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Taxation Law (BLB3134)
Victory University
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taxation law notesPreview text
Sample questions and answers : Kindly be reminded that the calculations herein are NOT for the current year. These are past year practice questions. Whilst the legal principles are the same the rates are different. SOURCES OF LAW 1 Is it possible for a government not to impose taxes and still provide government services? The answer is yes, but this depends upon the style of government. Where the government owns all, or the major means of production, and hence income generated, it does not need to tax. Thus countries such as the UAE do not tax and provide significant services through the income earned by the assets they own (in this case oil production). 2 What are the primary sources of tax law in Australia? The first is obviously the tax legislation, then the court decisions interpreting the legislation. Secondary source material of importance is tax rulings from the ATO. 3 What is the name of the relevant legislation in relation to Income Tax in Australia? Income Tax Assessment Act 1936 and Income Tax Assessment Act 1997. 4. What is the significance of case law for taxation? It interprets the legislation.. The ITAA has many terms and phrases which are not loose in their wording (deliberately so). The courts must therefore fill out the meaning of the word or phrase. A very good example of this, as will be seen later in the course, is the word income. The legislation cannot be read without gaining understanding of a provision as refined/interpreted by the courts. THE TAX LEGISLATION 1 Explain why there are two Income Tax assessment Acts (ITAA36 & ITAA97) and how they interact. Discuss the style and structural differences between ITAA36 and ITAA97. There are two Acts because of the Tax Law Improvement Program (TLIP). This was designed to rewrite the 1936 ITAA in a more structured way using plain understandable language. This would represent all the things that the 1936 Act did not. Well into this process the government of the day decided to actually change tax law. The rewrite was therefore stopped as an entirely new and different tax regime was to be introduced. The government however never introduced the new regime and never really recommenced the rewrite process commenced under the TLIP process. Have students look at the ITAA 1936 and ITAA 1997 to identify differences. The differences in the numbering of sections and the structure of the Acts are very clear. 2 Identify some of the Commonwealth, State and Territory, and local government taxes that are levied in Australia. Commonwealth are Income Tax, excise duty, capital gains tax, fringe benefits tax. State taxes are payroll tax, land tax, various “stamp duties” on land and other transactions. Local government imposes “rates” based on the value of land. 3 What is the role of the PAYG system? This stands for pay as you go and it means that taxpayers pay tax throughout the year rather than in one lump sum at the end of the year. This ensures a constant flow of income into the government so it can better budget. There are two streams to the PAYG system, the withholding system and the instalment system. This is the tax collection system. 4 What is self assessment and what is its significants for a taxpayer? Self assessment is where taxpayers determine their own tax liability for the year, based upon the tax laws. If they misapply a tax law then significant penalties can apply. The responsibility of applying the law correctly is placed upon the taxpayer, and given the complexity of much of the tax law, this is a significant responsibility. Because the taxpayer applies the law the tax office issues “tax rulings” that give guidance to tax payers on how the tax office believes tax laws should be applied. This is especially true where the tax law can be difficult to understand or it is unclear exactly how the law is to be applied to given facts. A good example which students will look at later in the course, in this regard, is the concept of residency. 5. How does the taxation office make sure a taxpayer’s self assessed tax return is correct? The tax office conducts audits on selected taxpayers. There are a number of different methods by which the tax office decides which tax payers to audit. As will be seen the TFN and the ABN are two methods the tax office uses. TAXABLE ENTITIES 1 There are only two taxable entities that are recognised tax payers. What are these two taxable entities? The first is a company, the second is a natural person. Any other “entity” such as a partnership, or a trust are not a taxable entities. 