Tax Implications Of Asset Liquidation

The Issue

Question 1

Issue

The client in the given scenario has got some proceeds from liquidation od selected assets in the current tax year. The purpose of the given analysis is to provide advice to the client in relation to potential taxation implications of the provided transactions.

Law

Proceeds Nature

The pivotal question which assumes relevance in proceeds being derived by a taxpayer is to ascertain the underlying nature of these proceeds. Two essential choices are presented for proceeds being revenue or capital. Each of these possibilities could be possible based on the the underlying case facts (Coleman, 2016). For instance, a real estate company involved in selling of property would assume the proceeds as revenue as property is trading stock from the perspective of the company. In contrast, if there is an individual who had purchased vacant land a decade back and has now liquidated the same, the proceeds would be capital since there is no business involving real estate and thereby the land would be a capital asset leading to obtaining capital proceeds. This differentiation assumes importance owing to difference in tax treatment being given to the two types of proceeds. In case of deriving capital proceeds, no tax is levied on the proceeds but tax is possible on the capital gains in the process (Barkoczy, 2017).

CGT Relief

Section 149-10 has defined an asset class which is immune from CGT impact and is named as pre-CGT asset. For an asset to be included within the ambit of this class, there is a basic requirement of the asset purchase of being made at the time when the capital gains were ignored from taxation fold.  The requisite time period in order to ensure that above would be any time prior to 20^th September, 1985. If the purchase date of the asset belongs to this period, then CGT liability would not arise (Coleman, 2016).

A blanket exemption is provided by the above asset category. However, there are certain other provisions which provide exemption for certain specified assets and therefore are not so broad in coverage as the pre-CGT asset clause. As per s. 118-19, for a collectable to be qualified for application of CGT on the capital gains produced, the price of asset acquisition must necessarily be above $ 500 (Barkoczy, 2017).  The corresponding minimum purchase price in case of items meant for personal use is $ 10,000 so that CGT may be levied and if the above threshold is not met, then no CGT is levied irrespective of the underlying capital gains realised from sale (Wilmot, 2014).

CGT calculation

The process of CGT liability determination involves quite a few steps. The process begins when a CGT event highlighted in s. 104-5 tends to take place. Although there is a variety of these CGT events but the relevant CGT event from the perspective of the given scenario would be A1 considering that the client has sold several assets. Also, the underlying CGT event also communicates the relevant methodology for deriving the potential gains or losses form asset liquidation (Woellner, 2017).

The Law

For taking forward the process, the asset cost base need to be determined. Section 110-25 is helpful in this regards since it lists down the essential elements that tend to form the cost base of asset and are summarised as follows (Wilmot, 2014).

Some of the elements mentioned above may be missing for a given asset and hence would be excluded from the cost base computation.

Post the derivation of capital gains related to the asset, there is adjustment on account of existing capital losses. These capital losses may be produced in the same tax year or may be pending from the years gone by. These capital losses cannot be adjusted against taxpayer’s taxable income.  The resultant capital gains are given rebate which can happen two alternative mechanisms namely indexation and discount (Hodgson, Mortimer and Butler, 2016).  The application of these methods is driven by the satisfaction of the underlying conditions. For instances, for the application of indexation method, a necessary condition is that the purchase of asset ought to have been prior to September 1999 (Reuters, 2017). The indexation method true to its name allows indexing the cost base to the change in the inflation rate so as to ensure that the nominal gains are not taxed and CGT is limited to only real gains. Usually a more effective method is discount method which has been outlined in s. 115-25 ITAA 1997 (Nethercott, Richardson and Devos, 2016).  This method allows for rebate on long term gains whereby only 50% of the gains would be considered taxable while the remaining would be ignored. The necessary condition however, are gains being long term which can be ensured by asset holding period to be in excess of one year (Gilders, et. al., 2015).

