LAWS5065 Taxation Law

Bruce Lee is a Lawyer with his own legal practice and registered for GST His receipts and payments (not including GST) for the year ended 30 June 2018 are as follows:

Receipts

340,000    Professional legal fees 
25,000        Payment by the owner of the building for a new 10-year lease
8,000        Income from part-time military service (note 1)        
7,000        Dividends received from an Australian resident company fully franked 
34,000        Salary received from part-time lecturing at the University 
($6,000 in PAYG W) 
5,000        Interest on Bank Deposits 
10,000        Rental income from an investment property  
2,000        Profit on sale of office equipment (note 3)    

Payments
14,000    Office rent 
40,000    Payment to the cleaning contractor
50,000    Salary paid to employee secretary   
290         Purchase of new calculator
1,400    Cost of meals and entertainment for himself and clients
1,200        Train fares for travel to and from work 
2,200        Rates on family home 
900                   Electricity for family home 
1,000                   Tax agent’s fees for preparing tax returns for 2016/2017
2,000        Rates paid on abovementioned investment property  
15,000        Interest paid on loan to acquire the investment property  
5,000    Cost of painting the investment property immediately after purchasing the property   
1,000    Cost of replacing roof tiles on the investment property after the roof was damaged in a severe storm in February 2018  
15,000        Cost of extending the bathroom in the investment property  

Notes
The part-time military income is exempt.  
(1)Bruce has a carry forward past year tax loss of $12,000.
(2)Bruce does not have private hospital insurance.  

REQUIRED
Bruce would like to minimize his tax liability for the year. Calculate Bruce’s tax liability for the year ended 30 June 2018.

Step by Step Instructions 
Step 1: Please read and understand the question.
Step 2: Only material for weeks 1-7 is included (provided).
Step 3: Cite cases and legislation in your answers. Proofread and double-check. You can use free app, like Grammarly or something similar.

Introduction:

The ordinary income represents the income under the ordinary concepts and hence it is considered taxable under “section 6-5 of the ITAA 1997”. The taxation official in “Scott v CT (1935)” held that income should be ascertained in compliance with the normal perceptions and use of mankind (Woellner et al. 2016). “Section 6-5” states that gains originating from performing of business activities is held as ordinary income. The present case study is based on determining the income tax liability for Bruce and determining allowable deductions to lower the income tax liability. To characterize receipts as the ordinary income from the commercial action consist of determining whether the taxpayers is carrying on the activities of business or whether the considerations of earnings are treated as ordinary incomes from that commercial activity.

As per “section 6-1 of the ITAA 1997” deriving proceeds from the personal effort represents revenue comprising of salaries, pays and wages (Braithwaite 2017). “Section 6-1 of the ITAA 1997” also includes proceeds that a taxpayer obtains from the business that is conducted alone or as partners. The case facts reveal the transaction reported by Bruce originating from the receipt of professional legal fees. The professional legal fees constitute receipts from the normal proceeds of the business activity. The professional receipts would be characterized as ordinary income from the business carried on.

Agreeing to the “section 6-5 of the ITAA 1997” any revenues originating from the person service of the taxpayer does not represents ordinary income (Blakelock and King 2017). As held in “FCT v Brent (1971)” receipt of lump-sum or the one-off receipts for the performance of specific tax is held as normal revenue. Quoting the reference of “section 6-5 of the ITAA 1997” receipts from the property is held as income (Edmonds 2018). The receipt of $25,000 from the 10-year lease constitute a one-off receipt. Therefore, the one-off lease receipts would be treated as ordinary proceeds and forms the part of taxable proceeds.     

According to the Australian Taxation Office irrespective of a person has a single or more employment or working as full time or part-time, the individual taxpayer is obligatorily required to declare such income from employment while filing tax return. As held in “FCT v Dean (1997)” receipts from employment is held as chargeable wages (Neil et al. 2015). Receipts of salary by Bruce from the part time lecture in university constitute income from employment. The receipts would be held taxable under ordinary concepts of “section 6-5”.

According to “section 44 (1) of the ITAA 1997” taxpayers are required to declare dividend income in their tax return. Dividends are usually received from the investment in listed entities, trust that trades publicly and corporate unit trust (McLaren and Cormick 2018). Certain dividends have franking credits enclosed in it and a taxpayer can claim set-off from their tax return. Dividends received by Bruce from the Australian sourced investment forms the part of chargeable earnings and the franking credit can be set-off to reduce the tax liability.

