1. Amber owned and operated a boutique chocolate shop in Sydney that she purchased for $240,000 in August 2010. The purchase price consisted of equipment and stock worth $110,000 and the balance being goodwill. Following the birth of her child, Amber decided to sell the shop in February 2018 for $440,000 of which $280,000 was attributed to goodwill.
Amber was also required to sign a contract restricting her from opening another similar business within a 20km radius for the next 5 years. She received an additional sum of $50,000 for this contract.
Due to their expanding family, Amber and her husband purchased a four bedroom home in the outer suburbs of Sydney in June 2018. The purchase was partly funded by the sale of the business but also by the sale of Amber’s one bedroom inner-city apartment. Amber had lived in the apartment since she inherited it from her Uncle in October 2013. He had purchased it in September 1992 for $180,000 and lived in it until he died. At the time of his death the apartment was valued at $390,000. Amber signed a contract for the sale of the apartment in May 2018 for $550,000 and settlement took place in July 2018.
Advise Amber of the taxation consequences of these transactions. You are not required to calculate any capital gains or losses.
2. Jamie is a real estate agent working for ‘Houses R Us’ real estate. As part of his employment contract, Jamie receives a base salary of $50,000 per annum plus 10% of the agency’s commission on sold properties where he has had a direct connection with the sale. He is also provided with a car, a Toyota Kluger costing $48,000. He is not required to contribute to the running costs of the car which total $13,500 per year and is allowed to use the car outside of work hours and on weekends.
Jamie's salary package also includes a laptop which cost $2,300 and a mobile phone costing $1,200 per year. His employer also reimburses his annual professional subscription of $550 and provides him with an entertainment allowance of $2,000 per year.
Jamie was also lucky enough to achieve the highest sales for the previous six month period and was rewarded with a high tech home entertainment system worth $4,800.
‘Houses R Us’ also offer their staff loans of up to $100,000 towards purchasing their own house at a rate of 4% per annum. Jamie is considering taking up this offer to purchase his first home.
Advise Jamie and ‘Houses R Us’ of the taxation and FBT consequences of these transactions. You are not required to calculate any FBT liability.
As per the case facts outlined, Amber has enacted certain transactions involving sale of certain assets and other contractual agreements. In this background, it is essential to outline the various tax liabilities that would potentially arise for Amber. The various issues in this regards are indicated below.
1) Owing to liquidation to chocolate shop, proceeds would be obtained and it needs to be outlined if capital gains tax would be applicable on any or all of these assuming the proceeds are capital.
2) Owing to the contract regarding restrictive covenant, proceeds would be realised and it needs to be analysed if this is revenue or capital and suitable taxation treatment discussed.
3) Owing to the apartment sale, the tax treatment of the proceeds and potential capital gains implications of the same.
The relevant law keeping in mind the various transactions have been discussed as indicated below.
The first critical question that arises with regards to certain assets is whether these can be labelled as capital assets or not. To answer the same, s. 108-5 ITAA 1997 is relevant since it lists down the various capital assets from the perspective of taxation. A noteworthy aspect as per this section is that capital assets does not consist of only tangible assets but also consists of intangible assets (example: goodwill) (Woellner, 2015). Identification of assets as capital assets is a key step as for a capital asset the proceeds arising from sale would be capital and hence tax free. Thus, in case of capital assets sale, the only potential tax implications can arise on account of loss or gain in capital owing to higher or lower cash proceeds when compared with the cost base. Another vital point to note is that in case of trading stock any capital gains or loss would be ignored from CGT liability in accordance with s. 118-25 ITAA 1997 (Sadiq et. al., 2015).