4 Joan and Mary ran a chocolate retail business together. The company they ran the business through was called ChocoHolic Pty Ltd. For the financial year just ended, $330,000 worth of chocolates had been sold. As well, there were allowable deductions of $280,000. These deductions included a salary paid to Joan and Mary of $60,000 each. Calculate tax payable on these facts. If you think you need further information explain what it is and why you need it. There are three taxpayers here; the company, Joan and Mary. The company has taxable income of $50,000. The salaries paid to Joan and Mary are deductions to the company, for the company is a separate tax entity to Joan and Mary. Thus, Joan and Mary are not paying themselves an income form their own money. The income belonged to the company. A company has a flat tax rate of 30% on all taxable income. Thus the tax payable for the company will be $15,000. No medicare levy is payable by a company. Joan and Mary will need to pay tax on their salary from the company of $60,000. This will form part of their assessable income. We have no information on deductions so we cannot calculate their taxable income. Thus we cannot calculate their tax payable. 5 How would your answer differ, if at all, if in question 4 Joan and Mary ran the business as a partnership? A partnership is not a taxable entity, thus the partnership will pay no tax. Instead the partnership needs to fully distribute is net income to the partners. The partners will then show their share of the net income of the partnership as assessable income (s92 ITAA 1936). The net income of the partnership will be $330,000 less $160,000 = $170,000. The ‘salary’ paid to each of Joan and Mary is not deductible. This is because a partnership is not a legal entity. Therefore the $60,000 belonged to Joan and Mary all the time. As with the answer to question 4, we do not know the taxable income of Joan and Mary, therefore we cannot calculate their tax payable. Assuming they share the profit and losses of the partnership equally, each will have assessable income of at least $85,000. RESIDENCY 1 What are the jurisdictional links used for imposing income tax in Australia? Residency and source. Residency taxes a person on all income because they are a resident and thus Australia has jurisdiction over the person. Source is taxed because it is earned in the jurisdictional control of Australia. 2 Explain why Applegate was not a resident for the purposes of the Income Tax Assessment Act in the case of FCT v Applegate 79 ATC 4307. Applegate had his domicile in Australia and thus prima facie was a resident because of the second statutory test for resident. However, he was able ti satisfy the exception to the domicile test, that is he could show he had a permanent place of abode outside Australia. Students should be able to demonstrate why he was domiciled in Australia and why he could demonstrate the fact that he had a permanent place of abode outside Australia. This latter phrase carries two meanings. First, whilst outside Australia the person has a permanent place to stay. Second, they are gone for a reasonable period of time. 3 Are the following residents of Australia for income tax purposes? If you need more information indicate the information needed. (i) Clodhoppers Ltd, a footwear company incorporated in Malaysia opens a branch office in Melbourne. Not a resident because it is not incorporated here and does not have its central management and control or its voting power here (it is only a branch office). (ii) Alpha Beta Pty Ltd is a company incorporated in Australia. It is a wholly owned subsidiary of a Singaporean Company. Alpha Bet carries on no business in Australia. It is a resident because it is incorporated (registered) here. (iii) A company incorporated in Singapore to carry out merchandising activities in Singapore has its central management and control in Sydney. Its voting power is controlled by Australian residents. Would your answer differ if its central management and control was in Singapore, but its voting power was still in Australia? It is a resident of Australia. The high court decision of Malayan Shipping Company makes it very clear that business is being carried on where central management and control (i. Board of Directors) meet. When the directors meet they are doing business. Thus, if central management and control is in Australia (but it is not registered here) it will be a resident. If its central management and control was not in Australia but its voting power was, it would not be a resident because it was still not carrying on business here. 4. Why is source important for income tax purposes? It determines the right of the Australian government to tax the amount when derived by a non resident. Source can also be important for Australian residents through the operation of double tax agreements. Such agreements often give the country of source the right to tax. 5 Joanne is a nurse living in Carlton. She is a resident of Australia. She sees an advertisement in the paper asking for expressions of interest for nurses to work on a U. base in Saudi Arabia. Joanne responds to the advertisement and is later offered a 3 year contract. Joanne accepts. Her employer is an employment agency operating out of Melbourne. She leaves Australia on 1 July 2007. She comes back every 3 months to see her family (free air travel is provided for her to travel home). Joanne has her salary paid into her Australian bank account. Where is Joanne’s salary sourced? Joanne’s salary is sourced in Saudi Arabia. That is where she provides the personal services. CAPITAL GAINS The gain will be calculated by reducing the capital proceeds by ($2 million) by an amount the land could have been sold for without the building on it. This is done by obtaining a registered valuer’s opinion on what that price could have been. See Tax Determination CGT (TD) 9 which provides “2. There is no statutory formula to be used by taxpayers in determining the consideration for the disposal of an asset deemed by section 160P to be a separate asset. 