Tax Treatment Of Various Transactions And Benefits

Sale of Assets

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.

Required

Advise Amber of the taxation consequences of these transactions. You are not required to calculate any capital gains or losses. 

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.

Required

Advise Jamie and ‘Houses R Us’ of the taxation and FBT consequences of these transactions. You are not required to calculate any FBT liability

This assessment task will assess the following learning outcome/s:

be able to identify and explain the rules of law relating to taxation law topics covered in the subject.
be able demonstrate a capacity to engage in legal research.
be able to use legal research skills to apply the law to legal problems relating to taxation so as to reach a solution.
be able to analyse legal rules so as to differentiate between possible outcomes to the legal issues arising from novel fact situations.

Issue

The central concern based on the given factors is to highlight the relevant taxation treatment in relation with the transactions mentioned below that have been encountered by Amber (taxpayer).

1) Possible capital gains arising from chocolate shop sale and levying of CGT (Capital Gains Tax) on the same.

2) It needs to be determined if restrictive covenant related proceeds that have been derived from a separate contract would be categorised as revenue or capital proceeds.

3) Possible capital gains arising from the inner city one bedroom apartment sale needs to be highlighted considering the inheritance aspect involved and the underlying implications.

Law and Application

The various transactions of interest have been analysed below whereby first the relevant law is stated and then the same is applied in the wake of the given case facts.

LAW - Sale of shop

In accordance with s.108-5 ITAA 1997, goodwill is one of the capital assets on which capital gains tax would be levied. However, this is not true for trading stock since in this context s. 118-25 ITAA 1997 states that any capital gains or loss implications from the sale of trading stock would not be considered for computing CGT liability (Reuters, 2017). One reason for the same is that it is a consumable in the business which is sold to customers either directly or after further processing and therefore is responsible for producing assessable income under s. 6-5 ITAA 1997 (Coleman, 2015).

As per s. 104-5 ITAA 1997, event A1 corresponds to the sale of any capital asset. In the case of A1 event, the underlying capital losses or gains can be computed y considering the selling price of the asset under consideration and deducting the asset cost base from the same.  Besides, before the application of capital gains @ 30%, there are two methods for computation of capital gains that need to be highlighted (Reuters, 2017). One of these is the discount method highlighted in s. 115-25 ITAA 1997 whereby for long term capital gains, a 50% deduction is allowable. The gains would be long term only when the said asset has been held for more than a year. If this condition is not fulfilled, then the discount method cannot be applied. Additionally, as per the indexed method, the cost base of the asset is increased so as to reflect the impact of inflation and hence reducing the taxable capital gains.

Restrictive Covenants

APPLICATION- Sale of shop

It is imperative to note that the proceeds from the sale of shop would be considered as capital proceeds as the underlying asset is a capital asset and these proceeds would be exempt from tax. However, the same cannot be said about any capital gains that may be derived on account of any capital gains or losses that Amber may have made. It is critical to note that the shop sold by Amber comprises of a host of assets and all these do not have similar treatment with regards to capital gains. The relevant treatment of these is discussed below.

Goodwill is a capital asset and the sale of business has resulted in A1 event. Also, the cost and sales proceeds related to goodwill have been segregated and hence using the approach highlighted in s. 104-5, the capital gains can be computed.  Owing to the shop being held for more than one year, the capital gains arising from sale of goodwill would be long term and hence discount method can be deployed for reducing the taxable capital gains to 50%.

With regards to the equipment used at the shop, the resultant capital losses or gains can be computed by deducting the equipment book value from the sales proceeds. It is noteworthy that the equipment cost price is not used for capital gains or losses computations since there is depreciation on the equipment which would be already deductible by the business for tax purposes. Besides, this asset has also been held for more than a year and hence the resultant capital gains would be long term thereby allowing the application of discount method for reduction in taxable capital gains. With regards to the trading stock, s. 118-25 would be applied and hence any capital gains or losses in this case would be ignored.