Potential capital gains or losses can arise when a capital event takes place which are highlighted in s. 104-5 ITAA 1997. In relation to sale of a capital asset, the relevant event is named A1. The listing of correct capital event is imperative as every event has a particular methodology for capital gains /losses computations which is outlined in s. 104-5 ITAA 1997. In case of asset disposal, capital gains can be derived by finding the difference between asset cost base and proceeds derived from sale (Coleman, 2015). Further, there are two methods provided in tax legislation to avail capital gains concessions which are discount method and indexation method. The discount method is explained under Division 115 ITAA 1997 and provides for a flat 50% capital gains discount only when the underlying capital gains are long term which would happen when the asset holding period would be higher than a year. The other method i.e. indexation method aims to provide concessions by providing inflation adjustment in the cost base of asset which would result in lower capital gains which are subject to CGT or capital gains tax (Barkoczy, 2017).
A crucial issue in relation to restrictive covenant is the nature of proceeds which becomes a vital aspect as revenue proceeds would be assessable income while capital proceeds would not be assessable income. In case of capital receipts, the potential capital gains tax implications gain prominence. Some direction with regards to ascertaining the nature of proceeds from restrictive covenant can be obtained by analysing tax ruling TR 95/35. One of the noteworthy principles is that any restriction imposed on any legally available right of the taxpayer though compensation would result in capital proceeds (Krever, 2016). This is because the underlying right of the taxpayer was an asset which has been restricted and adversely impacts future earnings potential. The same is also reflected in a relevant case i.e. Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 where constraint on the right to sue was levied in exchange for payments or compensation. The honourable court indicated that if the right to sue was legally permissible to the taxpayer, then the restriction of the same would lead to capital proceeds (Nethercott, Richardson & Devos, 2016).
It has already been discussed that capital gains or losses are computed only when there is a capital event. However, death of the owner is not such an event and is not mentioned in s. 104-5 ITAA 1997. The asset typically passes on the legal heir and when there is asset disposal on the part legal heir, then implications in terms of capital gains could arise. To compute the extent of these capital gains, the market value of the asset at time of death needs to be deducted from the proceeds obtained on asset sale (Krever, 2016). Another issue in sale of property relates to signing of contract in current tax year and settlement in the next tax year. Guidance is provided in accordance with tax ruling TR 94/29 which makes it clear that for such cases, CGT liability has to be computed and levied in the same year as contract enactment irrespective of time of settlement (Woellner, 2015). Also, certain residential apartments may be exempt from any CGT liability if the same has been used by the taxpayer as main residence from the time of purchase. This is as per subdivision 118-B ITAA 1997 which allows 100% exemption for any capital gains derived from main residence same. Critical aspect for main residence is usage of property as residence and no assessable income being derived from the house through rent or other means (Barkoczy, 2017).
The boutique chocolate shop which has been liquidated by Amber comprised of following three assets namely goodwill, equipment and stock. The relevant tax treatment of each is highlighted as follows.
1) Goodwill – It is a capital asset as per s. 108-5 and hence sale proceeds would not be taxed. Disposal of goodwill would be A1 event and hence the deduction of cost of goodwill from sale price would provide the capital gains made on the transactions. Concession in the form of Division 115 discount method would be applied as holding period exceeds one year. CGT would be applied on the remaining capital gains.
2) Equipment – The treatment of equipment differs from that of goodwill owing to regular depreciation and related taxation deduction that the taxpayer obtains. Thus, for computing the capital gains or losses comparison between book value and market value ought to be drawn. A higher market value than book value yields capital losses while the other would lead to capital losses. Suitable concessions would apply for reduction of capital gains tax liability.
3) Trading stock – Any gains or losses made on trading stock sale would not be levied CGT but rather would be treated as assessable income under s. 6-5 ITAA 1997 or tax deductible loss under s. 8-1 ITAA 1997.
On account of the contract that Amber has entered into with the buyer of her chocolate business, he legal right of operating business of her choice at any time and geography becomes constrained. This would have adverse implications for the future earnings potential over the period of applicability of covenant. In accordance with the relevant discussion, it is apparent that the relevant proceeds drawn would be capital and non –taxable. But it is possible that Amber may have realised capital gains owing to which capital gains tax would apply.
