Taxation Consequences Of Transactions – Amber And Jamie Case

Question 1

Question 1

Issue

In the given case, Amber is an individual taxpayer who has undertaken three major transactions listed below.

• She has sold her chocolate shop
• She has signed a contract thereby executing a restrictive covenant with the buyer of the chocolate shop
• She has sold her one bedroom apartment which she inherited from her uncle in 2013

With regards to the above transactions, the key issue would be to highlight the nature of proceeds that tend to arise from each of these transactions. Also, in case of capital proceeds, the possible CGT implications also need to be outlined without computing the same.

Law

This section highlights the relevant discussion in relation to the applicable law with regards to the transactions that have been outlined in the issue section.

One of the key aspects with regards to capital assets is that it is not limited only to tangible or fixed assets but also includes intangible assets such as goodwill which has been highlighted in the form of s. 108-5 ITAA 1997 (Woellner, 2015). This section specifically includes goodwill as a separate capital asset. One of the key implications of a given asset being defined as capital asset is the proceeds arising from asset sale would be capital. Only revenue proceeds are taxable and may contribute to assessable income, therefore no tax is levied directly on the capital proceeds. However, if the capital proceeds generated from sale of capital assets tends to be higher or lower than the capital cost (also called as cost base), then capital gains or capital losses would arise respectively and the same would be subject to levying of CGT (Capital Gains Tax). The CGT implication is potentially triggered with the happening of a capital event as per s. 104-5 ITAA 1997 (Krever, 2016). This is considered imperative as the capital gains computation methodology is driven by the underlying capital events as the formula tends to vary slightly for different capital events. Besides, CGT liability can only arise when a capital event has happened.

The treatment of stock is different from the other capital asset as s. 118-25 ITAA 1997 clearly states that any capital gains or losses that arise on the sale of the same should not be subject to CGT (Barkoczy, 2017). Also, for each of the capital assets, the cost base is to be computed which needs to be carried out in accordance with s. 110-25 ITAA 1997 (Woellner, 2015). The cost base in accordance with this section tends to be comprised of five elements. The capital gains can be computed by reducing the cost base from the capital proceeds from sale.  Before, CGT is levied, these capital gains can further be reduced using one of the two available techniques i.e. indexation method and discount method. Discount method outlines as per s. 115-25 ITAA 1997 provides a discount of 50% on the capital gains provided that the asset under question has been held by taxpayer for more than a year (Hodgson, Mortimer, & Butler, 2016). Alternatively, indexation method tends to reduce the taxable capital gains by enhancing the cost base of asset by altering for inflation.

Question 2

In relation to the proceeds obtained from restrictive covenant, it needs to ascertained if the proceeds would have capital nature or revenue nature. This classification forms the basis of the resultant taxation treatment in regards to restrictive covenant. The discussion highlighted in tax ruling TR 95/35 is crucial since it highlights how restrictive covenants tends to impose restrictions on the otherwise legitimate right that an individual may have. This is apparent when there is a base of business and the seller has no restrictions of starting a new business at the location and time of his/her preference. However, through the implementation of restrictive covenants, requisite temporal and geographical restrictions are placed on the legal right that taxpayer otherwise has. It is imperative to note that the right is an asset capable of future profit generated and with restrictions imposed, the resulting proceeds would be capital as has been validated by the decision and related legal discussion in relation to Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 case.