Timing of CGT Application

The capital asset liquidation may present a unique problem owing to the time difference between the sale contract enactment and the proceeds being actually paid by the buyer. Due to this time difference, a situation may arise where the above mentioned events tend to occur in two different tax years. This presents a problem for the taxpayer in deciding as to whether the underlying CGT implications tend to be reflected in the year of contract enactment or when the eventual proceeds are received (Deutsch, et. al., 2015).  This problem can be resolved by referring to TR 94/29 which provides clarity in this aspect by highlighting that CGT implications tend to be reported in the same year as the asset sale contract is enacted. The proceeds may be received later.

Application

Proceeds Nature

Based on the given information, it is known that the client is not engaged in business with regards to the given assets that have been liquidated. She is instead an investor along with being a collector. The evidence presented clearly suggests that capital nature of the proceeds derived from sale of assets as the client does not run any trading business. As the proceeds would be termed as capital, therefore no tax would be attracted on these proceeds. However, any increase or decrease in the proceeds derived when compared to the cost base would lead to the application of CGT and resultant tax outflow.

Proceeds Nature

CGT Relief

In line with the discussion in previous section, it is essential to consider the respective acquisition date of various assets. This would lead to conclusion if any of the assets sold are pre-CGT assets. After taking into consideration the buying data attached with the various assets, it may be concluded that painting is that one asset which falls within the pre-CGT asset category. Other assets in fray have their acquisition dates in a period where CGT was already applicable. The net result is that there is no CGT burden with regards to the painting asset (Sadiq, et.al., 2015).

In relation to the collectables, the only asset is antique bed which is successful in meeting with the threshold value in excess of $ 500 as the underlying price paid to buy this bed was $ 3,500. In relation to personal use item, a suitable choice would be violin. This has the features of a collectable but the regular usage of this by client with the underlying intent to entertain herself would imply the asset being for personal use. The acquisition of violin has been done at $ 5,500 which fails to cross the minimum threshold level in excess of $ 10,000 and the result is that violin would have CGT exemption.

CGT calculation

The requisite CGT computations for the remaining assets are as highlighted below.

Net Capital Gains

Timing of CGT Application

In the liquidation of land asset, it has been observed that the contract for sale of land has been signed in the current year but the seller would pay the receipts only by next year. However, irrespective of the above fact, the potential CGT liability on land sale would have to be borne by the client in the current tax year as per the understanding highlighted in TR 94/29.

Conclusion

The calculations that have been illustrated above clearly highlight that the capital gains subject to CGT would be $ 139,100. The assets that would attract CGT would be land, antique bed and shares with the other two assets i.e. painting and violin being exempted from all CGT liability.

Question 2  

Issue

As per the given facts, Jasmine is an employer who is working at Rapid Heat. In the capacity of the employer, Rapid Heat has provided various non-cash benefits that are personal which are constituted as fringe benefit. The liability in terms of FBT (Fringe Benefit Tax) that would be levied on the employer and employee ought to be determined by referred to the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986).

Law

Relevant fringe benefits that the employee has been extended are discussed as follows.

• Car Fringe Benefit

The necessary condition for car fringe benefit is to ensure that the employee can use the car provided by employer in personal use. The permission in this regards may be tacit or explicit.  The use of car limited in scope to only office work would not yield fringe benefits. The relevant computation of potential tax liability that would be levied on the employer is indicated as follows (Nethercott, Richardson and Devos, 2016).

CGT Relief

1) The statutory formula for the value of fringe benefit extended is highlighted below(Woellner, 2017).

2) The fringe benefit taxable value would be found by finding the product of the first step output and the gross up factor

3) The final fringe benefit tax that is payable by Rapid Heat can be determined by finding the product of the rate of FBT applicable and the second step output value.

• Loan Fringe Benefit

An essential condition for the employee to be able to avail this benefit is that the loan should be provided to employee at low cost. This would help the employee to have savings related to interest cost.  The interest rate that the lending should be done by employer is RBA benchmark rate. Any discount on this rate would imply that the employer has provided employees with fringe benefits related to loan. The relevant computation of potential tax liability that would be levied on the employer is indicated as follows (Woellner, 2017).