As per the information provided in the given case, the apartment has been inherited by Amber after her uncle passed away in 2013 and hence it is an example of deceased estate. It is known that her uncle resided in the apartment which commenced from the time of purchase and continued until his death. Thus, this was the main residence for his uncle. After inheriting the apartment, Amber also has resided till the time of sale. Therefore, it would be appropriate to indicate that neither Amber nor her uncle has drawn any assessable income from the apartment and have continued to use this as main residence. As a result, the sale of house would not result in any CGT liability as main residence exemption would be provided. Also, the proceeds from house sale would be capital and thereby immune from any taxation.
It can be concluded from the above discussion that no tax would be levied on proceeds of the apartment. Further, the proceeds obtained from restrictive covenant might lead to CGT liability but the proceeds are non-taxable owing to their capital nature. In relation to shop, CGT and equipment are capital assets whose proceeds are non-taxable but CGT liability would arise. However, the profits or losses on sale of stock would be revenue income or expenses and would be suitably recognised.
In the given case, various cash inflows and outflows are realised by employee (Jamie) and employer (House R Us) and the objective is to highlight the tax implications of these for both these parties with specific emphasis on the following.
Salary and Commission
Any income which is derived from ordinary income is categorised as ordinary income and contributes to assessable income as per s. 6-5 ITAA 1997. One of the key elements of ordinary income is employment related income which includes salary and other related cash benefits. Further s. 8-1 ITAA 1997 allows general deduction in regards to any outgoing or expense provided that a direct and sufficiently close relationship with the assessable income production can be established. Further, the expense should not be capital or else general deduction would not apply as highlighted in ss. 8-1(2) ITAA 1997 (Nethercott, Richardson & Devos, 2016).
Employee (Jamie): Salary and 10% commission would both be ordinary income and therefore taxable for the employee in accordance with s. 6 (5) ITAA 1997.
Employer (House R Us): The salary and related benefits to the employee is a crucial aspect which directly assists the company in assessable income production. Besides, it is an expenditure of revenue nature and hence employer would enjoy general tax deduction.
In accordance with Division 2, FBTAA 1986, car benefit is extended to the employee when an employer owned car is given to the employee for use in personal work besides professional work. The computation of related FBT liability is listed in s. 9 and s.10 FBTAA 1986. Further, the employee does not have to pay FBT or any other tax. Complete FBT liability is on the employer (Wilmot, 2016).
Employee (Jamie): The employer has provided a Toyota Kluger car to Jamie which he uses for personal use on holidays and weekends. Hence, car fringe benefit has been extended but no taxation implication for Jamie.
Employer (House R Us): It is apparent that the employer has extended car fringe benefit to the employee Jamie. The relevant car fringe benefits are computed as per s. 9 FBTAA 1986
Further, the above value is used and multiplied by gross up factor to compute the taxable value of car fringe benefit on which FBT tax at the rate of 47% would be levied. It is imperative to note that the car benefit is part of employee benefit which is integral to production of assessable income, hence tax deduction can be availed by the employer as per s. 8-1 ITAA 1997.
The issuance of mobile electronic devices by employer does not amount to any FBT since the same is done to assist in professional work and derivation of assessable income. Therefore, under the provisions of FBTAA 1986, no FBT obligations would arise (Coleman, 2015).
Employee (Jamie): The employer has provided Jamie with a mobile phone and laptop device. These are however for professional work and would be taken back if the job is terminated. Thus, this does not extend any economic benefit to the employee and therefore no tax implications.
Employer (House R Us): As has already been highlighted, in this case, no FBT would be applicable. Further, the nature of expense on the laptop and mobile would be capital in nature and therefore non-deductible under s. 8-1 ITAA 1997. However, annual depreciation would be charged on the assets based on their useful life. This decline in value is tax deductible and would allow deduction for the employer.