Apartment

In accordance with s. 108-5 ITAA 1997, apartment falls within the ambit of a capital asset provided it is not used as a trading stock. Hence, this would imply that the apartment sale related proceeds would be capital only and thereby would not induce any taxation liability. However, considering that there may be mismatch between the cost base and the proceeds of sales, hence capital gains or losses may arise. However, this would not arise when the owner dies since this is not a capital event as per the definition and description highlighted in s. 104-5 ITAA 1997 (Deutsch, Freizer, Fullerton, Hanley, & Snape, 2015). However, the asset disposal by the legal heir would lead to potential CGT consequences for the taxpayer. Besides, in sale of capital assets a common observation is that the receipt of payment tends to take place post the contract enactment for asset sale. Further, in case of land and property where the amount of sale can be substantial, this may extend into months and hence a timing mismatch may develop when settlement of sale does not happen in the year of contract enactment (Wilmot, 2016). In this context, advice is offered by TR 94/29 which highlights that CGT liability would be levied when sale contract is enacted between the parties and not when the contractual obligations are settled (Sadiq. et.al., 2017). Also, in relation to the house, if it is used by the taxpayer to reside, then it may be main residence of the taxpayer and would be eligible for CGT exemption under the main residence exemption that is highlighted in subdivision 118-B ITAA 1997 (Nethercott, Richardson, & Devos, 2016).  For main residence fulfilment, it is imperative for the property must not produce assessable income in the form of rent.

Discussion on Amber’s Transactions

Application

Chocolate Shop Sale

The chocolate shop sold by Amber comprises of different assets and therefore the application of the relevant law needs to be discussed individually for the identified assets namely, equipment, goodwill and stock. The proceeds from sale are capital only owing to the underlying assets being capital assets. Therefore, possible tax can arise on account of only CGT which is discussed below.

A particular asset is goodwill whose sale triggers an A1 capital event as per s. 104-5. This would require computation of capital gains considering the given information pertaining to the cost price and the sale price of goodwill. Further, s. 115-25 discount would be applied to derive taxable capital gains as the shop has been held by Amber for more than one year.

Equipment is another asset whose disposal would require capital gains computation as per s. 104-5. However, there is fundamental difference between equipment and other capital assets in the sense that regular depreciation is charged on the equipment which Amber would claim as tax deduction. Thus potential capital gains would compare the sales value with the book value and not the historical cost price. Section 115-25 discount is also applicable in the given case. For stock, no CGT implications would arise which ought to be not considered.

Restrictive Covenant

In the given instance, Amber has been subject to restrictive covenant whereby restrictions have been imposed with regards to the geography where she cannot open a business and also the particular time period when business opening is forbidden.  There is restriction of Amber’s legal right through this covenant resulting in future cash flow loss and therefore the resulting proceeds would be classified as capital and non-taxable. But, if there are capital gains related to this covenant, then these would be applicable for CGT liability on Amber.

Apartment

The apartment is a deceased estate which has been passed on to Amber after the death of her uncle in 2013. It is noteworthy that her uncle since the time of purchase of apartment about two decades ago has used the same for residence purposes only and not for any income generation. The apartment served as his main residence from the purchase time to his death. The given property after inheritance was used for residence by Amber who made the apartment her main residence. Considering the above facts, it may be concluded that full exemption from any resultant capital gains or losses would be available to Amber as per subdivision 118-B ITAA 1997. Besides, the sales proceeds related to apartment are capital proceeds and hence not subject to tax.

Discussion on Jamie’s Transactions

Conclusion

As per the above discussion on the various transactions, it may be derived that the apartment which Amber has sold does not result in any tax outflow for Amber considering both CGT and other tax implications. In case of restrictive covenant, the proceeds are capital and hence immune from taxable but if any capital gains are realised, these would be applicable for potential CGT consequences. In regards to the chocolate shop sale, CGT implications would arise for goodwill and equipment but the same cannot be concluded about stock. 

Question 2

Issue

The issue is to advice Jamie and House R Us about their taxation and also Fringe Benefit Tax (FBT) consequences on the account of respective transactions performed during the tax year.

Law and Application

Transaction 1: Base salary and agency commission

Any income derived by taxpayer from ordinary sources such as income from employment agreement (personal exertion) is termed as assessable income of taxpayer under s. 6-5, Income Tax Assessment Act 1997 (ITAA 1997). The assessable income will be taxed on the part of taxpayer. According to s. 8-1, ITAA 1997 the expenditure that has been realised to generate assessable income and is revenue expenses will be tax deductible for employer. On the other hand, capital expenses would not be tax deductible as per ss.8-1(2), ITAA 1997 (Reuters, 2017).  