3. It is not mandatory that taxpayers obtain an independent valuation for the purposes of apportioning the consideration received on disposal. Each taxpayer should take whatever steps are appropriate to determine the valuation of the particular asset. Taxpayers who choose to do their own apportionments will, of course, need to be in a position to justify the estimates that they make.” 6 Under which provisions are capital gains and capital losses relating to the following assets disregarded: (a) cars, (b) pre-20 September 1985 assets, (c) collectables acquired for $500 or less, (d) personal use assets acquired for less than $10,000, (e) assets used to produce exempt income, (f) depreciating assets, (g) trading stock, (h) damages for personal injuries, (i) gambling winnings, and (j) the main residence? [Barkoczy paras 19, 19, 19] Cars – section 118; Pre 20 September 1985 – must look at CGT event itself. Each CGT will stipulate this; Collectibles acquired for less than $500 section 119-10(1); personal use assets 118(3); used to produce exempt income section 118-12; depreciating assets section 118-24; trading stock section 118-25; damages for personal injuries section 118-37(1)(b); gambling winnings section 118-37(1)(c); Main residence section118-110. 7 Over the last 12 months, Eric acquired the following assets: an antique vase (for $2,000), an antique chair (for $3,000), a painting (for $9,000), a home sound system (for $12,000), and shares in a listed company (for $5,000). Last week he sold these assets as follows: antique vase (for $3,000), antique chair (for $1,000), painting (for $1,000), sound system (for $11,000) and shares (for $20,000). Calculate his net capital gain or net capital loss for the year. [Barkoczy paras 19, 19, 19, 19, 19, 19] Each asset needs to be classified as to type to determine if a gain or loss is made. The antiques and the painting will all be classified as collectibles, so the rules in relation to collectibles will be applicable. The sound system is a personal use asset. Accordingly the following is the result: The antique vase a gain of $1,000 The antique chair a loss of $2,000 The painting a loss of $8,000 Sound system a loss of $1,000 Shares a gain of $15,000. The losses for the collectibles can only be offset against gains on collectibles. Thus, there will be a carry for forward loss of $9,000 on the collectibles. The loss on the sound system is ignored. The gain on the shares is subject to CGT. As this asset was sold within 12 months of its acquisition no discount is allowed. (section 115-25(1)) The full $15,000 is therefore assessable. Thus the assessable CGT gain is $15,000. (NOTE in relation to the shares the assumption is made that they have not been acquired to trade in. If this were the case they would be assessed as trading stock, not as a capital item. If they were acquired to trade in then there would be no capital gain in this situation, but there would be ordinary assessable income.) 7 Jason worked for an organization called The Argonaughts. In December 2012 he gave notice of his resignation, which would become effective on 30 June 2013. Jason over the years had accumulated considerable knowledge on the ‘secret process’ the organization used. Accordingly, the company paid Joseph $70,000 not to work for any competitor for a 2 year period. As well Jason’s annual salary was $70,000. Calculate tax payable by Jason for the 2014/2015 income year. Assume no deductions. We cannot calculate his tax payable as we do not know his taxable income i. we are not told of his deductions. However, we can calculate his assessable income. This will be $140,000. The salary is clearly ordinary assessable income. The restrictive covenant that Jason enters into is capital, and will be taxed as a capital gain. Jason cannot claim a discount on this $70,000 because it is a CGT event covered by event D1. See section 115-25 and in particular 115-25(3). GENERAL DEDUCTIONS 1. Yuri borrowed $100,000 from a bank at a commercial interest rate of 8%. He immediately loaned the borrowed funds to the trustee of his family trust an interest rate of 1 % pa. The trustee used the funds to renovate a holiday home owned by the trust and used by Yuri's family. Advise Yuri as to whether he is entitled to any deductions for his interest expenditure. [Barkoczy para 13, 13, 13, 13] This is an example of the need to apportion income. The loss of 7% is not deductible because it was not incurred in gaining or producing income. Its only purpose was to avoid tax by getting a tax deduction. This problem is based on the case of Ure v FCT 11 ATR 464 (case 507 in Australian Tax Casebook and in Barkoczy page 307). 