide benefit to those wealthier and high income group of taxpayers since they can afford to gain access of the professional advice as to when they can gain the benefit of tax concession. On the other hand, individuals with low-income taxpayers and small business with small start-up fund with lower rate of marginal tax will only gain small benefit from the small business capital gains tax concession since they are faced with regressive amount of compliance cost.
Based on the grounds of equity an argument has been put forward that states that small business must receive tax relief in the areas of retirement and roll over relief because of the obtainability of superannuation to the employees along with roll over relief for other business as well. A reduction of 25 per cent in retirement concession results breach of equity in small business capital gains tax concession (Jones 2015). As originally stated in division 152 concession faced criticism for its inequality since it was evident during the submission to the taxation board review in 2005. At the time of submission to the taxation board, it reflected irregularities and circumstances where no kind of tax relief was provided to the small business. Consequently, certain amendments were made in order to address the irregularities of the small business due the existence of technical issues.
As evident from the above stated discussion that the cost of tax compliance are noteworthy and they heavily fall on the small business. In relation to simplicity Jacob (2016), has noticed that division 152 that was originally enacted has failed to meet the criteria that was set in the tax policy. It reflected inadequacy in the clarity of rules towards small business and as evident from the study small business capital gains tax is regarded as one of the highest contributor of intricacies in the rules of capital gains tax. The study further lays down that division 152 is subjected to wide set of amendments because these amendments helps in widening up the scope of division 152 rather than simplifying the operations.
According to Mehrotra and Ott 2015) a large number of small business tax practitioner have found that clients often finds it difficult to understand the theory of small business capital gains tax concession. Survey performed by numerous scholars have found that there is poor awareness among the tax practitioners towards small business capital gains tax concession because they perceive this notion to be difficult to understand. Studies have pointed out that benefit of tax derived by the business goes further than the additional cost of compliance and these types of concessions is regarded as one of the most pursued considerations while providing recommendations on structure of business. The discussion lays down the reflection of difficulties that forms a substantial obstacle for small business to obtain the access of concession defined under division 125.
The small business capital gains tax concession was considered to be the expensive affair since it was noticed that anticipated tax spending comprised of $1,185 million for the year 2015-16. The amount of exemption for capital gains based on the small business retirement comprised of the amount of $430 million for the year 2015 (Cavusgil et al. 2014). In contrast to this, the exemption amount of small business assets that was held for more than fifteen years stood $2058 million with reduction in small business capital gains tax stood $550 million.
The structure of small business capital gains tax is designed in such a way that it offers ample amount of relief to numerous business that are rich in asset. It appears to be better embedded in the Australian taxation system given that the taxpayers beside small business also obtained the concession relating to their retirement and roll over relief. Although division 152 has gone a series of amendments in terms of past reviews there is yet prevailing circumstances of multifaceted midpoints that needs cautious attention (Kotey and Sorensen 2014). It appears to be needlessly complicated with large number of difficulties and irregularities, which is still present. Division 152 is regarded as inconsistent with the policy of simplifying the law and helping small business. Because of complex requirements and dynamic nature of small business it has resulted in uncertainty as whether numerous small business can pay for current multifaceted professional guidance.
The existing form of small business capital gains tax concession has made it difficult to defend because they are very expensive to the community and have usually breached all the four criteria of tax namely economic efficiency, equity, simplicity and fiscal adequacy. The descriptive memorandum accompanying the legislature of tax concession has represented vague rationales for large number of these reformations. As opined by Lewis, Richard and Corliss (2014), there is a little evidence to recommend that purpose of policy has been undertaken seriously. In addition to this, defining a small business is generally not considered as easy because there is no easy process of drawing a line and normally there is no need of overall justification of policy. Generally, it is apparent from the problem that there is a need for formal review of procedure so that it can vindicate the small business tax concession.
The above stated discussion has provided an in depth overview of the small business capital gains tax concession as there are large number of small business rich in assets is rooted in the Australian taxation system. The study evidently provides that it is difficult to justify the small business concession in their existing format because the provision goes beyond the roll over and retirement relief. The discussion has pointed out the unclear rationales for tax reformation and has even provided justification of the difficulties existing in small business. The discussion has critically stated that there is need for formal review so that it can rationalise the tax concession of small business.
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