Employee- Jamie is working as real estate agent for Houses R Us real state and has received an amount per year in the form of base salary of $50,000 and 10% agency commission. This income is part of his assessable income as it derives from ordinary sources under s. 6-5, ITAA 1997 and will be taxed with respect to the personal income tax of Jamie.

Employer -Houses R Us is providing their employees a base salary and commission which is part of assessable income of employees and also has revenue nature. Therefore, the expenditure will be tax deductible under ss.8-1(2), ITAA 1997.

Transaction 2: Toyota Kluger car to Jamie 

According to Division 2, Fringe Benefit Tax Assessment Act 1986 (FBTAA86), car fringe benefits will be provided by employer to employee only if the use of car is not limited to office related work. It means when the car is still available to employee by employer for personal utilization, the employer would have be levied FBT liability (Krever, 2016). However, employee who has received the car fringe benefit will not be levied any FBT liability. The deduction can be claimed only for the case when the scope of car usage is also for office work along with the personal utilization by employee (Sadiq. et.al., 2017).

Capital Gains Tax (CGT) Implications

Employee-Houses R Us has made a car available for Jamie for personal work and on weekends. Hence, car fringe benefit has been provided by employer. Jamie will not be accountable for FBT liability for car fringe benefit.

Employer- Due to car fringe benefits, the FBT liability has to be borne by Houses R Us. Further, as the car was held used for work purposes as well and hence, the deduction can be claimed based on the underlying scope of car utilization for office work.

Transaction 3: Electronic Device (Mobile phone and a laptop)

In accordance with relevant provisions of FBTAA 1986, no FBT is levied on the employer for any portable electronic device that is extended to employee for official work. The same does not extend to payment of any related bills especially when the usage is personal (CCH, 2013).

Employee: It is known that employer has given a mobile device and laptop which is for assisting in work and it is used for the same and hence no tax implications arise for Jamie.

Employer: It is apparent that the employer would not have to face any related FBT liability on extension of electronic devices for professional use. With regards to tax deduction, s. 8-1 would not help considering that the expense on the device is capital. However, considering that these are depreciating assets, hence annual depreciation may be deducted by the employer on these devices.

Transaction 4: Professional subscription fee (Annually)

A key aspect is that reimbursement is provided to the employee for subscription fee of the magazine. For assessable income to be produced, TR 92./15 highlights that economic benefit ought to be received by the employee (Sadiq, et. al., 2015). Also, for revenue expenses related to assessable income production, the employer can claim general tax deduction under s. 8-1 (Coleman, 2015).

Employee – The employee Jamie has received reimbursement for the magazine subscription fee and hence no money has been spent on employee. As a result, no assessable income for employee since only reimbursement is extended and no allowance is given. However, since no expense, hence no tax deduction would arise.

Employer – Revenue expense has been incurred by employer since the magazine is related to the company’s business and hence contributes to assessable income production, thereby allowing deduction under s. 8-1 (Barkoczy, 2017).

Transaction 5: Entertainment Allowance  

It is imperative to separate reimbursement from allowances with regards to the taxpayer. From the perspective of employee, allowance would tender an economic benefit that is not linked to any particular expense (Deutsch, Freizer, Fullerton, Hanley, & Snape, 2015). This implies that employees are entitled to the allowance amount without providing any supporting proofs for underlying expenses as indicated in TR 92/15. On the end of employer, this would be tax deductible owing to being an integral component of assessable income generation and hence deductible under s. 8-1 ITAA 1997 (Reuters, 2017).

Fringe Benefits Tax (FBT) Implications

Employee – An entertainment allowance to the tune of $ 2000 p.a. is extended to Jamie and no proof has to be given by Jamie. Therefore, on account of this, Jamie does derive economic benefit and therefore, this amount would be reflected in the assessable income for Jamie.

Employer – On the end of the employer, it is a revenue expense related to the business which is necessary for obtaining assessable income and hence general tax deduction under the aegis of s.8-1 applies.