2. Pinewood Pty Ltd was registered to undertake pine plantation developments. Two items of expenditure were incurred during the relevant year: clearing the land ready for planting and weeding around newly planted trees. Are either of these expenses an allowable deduction? What are the general tests the courts use in determining whether such expenditure is deductible? The weeding around the trees is deductible as it is expenditure that maintains the trading stock. The expenditure on weeding is ongoing and of short term benefit. The clearing of the land would not be deductible as it is capital expenditure and thus comes within the first of the four negative limbs. The tests applied in the Sun Newspaper case suggests this expenditure is capital. It is a once off expense which gives a long term benefit and is designed to prepare what is capital (the land) ready for use. 3 Bill Baxter is an electrician by trade. He is also a professional footballer. He incurs expenses in traveling between Melbourne and Sydney to negotiate a contract with another football club. Are the expenses associated with getting the new contract deductible? (vi) An amount of $10,000 paid to a solicitor for preparing a joint venture agreement. This is expenditure which is either too early in time, for the business cannot operate until the agreement is drawn up and signed, or it is capital expenditure, and therefore not deductible. A joint venture agreement is the “structure’ of the business. It is similar to a partnership agreement. (vii) Fines paid for breaches of the Trade Practices Act 1974. This is not deductible, even though it may have been as a direct result of carrying on a business. Section 26 denies a deduction for fines. (viii) $4,000 worth of petrol paid on behalf of the managing director. The cost of the petrol had nothing to do with the generation of assessable income. This is deductible because it is a normal payment i. it is a benefit in place of salary. However, because it is a benefit it is subject to fringe benefit tax. Thus, whilst the employer can claim a deduction, there will be tax also to pay on the benefit. 6. The taxpayer incurs legal expenses when it institutes legal proceedings to stop a rival from acquiring shares in a company that the taxpayer is in the process of taking over. Are the legal expenses deductible under s8-1? The answer is no. This is capital expenditure. The taxpayer is trying to buy a new business. Buying a new business (new structure) is clearly capital in nature. All the costs associated with trying to buy the new business will also be capital. Thus, these legal fees to try and stop someone else buying the business, so that the taxpayer can buy the business, is capital. Joseph worked for a large IT company developing software. At the end of a financial year he was called in by his employer and told he was being made redundant. He was however advised to set up a company and his services would be utilized through the company as and when required. He thus set up JIT Pty Ltd, as a consulting IT business. Much of his work is for his previous employer. The business is run from his residential premises in a room set up especially for the conduct of the business. The company pays government rates and insurances on the premises, and contributes toward the heating and lighting costs of the premises from which it operates. In the first year of operation the company claims these expenses as a tax deduction. As well, Joseph claims his travel from the company’s premises to consulting jobs and back as a deduction. Explain the correctness of the company and Joseph in deducting these expenses. To answer this question the income activity must first be identified. This is personal services income. As deductions are in question, and it being a personal services business, division 85 needs to be considered, in conjunction with division 87. Division 85 generally denies deductions to a personal services business entity where home is set up as a place of business. The deductions that can be claimed in such a circumstance as those that could be claimed if the home was classified as an office only, not a place of business. On this basis not all the deductions listed above can be claimed, unless one of the tests in division 87 can be satisfied. The deductions that cannot be claimed are rates and insurances on the premises (section 85-15). Neither can Joseph claim travel (section 85-10). 3 What is the effect of the following transactions on the tax position of ABC Pty Ltd. You can assume all transactions occurred in the current financial year. Transaction $ Amount involved Purchased new motor vehicle on 1 July Depreciation allowance, but limited to motor vehicle depreciation limit. 