LAW -Restrictive Covenant

The major issue in context of the proceeds derived from agreeing to a restrictive covenant is to ascertain if the proceeds would have revenue or capital characteristics.  This becomes pertinent question since tax can be levied only on revenue receipts and not on capital receipts. In order  to ascertain the nature of proceeds, a case law worth discussion is Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 (Sadiq, et. al., 2015). In this case, an agreement was enacted between the contracting parties which related to giving up the right sue for a particular payment. In the legal discussion on the facts of this case, it was noted that by taking away any right which any given individual legally has, there is restriction imposed and hence any proceeds received in lieu of the same would be considered as capital receipts. The same line of thinking can be extrapolated in case of restrictive covenant whereby the legitimate right of the seller to establish a new business is curtailed owing to which a restraint is created. As a result, the proceeds obtained in the process would be termed as capital in line with the discussion in various tax rulings such as TR 95/35 (ATO, 2018).

Employee Compensation

APPLICATION – Restrictive Covenant

As per the case facts, Amber has signed another contract which restricts her from establishing a similar business for a distance within 20 km radius for a total time period of 5 years. For agreeing to the restrictive covenant, Amber has obtained a sum of $ 50,000. The given clause clearly restricts Amber’s otherwise legal right to establish another business wherever she seems suitable and whenever she finds it. Since the contract aims to restrict the rights available to Amber, hence the underlying receipts would be capital and would not attract any taxation. But, it is possible that CGT may be levied on potential capital gains that may arise from the contract.

LAW - One bedroom apartment-

A pre CGT asset is one which was bought in the era when CGT was not applicable and for such assets no CGT implications arise as has been highlighted in s.149-10 ITAA 1997, With regards to deceased estates, any capital gains or losses corresponding to the period before the death of the given individual would not be considered (Barkoczy, 2017). Also, it is noteworthy that through inheritance, the asset comes as free only but the acquisition cost is taken as the market value of the asset when inheritance takes place. This would be used for computation of future capital gains if required (Deutsch, Freizer, Fullerton, Hanley & Snape, 2015).  Further, in asset sale it happens at times that the contract for sale is signed in one year but the cash settlement of the contract stretches to the next year and hence there may be confusion with regards to when CGT would be applicable. Clarity in this regards can be obtained by TR 94/29 which makes it clear that the capital gains tax would be applicable in the year of enactment of sale contract for the given asset. Besides, if the taxpayer uses the given house as main residence, then CGT exemption is permissible under Division 118-B (Kreyer, 2016). It is necessary that the property must not be used for rent income even though the taxpayer may be out of town or country.

Application-One bedroom apartment-

In accordance with the given scenario, it is evident that the concerned property has been acquired from her uncle who expired in 2013. Also, the given property does not categorise as a pre-CGT asset since it was bought when CGT was applicable. Amber’s uncle after buying the property continued to reside there till the time of his death. Thus, it would be apt to consider the property as main residence during the period it was held by amber’s uncle. Post inheritance, Amber is also staying at the property and thereby using the same as main residence. Thus, the sale of property would not have any CGT implications owing to the application of Division 118-B as per which the main residence exemption would be claimed.

In accordance with the arguments given, it would be appropriate to conclude that CGT would be payable selectively on the capital gains made during the sale of the shop. This would exclude any capital gains or losses made on the trading stock which will not be taken into consideration. Also, the restrictive covenant related proceeds are capital receipts and thereby would not be taxed.  With regards to one bedroom property room which has been inherited from uncle, no tax implications would arise since the proceeds are capital and also the main residence exemption ensures no CGT liability.

Issue

The central issue it to determine the tax treatment and resultant liabilities levied on employer and employee on the account of various benefits which the employer Houses R Us has extended to employee Jamie during the financial year. Further, the various aspects will also be examined based on the relevant statute and law which are highlighted below.

• Whether the various amounts extended to Jamie by Houses R Us will be considered as assessable income of Jamie as per s. 6-5 or s. 6-10 of Income Tax Assessment Act 1997.
• Whether employee Jamie can claim any deduction on the account of interest paid for the loan.
• Whether amount spent on behalf of employer Houses R Us would be available for tax deduction or not as per s. 8-1.
• Calculation of fringe benefits tax (FBT) liability on House R us and Jamie for the case when House R has issued car and loan to Jamie.
  