Transaction 6: High tech home entertainment system

Assessable income for taxpayers can also result from statutory income as indicated in s. 6-10. Further, in this regards s. 21A ITAA 1997 recognises that noncash benefits related to the employment would be considered as statutory income and assumed to be convertible into cash irrespective of whether this is possible or not (Hodgson, Mortimer, & Butler, 2016).

Employee – In accordance with the given facts, a home entertain system has been provided to the employee Jamie for his exemplary performance whereby he has the best sales performance over the last six months. This is not a gift but rather a non-cash benefit that is linked to employment and hence would contribute to Jamie’s assessable income for the year.

Employer – For the perspective of the employer, the cash outflow related to purchase of home entertainment system is a tax deductible expense owing to the sufficient nexus with the assessable income production and part of employee benefits which is essentially a revenue expenditure and not capital expenditure.

Transaction 7: Loan of $100,000 to staff for 4% rate of interest

As per FBTAA 1986, concessional interest rate loan given to employee by employer will be termed as loan fringe benefit. The concessional interest rate is any rate which is below the benchmark interest rate stated by Reserve Bank of Australia for the given tax year. As represented in TD 2017/3, the benchmark interest rate of RBA for 2017/2018 is 5.25% per year.  Hence, any interest rate below then 5.25% per year would be considered as extension of loan fringe benefit (Nethercott, Richardson, & Devos, 2016).

Employee -Houses R Us is offering loan up to $100,000 to purchase the home to their employee at 4% per year interest rate. Jamie has taken the loan and would purchase his first home. It can be said that Houses R Us is offering concessional interest rate loan to employee by taking only 4% interests. Hence, loan fringe benefit is given on behalf of Houses R Us. Also, no FBT implication will be raised on Jamie.

Employer – Houses R Us has offered loan to buy home under loan fringe benefit and thus, FBT liability will be borne by Houses R Us. Further, tax deduction will not be present to Houses R Us because Jamie is purchasing his first home and likely will use it for residence for himself. 

Conclusion

The key factors of the conclusion are shown below.

• Salary and agency commission is assessable income as per s. 6-5, ITAA 1997 and the respective deduction can be availed by the House R Us on the expenses.
• Toyota Kluger car has been provided to Jamie for hours and on weekends for personal purposes. Therefore, FBT liability would have to be paid by Houses R Us for car fringe benefit. Deduction can avail by employer on the account of operating expenses on the car as per s. 8-1.
• Mobile phone and laptop are realised for office related purposes and thus, no fringe benefits has been given to Jamie and FBT liability will not be executed. Further, as they are depreciating and hence, the decline in the worth of these assets can be tax deductible by employer.  
• In accordance with s.8-1, subscription fee will be deductible for Houses R Us whereby, no personal income tax liability for Jamie.
• In accordance with s.8-1, entertainment allowance has contributed in the assessable income of Jamie and therefore, personal income tax liability will be raised for Jamie and respective deduction would be claimed by Houses R Us.
• In accordance with s.8-1, the deduction will be availed on behalf of Houses R Us because offering home entertainment system would be labelled  as statutory income and thus, contribute to assessable income of Jamie. Also, personal income tax liability will be raised for Jamie.
• Loan has been offered at concessional rate of interest (4%) which implies that loan fringe benefits has been given and therefore, FBT liability would have to be paid by Houses R Us. No deduction will be available for Houses R Us because the Jamie is not making any assessable income from home which he has acquired from the loan.

References

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.

Gilders, F., Taylor, J., Walpole, M., Burton, M. & Ciro, T. (2016) Understanding taxation law 2016. (9^th ed.).  Sydney: LexisNexis/Butterworths.

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.

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

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.

Wilmot, C. (2016)  FBT Compliance guide (6^th ed.). North Ryde: CCH Australia Limited.

Woellner, R. (2015) Australian taxation law 2014 (8^th ed.). North Ryde: CCH Australia.