For assessable income to arise for the taxpayer, some economic benefit ought to be realised as has been hinted in tax ruling TR 92/15. This is the case with allowance since amount received is not linked with amount spent by employee. However, in case of reimbursement no economic benefit derived since only the amount spent is returned back. Therefore, no economic loss or economic profit for employee arises. However, deduction on part of employer may be available under s.8-1 if the reimbursement or allowance is related to assessable income production (Nethercott, Richardson & Devos, 2016).
Employee (Jamie): No tax implication for the employee arises since owing to reimbursement of the subscription amount, Jamie is not better off nor worse off.
Employer (House R Us): The given expense has direct connection with assessable income production and therefore general deduction for subscription fee of professional magazine is permissible under the aegis of s. 8-1, ITAA 1997.
For assessable income to arise for the taxpayer, some economic benefit ought to be realised as has been hinted in tax ruling TR 92/15. This is the case with allowance since amount received is not linked with amount spent by employee. However, in case of reimbursement no economic benefit derived since only the amount spent is returned back (Sadiq et. al., 2015).
Employee (Jamie): Economic benefit is derived by employee since even in case of no expense related to entertainment, he would receive the same as entitlements. Hence, this is not reimbursement on basis of actual and therefore under s. 6-5, assessable income is derived by taxpayer.
Employer (House R Us): This is a revenue expense related to employee compensation which has direct nexus with assessable income production and hence s. 8-1 ITAA 1997 allows for tax deduction in this regards.
A crucial portion of assessable income is derived from statutory income which essentially deals with non-cash benefits that may be provided by the employer. The employer can also derived s. 8-1 deduction if the underlying expense is not capital and is linked to the production of assessable income (Woellner, 2015).
Employee (Jamie): The employee has been provided the home entertainment system as a prize for the performance on job where he has been the highest sales generator for the business over the past six months. Hence, the underlying value would be assessable income since this amount to employment related non-cash benefit which would be taxable.
Employer (House R Us): Considering that these gifts tend to provide encouragement to employees and part of normal business so as to maximise sales, hence s. 8-1 ITAA 1997 deduction would be available for the employer on the home entertainment system extended to Jamie.
As per division 4, FBTAA 1986, loan fringe benefits are provided to the employee when financial assistance is provided by the employer and the interest rate charged tends to be lower than the benchmark interest rate that RBA releases on an yearly basis. The benefits are passed on to the employee in the form of interest savings owing to rate being lower than RBA recommended value. In regards to possible deduction for the employer and employee, it is permissible if the employee uses the loan for producing assessable income. However, the FBT liability arising on account of loan fringe benefit would be applicable only on the employer (Hodgson, Mortimer & Butler, 2016).
Employee (Jamie): The employee has been provided financial assistance to the tune of $ 100,000 with an applicable interest rate of 4% p.a. Loan fringe benefits would be applicable as the RBA benchmark rate for 2017.2018 stands at 5.25%. Jamie would save on interest but no FBT payable by Jamie. He is using the loan proceeds for main residence and hence no deduction on interest payment since it is highly likely that it would be used for his residence and not for rental income.
Employer (House R Us): The interest rate levied by the employer is lesser than the rate given by RBA for the tax year under consideration and hence loan fringe benefit has been extended. The resultant FBT liability on employer would be dependent on the interest savings reaped by employee Jamie during the tax year along with the relevant FBT rate applicable. Further, no deduction for employer is available as the loan would not be utilised in assessable income production.
Based on the discussion of the various payments made and derived, the following summary may be drawn.
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.
Hodgson, H., Mortimer, C. & Butler, J. (2016) Tax Questions and Answers 2016 (6th ed.). Sydney: Thomson Reuters.
Krever, R. (2017) 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.
Wilmot, C. (2016) FBT Compliance guide (6th ed.). North Ryde: CCH Australia Limited.
Woellner, R. (2015) Australian taxation law 2015 (8th ed.). North Ryde: CCH Australia.
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