Amount of base salary and commission

Income derived by the taxpayer from ordinary sources will be classified as ordinary income as per s. 6(5), ITAA 1997 and would contribute to the assessable income (Austlii, 2018e). In present case, Jamie has received a base salary of $50,000 per year along with the agency commission which is 10% on the total sold properties and these are derived from ordinary sources and therefore, would be considered as assessable income of Jamie. Further, the personal income tax will be applied on Jamie for the received assessable income.

According to s.8-1, ITAA 1997 any loss or cash outflow which is incurred in regards to derive the assessable income will be considered for tax deduction. Though, ss. 8-1(2) represents that tax deduction cannot be claimed when the cash outflow constitutes of capital expenses or personal expenses or when expenses are incurred for the generation of non-assessable income. Here, House R Us has paid salary and 10% commission to employee Jamie which are revenue expenses for deriving assessable income and therefore, House R Us can claim tax deduction on the total amount paid to Jamie.

According to Division 2, Fringe benefits Tax Assessment Act 1986 (FBTAA86), when employer provides car to employee for personal work, then car fringe benefits have been given to the employee. Fringe benefit tax liability will be applied on employer only as per s. 9, FBTAA86 (Barkoczy, 2017).

House R Us has extended Toyota Kluger to employee Jamie and the use of car is not restricted to office work only which means he can use car for personal work. It indicates that House R Us has extended car fringe benefit to Jamie. Further, the operating expenses incurred on car are also paid by House R Us and not by Jamie. Therefore, employee would not be liable for any deduction on the amount paid in expenses. Further, no FBT liability will be raised on employee Jamie under car fringe benefit.

As discussed above, employer is held liable for the FBT liability raised due to the extension of car fringe benefits as per s. 9, FBTAA86 (Austlii, 2018c). The statutory formula for determining the taxable value of car fringe benefits is highlighted below (Austlii, 2018b).

Where,

A = Base or capital value of car

B = Statutory percentage

C =Number of days for which car was available for employee for personal work

D =Total number of days in FBT year

E = Contribution by the employee

F =Grossed up factor (Car is type I goods)

Now,

Fringe benefits liability would be determined based on the underlying applicable FBT rate.

The employer can claim for the tax deduction in accordance of s.8-1 for the operating cost incurred on car based on the scope of car being used for professional purposes. 

Laptop and Mobile Phone

When employer provides portable electronic devices such as mobile phones, laptop, tab and so forth to employee, then it would be exempted from FBT liability since the device has been used to employee for professional work (Sadiq, et. al., 2015).

Jamie has received a phone and laptop from House R Us for professional work. Further, it is evident that Jamie is not using these devices for deriving the assessable income for himself and no FBT liability would be applied on Jamie.

The usage of mobile phone and laptop is restricted to professional work only and Jamie is not allow to use these device for private work and therefore, no fringe benefits payable would be incurred on House R Us as the use of devices is limited to office work purposes only and not for personal use of Jamie. Further, the expenditure occurred on phone and laptop will be capital expenditure and no deduction would be availed by employer as per s. 8-1. Though, the depreciation in the asset that may be charged on the part of House R Us during the service life of the device would be tax deductible.

Professional Subscription

According to TR 92/15, it is imperative that employee must receive some benefits for deriving the assessable income. In present case, Jamie has not received any economic benefit through the annual subscription of magazine as the actual amount spent has been reimbursed. No tax liability will be imposed on Jamie as there is no expenses or/and profit while subscribing annual magazine (Barkoczy, 2017).

House R Us has expenditure in terms of subscription fee which has direct correlation with the assessable income generation. Hence, deduction would be available for House R US under s. 8-1, ITAA 1997 as the expenses incurred in professional subscription derives assessable income for employer.

Entertainment Allowance

TR 92/15 states that allowance is classified as an amount which is already defined and would be provided irrespective of the aspect that whether the respective expense has been incurred or not.

House R Us  has been provided $2,000 p.a. to Jamie as Entertainment allowance which contributes to the assessable income of the Jamie, irrespective of the fact that whether the he would spend the amount in entertainment or not. Therefore, the benefits received by Jamie would be taxed.