62,000 Purchased trading stock Deductible under s8-1 30,000 Revalued land and offices on site from which business run No effect as there is no CGT event 70,000 Acquired land to expand factory Capital expenditure, so falls within the first negative limb of s8-1. No deduction 120,000 Sold case of wine in November, purchased for $24,000 as an investment in February 1990. This will represent a capital gain. Because this is a company the discount method is not available. The company will therefore index the cost base and the gain will be the difference between the indexed cost base and the sale price. 56,000 Made allowance for annual leave to be paid to staff for Christmas leave. No effect. This is not deductible under s8-1 as it is not yet incurred. Also it will not be deductible because of s26-10. 12,000 Provided new motor vehicle to Managing Director, estimated to travel 20,000 kilometres per year. This will have FBT payable on it. We know the base cost of the car. If it is assumed the car has been available for 365 days and there was no employee contribution the taxable value is $62,000 x .2. This is then grossed up and tax calculated on the grossed up value at 47%. Same vehicle mentioned above. Gave to each staff member one piece of furniture valued at no more than $200. There will be no FBT payable here as this is a minor fringe benefit and thus exempt. s58P If the furniture represents trading stock (i. the company sells furniture) this will be disposal of trading stock and an amount that represents the cost of the stock will need to be added as assessable income. 9,400 Received fully franked dividend. The dividend will be assessable income, as will the value of the franking credit ($60,000 x 30/70 = 25,714). The franking credit will 60,000 Debts written off during the year is the only deductible amount. The accounts receivable are assessable income. The estimated bad debts and the estimated doubtful debts are not incurred. It is only when a debt actually becomes bad that it can be deducted. S25 sets out the criteria for a debt to be bad. Students should indicate what these tests are. 3 At one point in time previous year business losses could only be carried forward for seven years. Nowadays there are no restrictions on the use of previous year losses. Discuss Whilst this statement is generally true, there are a number of exceptions to this general rule. The first of these is Division 35--Deferral of losses from non-commercial business activities. In such circumstances losses made in certain non-commercial business activities are not deductible. The notion of non-commercial is defined in s35. Students should be able to identify what makes a business no-commercial, that is identify and explain the tests. Also division 165 subdivisions A and B deny losses to companies that satisfy certain criteria set out in those provisions. Section 165 deals with situations where a company has current year losses whilst section 165. 4 Martha was a primary school teacher. Martha was also keen on astrology. To encourage others Martha would run “observatory nights” to teach anyone who wanted to know a little about the stars. Martha charged people $10 to attend one of these sessions. Martha had an expensive telescope she used for her own star gazing, but also used it for her “observatory nights”. She housed the telescope in a converted garage, which was heated and far more comfortable for star gazing. Martha made a loss on her “observatory nights” business of about $7,000 per year, and has claimed this loss against her teacher’s salary. Can Martha claim the Observatory nights losses against her other income? This question is designed to have students consider the operation of division 35, the noncommercial loss provisions. A student may say this is not a business, rather a hobby. It is unlikely however that this would not be classed as a business. All the hallmarks of a business are apparent. Indeed, one reason division 35 was introduced was because individuals ensured the activity did run as a business. Division 35 would therefore be applicable in relation to Martha. Accordingly, Martha will not be able to offset the loss from the star gazing business against her other income unless she can satisfy one of (i) section 35-30 (assessable income test); (ii) section 35-35 (profits test); (iii) section 35-40 (real property test); or (iv) section 35-45 (other assets test). There is lack of information to be able to definitively answer this question, but on the available facts it is more than likely Martha would not satisfy any of the above test. Clearly there is no real property (land and or buildings) involved. We do not know if she had assessable income from the business of $20,000 or more, nor if she has made profits 3 times in the last 5 years. The closest she may come is the other assets test. If the depreciated value of her telescope is greater than $100,000, then this test will be satisfied. 