Pre-paid Rent and Tax Implications
1.
As per para. 129, TR 2002/14 lists down the following circumstances where a lump sum payment can ne treated as prepaid rent.
- Lump sum payment is made In exchange of the tenant being granted the right to stay for a fixed duration
- A pro-rate refund can be demanded by the tenant for any unexpired term portion
- The payment has been made to allow the usage of the property for the personal use and enjoyment of the tenant
Based on the given scenario, it does not seem that the above conditions are met and hence the payment of $ 15,000 received would not be termed as revenue receipts but would rather be termed as capital receipts and hence exempt from any tax. Thus, the payment would not be considered as revenue receipts for the tax purpose.
As per s. 25(1), ITAA 1936, the compensation receipts would contribute to assessable income if the compensation payment has been made only for the loss of income. However, in case where compensation receipts are for both capital loss and income loss, then the assessable income would be the component received by taxpayer for loss of income a highlighted in Mc Laurin v. FC of T
In the given case, it is apparent that compensation has been received for the loss of a business asset i.e. warehouse and therefore would be termed as capital receipts and would not be taxable.
In accordance with paragraph 25-5(1)(a) ITAA 1997, taxpayers are permitted to claim deduction in respect to the expenditure that the taxpayer incurs with regards to managing tax affairs. In accordance with s. 995-1, ITAA 1997, tax affairs would include lodging of tax returns as well as filing of any objection. Further, this deduction is available in the year in which the expense has been incurred.
In line with the above understanding, it is apparent that for the year 2016-2017, a total deduction of $ 500 + $800 i.e. $ 1,300 would be available in wake of expense on managing tax affairs. Further, this would be available in the current year even though it pertains to the tax returns of previous year since it has been incurred in 2016-2017.
In accordance to s. 8(1) business related expenses may be deductible. This section allows deduction of expenses that are related to the production of assessable income. However, expenses that are of personal or domestic in nature cannot be deducted under this section.
As per the given situation, when James is working at the hospital, he tends to avail the lunch from the hospital cade and spends a total amount of $ 2,000 on the same. This money would be considered as non-deductible owing to the personal nature of the expenses as these are not linked to production of assessable income.
Compensation Receipts and Tax Implications
The spending that the employer does on providing meals and entertainment outside the office premises would be considered as fringe benefits in accordance with FBTAA (Fringe benefit Tax Assessment Act) 1986. In accordance with Division 9A of FBTAA 1986, with regards to meal and entertainment expenses that are incurred on potential or existing clients, no deduction can be claimed. Also, considering that FBTAA is applicable, hence Division 32 would not apply which otherwise provides deduction for entertainment related expenses.
In line with the above, understanding, it is apparent that the expenses that have been incurred on the prospective clients entertainment would not be tax deductible.
2.
The key issue is to determine if Usman would be a tax resident of Australia or not for the year 2016-2017 in accordance with the relevant tax laws.
The tax residency has been highlighted and dealt with in s. 6(1) ITAA 1936. Tax residency is crucial since the underlying tax rules applicable tend to be different for Australian tax residents and foreign tax residents. In order to ascertain the tax residency of an individual taxpayer, this subsection highlights various tests which have also been outlined in the tax ruling TR98/17. These tests are highlighted below.
- Domicile Test – This test is used for testing the tax residency status of those taxpayers who tend to have Australian domicile but tend to reside outside Australia for personal or professional reasons. In this test, the major factor that is taken into consideration is whether the permanent abode of the concerned taxpayer still continues to be in Australia of has been shifted to foreign land. Based on this, the tax residency is determined.
- Superannuation Test – This test is applicable for those individual taxpayers who are employed with the Federal government and have been sent abroad for professional work thereby representing the government. In this case, the tax residency is primarily based on the participation of the concerned taxpayer in particular superannuation scheme.
- 183 day test – This test is used to determine the tax residency status of those individual taxpayers who are essentially foreign resident and thereby do not possess the Australian domicile. For satisfying this test, a taxpayer has to comply with the following two conditions.