The federal court in “Dixon v FCT (1952)” held that periodic receipts represents an income stream i.e., amount paid periodically (Davies and Wheelahan 2018). Any form of gain which is period is probably held as ordinary income. In “Blake v FCT (1984)” regular receipt is categorized as earnings in nature. Rental income from investment property received by Bruce would be held as assessable income because it carries adequate nexus with the income making activity.

An Australian resident that receives interest from the financial bank account or term deposits would be considered as income. Receipts of interest from the bank account or term deposits is held as taxable earnings (Swan 2018). The tax liability originates when a taxpayer is required to include the interest income in their taxable return. Similarly, the receipt of interest from bank by Bruce would be treated as the assessable income and are liable for taxation.

As explained in “section 108-5 of the ITAA 1997”, CGT asset signifies any form of property. The sale of office equipment lead to capital gain and the profits from such sale would be treated as capital gains tax (Burton 2018). The profit forms the part of taxable return and would be treated as ordinary earnings under “section 6-5 of the ITAA 1997”.

“Section 8-1” carries the potential of being applied to any taxpayer. A losses or outgoings might be held deductible under the general provision of “section 8-1” (Miller and Oats 2016). The two positive limbs of “section 8-1”explain that a person can subtract from their taxable proceeds any loss or expenditures that is occurred in making the taxpayer’s earnings. However, a taxpayer is prohibited to deduct any losses under the negative limbs of “section 8-1 (2)” if the expenses are capital, domestic or private in nature.

Bruce reports outgoings related to office rent, cleaning contractor and payment of salary to employee. As held in “FCT v Amalgamated Zinc Ltd (1935)” expenses incurred in producing or gaining taxable income is considered deductible under the positive limbs of “section 8-1 of the ITAA 1997” (James and Nobes 2016). Similarly, the expenses on office rent, cleaning contractor and staff salary payment are expenses incurred in producing or gaining taxable income and deductible within the positive limbs of “section 8-1”.

The Australian taxation office states that expenses incurred in purchase of equipment, tools and any other assets that directly forms the part of earning income, the taxpayer is allowed to claim deductions for the cost as a whole or in parts of such equipment (Cao, Chapple and Sadiq 2014). An item of equipment costing less than $300 can be immediately claimed as deductions. The purchase of calculator for business use purpose can be claimed for deductions immediately since its cost base is lower than $300.

As defined by ATO meals to clients are treated as business entertainment expenses. Similarly, the expenses incurred by Bruce for entertaining the client with food would be treated as allowable business deductions (Pinto, Kendall and Sadiq 2015). However, the meal expenses incurred by Bruce upon himself does not qualifies as deductions under “section 8-1” since it is a private expenditure.

The general rule in “FCT v Lunney” states that expenditure that is incurred by the taxpayer for travelling between the taxpayer’s home and regular place of work is non-deductible expenditure (White and Townsend 2018). The statutory provision of “section 25-100” provides interpretation that deductions is allowed to the taxpayer for the purpose of travelling directly between two places of work where the taxpayer is engaged in producing income. The common law in “Payne v FCT (2001)” states that travel between unconnected places of work is not permitted for deductions under “section 8-1”. As obvious Bruce reports expenses for travel between home and workplace. Therefore, based on common law Bruce would not be allowed to claim deductions for travel between home and workplace as it is a private expense.

Expenditure incurred by the taxpayer is not considered permissible deductions given the expenses meets any one of the negative limbs. As stated under “section 8-1 (2) (b) of the ITAA 1997” costs that are entirely domestic or private in character is non-allowable deductions because these expenses do not meet any of the positive limbs criteria (Woellner et al. 2016). Expenses reported by Bruce on rates, electricity for their family home does not qualify the deductible conditions of either one of positive limbs. Therefore, Bruce would not be permitted to claim for an allowable deduction under “section 8-1 of the ITAA 1997”. 

“Section 8-5 of the ITAA 1997” defines that specific deductions originates when there is a specific provision in the income tax legislation offers deductions to the taxpayers (Edmonds 2018). As stated under “section 25-5” a taxpayer is permitted to an allowable deduction for certain costs including the expenses incurred in managing the tax affairs. The tax agent fees incurred by Bruce for preparing the tax return qualifies for the specific deductions under “section 25-5 of the ITAA 1997”.    