House R Us would be claimed tax deduction on the extension of entertainment allowance to Jamie as per s. 8-1. It is because the expenditure is considered as business expense of revenue nature and also contributes in the assessable income of House R Us. 

Home Entertainment System

Non-cash benefits would contribute to assessable income of taxpayer as the benefit would be categorised as statutory income under 6-10, ITAA 1997. It is because the benefit given to employee has direct impact on the assessable income generation. Further, as per s. 21A, ITAA 1997 non-cash benefits cannot be converted to cash but still it would be supposed to be cash convertible and would be part of assessable income (Austlii, 2018a).

 It can be seen that House R Us has extended to Jamie for his tremendous sales performance for the company during the six months. It is apparent that he has received home entertainment system due to the involvement in his job and therefore, this non-cash benefit would be termed as statutory income and would be part of his assessable income.

The expenditure incurred to purchase the home entertainment system for Jamie is underlying expense, which contribute to the assessable income and therefore, the tax deduction would be available for House R Us as per s. 8-1.

Loan of $100,000

When employer provides financial help in the form of loan to their employee with no interest or at low interest rate as compared with the statutory rate declared by Reserve Bank of Australia (RBA), then loan fringe benefits would be given by employer to employee as highlighted in division 4, Part III FBTAA86. According to TD 2017/3, Reserve Bank of Australia has declared the benchmark interest rate for loan for FBT year 2017/18 as 5.25% p.a. Any loan amount which has been given to employee by employer lower than 5.25% interest rate would result in loan fringe benefits liability being levied on employer.

House R Us has provided a loan of $100,000 to Jamie to purchase home at an interest rate of 4% p.a. It is apparent that House R Us has set the interest rate lower than the benchmark interest rate declared by Reserve Bank of Australia which is 5.25%. It implies that House R Us has extended a loan fringe benefit to Jamie. Jamie would not be liable for any fringe benefits related liability on the account of loan fringe benefit.

Loan fringe benefits tax liability will be applied on House R Us. It has been assumed that as its Jamie’s first home and hence, he would use the home for his own residential purpose not for deriving income by renting the home (Austlii, 2018 d). Therefore, tax deduction would not be available for House R Us on the account of interest received as Jamie has used house for himself only as per s. 8-1, ITAA 1997. Further, the fringe benefits tax liability for House R Us would be calculated as shown below (Austlii, 2018c).  

Where,

A = Loan amount

B = Statutory interest rate set by RBA

C = Interest rate set by employer for loan

D = Days in FBT year

E = Days for which the loan was available for employee

F =Grossed up factor (Loan is type II goods)

Now,

Fringe benefits liability would be determined based on the underlying applicable FBT rate.

Conclusion

The final conclusion can be drawn based on the above analysis.

• The amount extended to Jamie in the form of salary and 10%of commission by Houses R Us will be considered as assessable as per s. 6-5. Further, House R Us can avail the tax deduction on account of extended amount.
• Fringe benefits liability would be raised on House R Us due to the extension of car fringe benefits to Jamie and also, deduction would be available by House R Us under s. 8-1. However, there would not be any tax liability on Jamie.
• The extension of mobile phone and laptop would not impose any fringe benefits tax liability on House R Us as the work domain is restricted to professional work only. Further, depreciation in asset value can be availed under deduction by House R Us.
• Annual professional subscription will be tax deductible as per s. 8-1 and no tax implication for Jamie.
• Expenses incurred in the form of entertainment allowance would be tax deductible for House R Us as it contributes to the assessable income of Jamie in the form of statutory income under s. 8-1, ITAA 1997.  
• House R Us has extended loan fringe benefits to Jamie and therefore, FBT liability would be imposed on House R Us. Further, there would be not FBT payable on the part of Jamie. Also, no tax deduction would be available for House R Us as the house purchased by Jamie from loan amount would not derive any rent income for him and he would possibly use the purchased house for himself only.

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 (9^th ed.). North Ryde: CCH Publications.

Coleman, C. (2015) Australian Tax Analysis (4^th 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 (6^th ed.). Sydney: Thomson Reuters.

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

Reuters, T. (2017) Australian Tax Legislation 2017 (4^th 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.