- The taxpayer during the assessable year under consideration must reside in Australia for a period of atleast 183 days. It is not necessary that the period of stay should be at one go and thereby it can be carried out intermittently.
- There should not any suspicion on the part of the Tax Commissioner about the intention of the taxpayer to make Australia as their home going forward
- Residency Test – The statute law related to tax does not highlight the precise definition of “resides” in legal terms. Thus, for applying this test, there is reliance on the various factors that the court over the years considering imperative for application of this test. These factors are as explained below
- The purpose of visit to Australia and the underlying significance of the same. Typically significant reasons would include coming to Australia for the purpose of studying or doing job for a period of atleast 6 months.
- The nature and strength of relationship (both in personal and professional sphere) that the given taxpayer has in Australia and the country of origin.
- The taxpayer’s social arrangement in place and the similarity of life in Australia with life in the country of origin.
In the given case, it is known that the taxpayer Usman has a French passport which clearly implies that Usman is not an Australian domicile holder. Since he is not an Australian domicile holder, hence domicile test would not be applicable in the given case. Further, since Usman is not employed by the Federal government of Australia, hence the superannuation test would not be applicable in the given case for determination of tax residency. Hence, only two tests are relevant for the situation at hand i.e. the 183 day test and residency test. The application of these tests to the given situation is highlighted below.
- 183 day test – For the year under consideration i.e. 2016-2017, it is apparent that for the complete year Usman has remained in Australia. As a result, the primary condition of staying in Australia for a period of 183 days has been satisfied by Usman for 2016-2017. However, there is no information given on Usman’s intent to settle down in Australia over the long term. Additionally, there is no detail of any fixed asset that he might have purchased in Australia despite being in Australia since 2012. If Usman had any intentions to settle in Australia, then we would have purchased fixed assets particularly a house but no such information is available. Also, his work visa will also expire soon. Thus, there is reasonable doubt in relation to Usman’s future intention to settle down in Australia. Hence, Usman fails to pass this particular test for tax residency.
- Residency Test – It is apparent from the given details that Usman has come to Australia for employment purposes and during the given assessment year for all the twelve months, he has worked in Australia. This clearly amounts to a significant purpose and hence Usman is able to pass this test.
Conclusion
Since Usman has been able to pass the residency test, hence for the purposes of tax, he would be treated as an Australian resident for the year 2016-2017.
3.
The key issue is to ascertain the capital gains implications for Norman for the year 2016-2017 in wake of the transactions undertaken.
In accordance with s. 108(5), the selling of an asset constitutes a capital event for which the capital gains/(losses) need to be computed taking into considering the selling cost and also the cost base of the asset.
In accordance with section 110-25, ITAA 1997, the cost base of the asset comprises of the following five elements.
- Money that has been paid for asset acquisition (s. 110-25(2))
- Any incidental costs which are related to buying or selling of the asset (s 110-25(3))
- Any cost incurred with regards to owing the asset (s. 110-25(4)). This typically comprises of elements such as interest costs related to acquisition of asset, land tax or other related taxes besides the cost of maintaining and repairing the asset.
- Any cost which is capital expenditure and incurred in order to increase the asset value or to preserve the value of the same (s. 110-25(5)).
- The final cost element refers to any capital expenditure that is incurred in order to preserve, establish or defend the title on the underlying asset (s. 110-25(6)).
Managing Tax Affairs Expenses and Tax Implications
The cost base is essentially the sum of the various costs related to the following five elements. Further, it is imperative to note that in accordance with subdivision 118-B there is CGT exemption available for the main residence of the taxpayer. This is implies that any capital gains arising from the sale of main residence would be exempt from any capital gains tax burden. The main residence is referred to as permanent address of the taxpayer and should be used for ordinary dwelling by the taxpayer. Also, to claim full exemption, it is imperative that the main residence should not be used for producing any assessable income. However, if the main residence is used for income generation, then only partial exemption would be available. It is essential to note that the assessable income generation could be in the form of either a home business or through rent.