5 6 During the 2012/2013 tax year, Tasman Ltd incurred the following expenditure: 1 November 2012: entertainment expenditure associated with the launch of a new product — $12,000 This is deductible despite section s32-5. It is deductible as an entertainment expense because it comes within the exception s32. 12 December 2012: expenditure on a staff training seminar on “motivation and sales psychology” — $2,500 As with the previous answer this is excepted from the non-deductibility of entertainment expenses because of s32. 4 January 2013: expenditure on a gymnasium attached to work premises — $120,000 This would be classified as a recreational expense and not deductible under section 26. However, 26(3)(b)(iii) would allow a deduction for this expense as it is a fringe benefit expense. During the whole tax year, expenditure on meals provided to staff in the executive dining room — $7,000. This is an entertainment expense under section s32, however it is an allowable deduction s32 and 32. Advise Tasman Ltd what deductions (if any) it could claim regarding the above expenditure for the tax year ended 30 June 2011. The first negative limb of section 8-1 means capital expenditure is not deductible. Why then do business continue to buy new capital equipment on a regular basis if there is no tax advantage? There is a tax advantage! The advantage is depreciation. The depreciation provisions are found primarily in Division 40 and in particular s40. 7 How would the purchase of the following items effect the taxable income of the business that makes computers: (i) Bought $20,000 worth of components to make the computers This expenditure is clearly deductible under s8 being incurred for gaining or producing assessable income. It is not capital equipment as the business makes and sells computers. Thus it is deductible as trading stock. (ii) Paid $15,000 rent on fork lift trucks that were hired for use in the business Same as for part (i). This is clearly in gaining or producing income. Because the business is leasing the fork lift trucks, they are not capital and thus the lease payments are an ordinary incident of running the business and hence deductible.. No depreciable item has been acquired because the company does not buy the asset (they do not own it), they Discount allowed by a merchant on selling his book debts to a finance company on the winding-up of his business. This is deductible. It is a loss incurred in gaining and producing assessable income. Bonus due to an employee, but paid directly to a charitable institution at the request of the employee. This is assessable income to the employee (because of s6(4)) and will be deductible to the employer as it is an expense of doing business. Paying a bonus to an employee is a business activity. The employee can claim a deduction however under s30, provided the requirements of s30 are complied with. i. the charity is a registered charity. Bank interest paid in respect of an overdraft secured on a taxpayer's private home and used in her business to purchase additional manufacturing plant. This will be deductible. The interest is being used for business purposes. Even though the loan on which the interest is being paid was to acquire capital equipment, the interest nevertheless is deductible for it is an ongoing expense which of itself acquires no asset. An amount paid by a company in bringing a new employee from overseas to take-up a position with the company in Australia. This is deductible as it is a business expense. However, as a fringe benefit FBT will be payable. Legal costs incurred by a wholesale merchant in discharging a mortgage over storage buildings, which had been used as security for a loan for the purpose of financing his business activities. This is deductible by virtue of section 25. 10. Required: (a) Give examples of a question of fact. (b) Give examples of a question of law. Answer : Before Review of Self Assessment (ROSA) and subsequent amendments to the Taxation AdministrationAct, it was only possible to apply for a private ruling when a question of law was involved. That no longer applies: TAA Div 359 Sch 1; see [24]. The issue is still relevant because the Administrative Appeals Tribunal makes findings on questions of fact which are followed if relevant up to High Court level. But itis only possible to appeal to the Federal Court from a decision of the AAT where a question of law is involved: see [24]–[24]. Fact Law Am I a resident? Is my income assessable in Australia under ITAA97,s 6-5? Am I carrying on business or ahobby? Is my income assessable under ITAA97, s 6-5, or not because is generated by a hobby? Am I a trader or an investor (shares)? Same issue when framing the question: a trader is assessable ITAA97, s 6-5; an investor is assessable under CGT: ITAA97, Pt 3-1. Also diff rules for losses. Am I operating in a partnership? Is my income assessable under ITAA36, Div 90 s94?
Sample questions and answers
Course: Taxation Law (BLB3134)
University: Victory University
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