1) The key starting point of loan fringe benefit computation is the underlying interest savings that employee has realised on the concessional rate considering the period for which loan has been availed during the assessment year (Wilmot, 2014).

2) The fringe benefit taxable value would be found by finding the product of the first step output and the gross up factor

3) The final fringe benefit tax that is payable by Rapid Heat can be determined by finding the product of the rate of FBT applicable and the second step output value (Woellner, 2017).

Deduction Rule (s. 18) – Production of taxable income using the loan amount by employee (not relatives or associates) would provide rebate in FBT liability to the underlying employer (Coleman, 2016).

• Internal expense fringe benefit

The help in non-cash form that employer may extend in regards to enabling meeting the employer personal expenses are referred to expense fringe benefit. This may be carried out by paying for any of the personal expenses of employee. One of these would be by paying the partial amount for the purchase of good that employee is interested in purchasing from the employer. The relevant computation of potential tax liability that would be levied on the employer is indicated as follows (Barkoczy, 2017).

2) The fringe benefit taxable value would be found by finding the product of the first step output and the gross up factor

3) The final fringe benefit tax that is payable by Rapid Heat can be determined by finding the product of the rate of FBT applicable and the second step output value  (Deutsch, et.al., 2015).

Application

• The FBT burden that the employer would have to bear on account of the fringe benefits provided is highlighted below.

Car fringe benefit

The information provided in the case clearly reflects that the car was purchased and given to Jasmine with explicit permission for private use.  Also, considering the relevant law, deduction are available only for major repairs. Further, the car being parked at airport does not hint towards car not being available for private use by Jasmine.

Loan fringe benefit

For 2017/2018, RBA benchmark rate = 5.25% p.a.

For 2017/2018, interest cost charged by employer = 4.25% p.a.

Since, employer cost < RBA benchmark rate, hence Jasmine would save interest.

There are two users for the loan given by Rapid Heat.

User 1: Jasmine who uses $ 450,000 in facilitating holiday home purchase. If Jasmine would earn rent income, then FBT deduction would be available for Rapid Heat.

User 2: Husband of Jasmine who uses $ 50,000 for share related invested. No deduction for employer.

Internal expense fringe benefit

The employer has a business of manufacturing electric heaters. One such heater is desired by Jasmine. The retail price is $ 2,600 but the employer makes the payment for half the share thereby leaving the employee better off since only the remaining $ 1,300 to be paid by her.

• The utilisation of loan now undergoes a change which is to the advantage of employer. This is because now the share investment would be under the ownership of Jasmine. This would imply additional FBT reduction for the employer as per the deduction rule. .

Conclusion

The above analysis of the various fringe benefits provided to employee clearly highlights that all the FBT liability would be borne by the employer and no portion of this falls on the employee. However, possible relief for the employer can come from loan related FBT rebate provided assessable income is produced using loan by employee.

References

Barkoczy, S. (2017) Core Tax Legislation and Study Guide 2017. 2^nd ed.   Sydney: Oxford University Press Australia.

Coleman, C. (2016) Australian Tax Analysis. 4^th ed. Sydney: Thomson Reuters (Professional) Australia.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., and Snape, T. (2015) Australian tax handbook.  8th ed. Pymont: Thomson Reuters.

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

Hodgson, H., Mortimer, C. and Butler, J. (2016) Tax Questions and Answers 2016. 6^th ed. Sydney: Thomson Reuters.

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

Nethercott, L., Richardson, G., and  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., and Ting, A. (2015) Principles of Taxation Law 2015. 7th ed. Pymont: Thomson Reuters.

Wilmot, C. (2014) FBT Compliance guide. 6^th  ed. North Ryde: CCH Australia Limited.

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