In accordance with given information, it is apparent that Norman who is a hairdresser by profession has bought the main residence in April 2016 with the following costs.
Purchase price of the main residence = $ 700,000
Stamp duty and legal costs (incidental costs related to buying) = $ 70,000
It is also known that the house has six rooms and in order to prepare 2 rooms for his hairdressing business, a sum of $ 100,000 has been spent.
The first aspect is that the cost of $ 100,000 does not add to the value of the house or improve the same and hence this would not be added into the cost base of the main residence. Also, it is apparent that eve n though 2 rooms are used for business, the other 4 rooms are still being used for personal dwelling.
In the given case, since two rooms are being used for assessable income generation, hence only partial exemption would be available for the capital gains which would in the given case be dependent on the floor area of the house which is dedicated to assessable income production. Hence, owing to the business being set up, the capital gains implication would be that earlier complete exemption on the main residence was possible but now partial exemption is possible based on the precise proportion of floor area of the house that is being used by the hairdressing business.
Conclusion
In wake of the above discussion, it would be fair to conclude that owing to home business being run by Norman, instead of complete exemption on the main residence capital gains, this would now reduce and hence some proportion of the capital gains realised by liquidating the main residence would be subject to CGT. The precise proportion would be the equal to the proportion of main residence’s floor area that has been occupied by the hairdressing business.
4.
R &D tax incentive is a tax incentive program which provides the companies with tax offsets if they engage is eligible research and development activities in accordance with Division 355 ITAA 1997. In order to be eligible for this incentive, it is essential that the underlying taxpayer is a R&D entity which refers to a company that is incorporated based on Australian law. Further, it is essential that these R7D entities must do research work in Australian only. It is imperative to note that for the purposes of this tax incentive, R & D activity should be essentially experimental and hence the outcome of this research should not be certain and also the objective is to generate new knowledge which then can be used for a host of applications. An R&D tax offset arises is the notional deduction for the year under assessment is at minimum $ 20,000. The notional deduction tends to arise amongst other cases when contribution is made under the CRC (Cooperative Research Centres) program. If this is satisfied, then a refundable tax offset of 43.5% of the eligible activities may be availed.
Further, deduction for the same cannot be availed under s.8(1) since it is experimental R & D and not directly related to the production of the assessable income. In the given case, since Central Queensland University is a registered RSP, hence by inking a one year contract, Avon would be able to avail the tax offsets in accordance with Division 355. This is because the company is an Australian company and is contributing to research by way of CRC program and hence the threshold for notional deduction would be met making Avon eligible for the refundable tax offsets. The remaining amount can be treated as capital expenditure under s. 40-880 and hence deduction on the same can be realised over a five year period using the straight line method.
References
[1] ATO, Income tax: Taxation of retirement village operators (2002) < au/atolaw/view.htm?locid=%27TXR/TR200214/NAT/ATO%27&PiT=99991231235958″>https://law.ato.gov.au/atolaw/view.htm?locid=%27TXR/TR200214/NAT/ATO%27&PiT=99991231235958>
[2] Barkoczy, Stephen, Foundation of Taxation Law 2015, (North Ryde, CCH, 2015)
[3] Mc Laurin v. FC of T (1961) 104 CLR 381
[4] Deutsch, Robert, et. al., Australian tax handbook. (Pymont, Thomson Reuters, 2015)
[5] Gilders, Frank, et. al., Understanding taxation law 2015. (LexisNexis, Butterworths 2015)
[6] Austlii , FBTAA 1986 (2017) < https://www8.austlii.edu.au/cgi-bin/viewdb/au/legis/cth/consol_act/fbtaa1986312/>
[7] Austlii, ITAA 1936 – s. 6, (2016) < https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s6.html?
[8] ATO Taxation Ruling TR98/17, (1998)< https://www.ato.gov.au/law/view/document?Docid=TXR/TR9817/NAT/ATO/00001>
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