A taxpayer is permitted to claim deductions for expenses that is occurred when the rental property is available for rent or it is rented out. Bruce reports expenditure on rates incurred in rental property and also reported interest on loan incurred in acquiring the rental property (Pinto, Kendall and Sadiq 2015). Mentioning the decision in “Amalgamated Zinc Ltd v FCT (1935)” Bruce can claim deductions under “section 8-1 of the ITAA 1997” on rates and interest incurred on the rental property since these expenses are incurred in producing the assessable rental income.

“Section 25-10 of the ITAA 1997” prohibits a taxpayer from claiming deductions relating to cost incurred on notional repair. As held in “Inland Revenue Commissioners v Shipping Co Ltd (1923)” a taxpayer that undertakes the initial repair to correct the defects that was present while acquiring the property is treated as expenses of capital in nature and no deductions is allowed. Bruce reports cost for repainting the investment property (James and Nobes 2016). These costs can be treated as capital expenses which is occurred to remedy the defects present in the property prior to subletting. These expenses do not arise from Bruce own use of property to obtain the rental earnings. Hence, no deductions are allowed in this circumstances.

As per “Section 25-10” a taxpayer is allowed to an entitlement of permissible deduction for spending that is happened in replacing a portion of investment property that is damaged during storm (Swan 2018). As understood Bruce reported an expense on replacing the tiles of roof that is damaged in storm. Since the investment property was held for generating taxable income therefore a deduction is allowable to Bruce under “Section 25-10”.

An individual taxpayer is prohibited from claiming any deductions when an improvement made to the investment property surpasses the meaning of repair as it alters the original character of the item. A taxpayer in this circumstances is not allowed to claim deduction (White and Townsend 2018). On noticing that the work lead to substantial improvement, any form of addition or alterations is not treated as repair and no allowable deductions is permitted under “section 25-10”. Expenses reported by Bruce for extension of bathroom on the rental property constitutes substantial improvement. Therefore, no permissible deductions are permitted under “section 25-10”. 

The above stated calculations provides that Bruce total assessable income stands $430,000. Bruce further reports he has a carry forward of loss from the previous year therefore, the carry forward of loss can be used to set-off by Bruce to reduce the tax liability. Additionally, Bruce has no private hospital insurance and would be liable for Medicare levy surcharge of 1.5% on the overall taxable income. The total tax liability stands $116,096.85.

References:

Blakelock, S. and King, P., 2017. Taxation law: The advance of ATO data matching. Proctor, The, 37(6), p.18.

Braithwaite, V., 2017. Taxing democracy: Understanding tax avoidance and evasion. Routledge.

Burton, M., 2018. Extending the tax expenditure concept in Australia.       

Cao, R., Chapple, L.J. and Sadiq, K., 2014. Taxation determinations as de facto regulation: private equity exits in Australia. Australian Tax Review, 43(2), pp.118-141.

Davies, G. and Wheelahan, E., 2018. The application of Pt IVA to stapled structures. Tax Specialist, 21(5), p.195.

Edmonds, R., 2018. Resource Capital Fund IV LP: The issues on appeal?. Taxation in Australia, 53(1), p.22.

James, S.R. and Nobes, C., 2016. Economics of Taxation: Principles, Policy and Practice. Fiscal Publications.

McLaren, J. and Cormick, R., 2018. Dividend imputation: a critical review of the future of the system. In Australian Tax Forum (Vol. 33, No. 1, p. 141). Tax Institute.

Miller, A. and Oats, L., 2016. Principles of international taxation. Bloomsbury Publishing.

Neil Brydges, C.T.A., Counsel, S., Yuen, K. and Lawyer, S.L., 2015. Trusts, income tax, CGT and foreign residents.

Pinto, D., Kendall, K. and Sadiq, K., 2015. Fundamental Tax Legislation. Thomson Reuters.

Swan, P.L., 2018. Investment, the Corporate Tax Rate, and the Pricing of Franking Credits.

White, J. and Townsend, A., 2018. Deductibility of employee travel expenses: The ATO's guidance. Taxation in Australia, 52(11), p.608.

Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2016. Australian Taxation Law 2016. OUP Catalogue.