Are annual payment from lottery winnings taxable income?
In the given case, an instant lottery called “Set for Life” is conducted by the Lotteries Commission. It is required by the participants to look for three tickets which have written: “Set for Life”. The participant who wins the lottery receives the annual payment of $50,000 for the next 20 years. The first of the series of payment is to paid on the win instantly. After that, they are paid every year on the anniversary of the date on which the participant won (Gripaios, Bishop and Brand, 2010). The interesting question to be considered here is that if the lottery winnings should be considered the income of the winner or not. If they are considered the income of the individual, then these are subjected to taxation laws by the government. And a part of this income will then be paid to the government as per the rate of taxation applicable to the income earned through a lottery.
Now, let us understand the present stand taken by state authorities on the issue of lottery wins. The lottery payment is considered a form of income by the state authorities. Therefore, the state imposes taxation laws on the prize money. This money is subjected to taxation and the winner is obliged to pay the state authorities the tax according to the tax rate applied by the state. Therefore, it is required by the winner of the lottery to report to the taxation authorities of the state and then pay the taxes according to the,e taxations rules and norms of the state. Only a meager prize amount is not supposed to be brought the tax net (Western Australian Current Regulations, 2014). This amount is different for the different country. However, if the prize money excludes the minimum amount which is not liable to taxation, then it is mandatory for the person to report to the taxation authorities of the state. The common practice adopted nowadays is the deduction of the taxation amount by the prize distributor before awarding the prize to the winner. Thus, the amount received by the winner is usually deducted for taxation. There are different tax rates applicable to the different sum of money won. The rate of taxation also differs from the activity by which the money is won (Bergsma and Tayal, 2018). For example, the tax rate may be higher on the prize money earned from winning a horse race in comparison to the money won through a lottery. Also, in case of a win of a horse race, the prize money is subjected to taxation at a lower amount than the prize money won through the lottery. Usually, the taxation rate on prize money is more than 25 percent which is very high in comparison to the tax rate applicable to the income.
Is the annual payment income?
In the case provided to us, the annual payment must be considered as an income. Therefore, it should be subjected to the rules and norms of taxation. This is so because the prize money which is won by the participant seeks the same good and services which the income of the winner seeks. In case the prize money is not subjected to taxation, the excessive amount of the money possessed by the lottery winners will create a huge demand for the products and services available in the market. The surge in the demand for the goods and services will eventually lead to the scarcity of those goods and services which do not expect the new demand (Bennett, 2014). This imbalance between the factors of supply and demand of the factors will result in the rise in the prices of the goods and services. The increase will cause inflation of the goods and services. Not only does this causes inflation in the market, but it also prohibits the regular customers from purchasing the goods and services (McEvoy, 2009). The winners of the lottery also disrupt the supply and demand balance of the labour market.
Calculating the taxable income of a company
Winning lotteries cause the labour to abandon their jobs. In fact, in many cases, it has been witnessed that the lottery winners heavily depend on the prize money earned by them. They seek income from the prize money they win as their primary sources. In some other cases, the huge amount of prize money is invested in the form of equities and stocks. This investment may also lead to disruption of the financial markets (Bennett, 2014). Unforeseen lottery winnings cause disparity in the society because of the sudden increase of inequality of income. The inequality of income has many negative effects on the economy of the country as well.
The taxation of the prize money adheres to the principle of maintenance of equality of income in the society and the ideals of progressive taxation. The inclusion of the prize money in the taxation system helps to control the rise of illegal activities. It helps to track the flow of the money. Usage of the prize money is often related to black markets, the smuggling of drugs and weapons and other illegal activities. Thus, it is understood that the lottery wins may have far-reaching consequences on the economy and the society. Therefore, it is essential to include the prize money in the gamut of taxation.
The taxable income of the company refers to the gross sales revenue of the company mins the deductions for the expenses incurred by the company. These deductions include different expenses from the activities of the business and the king of the business or the sector in which the business is involved. Therefore, we can represent the taxable income of a company as:
Taxable income = Gross Sales Revenue – Gross Deductions
To calculate the taxable income of the company, we will have to calculate several entities related to the company. The entities which are to be calculated for the determination of the taxable income of the company are mentioned below:
a. Gross Sales – Gross sales of a company refers to the total income of the company in a financial year. The gross sales include the revenues from various operations of the company. These operations may be the sale of goods and services, leasing of the property of any kind and the interest received on its loans (Department of Industry, Innovation and Science – Australia, 2018).
b. Cost of goods sold – In the case of a company whose main operation is the selling of goods, the cost of goods sold should be calculated. This can then be reported for the determination of gross profits.
c. Expenses – The next step is the calculation of the business expenses during the financial year. The business expenses include the administration expenses, impairment expense, debts, rents, and other expenses.
d. Depreciation – Depreciation is the amount of the money which is to be invested in the repairment of the damage of the tools of the business. It is usually related to the machinery involved in the business operations (Hutchens, 2017). The calculation of the depreciation of the assets of the company required careful analysis and scrutiny of the assets. The assets are tracked for a certain amount of time. For the purpose of convenience, often a generalized rate of depreciation is calculated and adopted for machinery and other tools used in the business.
Principle established in IRC v Duke of Westminster and its relevance today in Australia
After the above-mentioned parameters have been calculated, then the gross deductions can be subtracted from the gross sales of the company (James, S. and Alley, C., 2002). This gives us with the required answer which is the taxable income of the company. With the understanding of the above-mentioned concepts helpful in the derivation of the taxable income of the company, we can now calculate the taxable income of the Corner Pharmaceuticals.
The details provided to us about the Corner Pharmacy in the question are mentioned as follows. “The Corner Pharmacy is a chemist shop. The shop provides no credits sales. It accepts major credit cards. It sells items off the shelf and the proprietor fills prescriptions for cash and for payments made under the Pharmaceutical Benefits Scheme [PBS] (Department of Industry, Innovation and Science – Australia, 2018). Three (03) assistants are employed.” Further, the financial data is provided regarding various operations carried out by the Corner Pharmaceuticals.
Cash sales $300,000
Credit card sales $150,000
Credit card reimbursements $160,000 PBS:
-Opening balance $25,000
-Closing balance $30,000
-Billings $200,000
-Receipts $195,000
Stock
-Opening stock $150,000
-Purchases $500,000
-Closing stock $200,000
Salaries $60,000
Rent $50,000
1. Gross Sales – To calculate the gross sales of the company, we add the total sales. Therefore, add cash sales, billings and credit card sales.
Cash sales – $300,000
Credit Card Sales – $150,000
Total – $450,000
2. Difference between billings and receipts is to be added to the gross sales.
Billings – $200,000
Receipts – $195,000
Total – $ 5,000
3. To this is added the difference between the closing and the opening balance.
Closing balance – $ 30,000
Opening balance – $ 25,000
Total – $ 5,000
4. Add the difference between the stocks values.
Closing stock – $200,000
Opening stock – $150,000
Total – $ 50,000
5. Add all these values to get the gross sales = 450,000 + 5000 + 5000 + 50000 = $505,000.
6. Deductions – To calculate the deductions to the gross sales, sum up the salary paid to the employees and the rent on the property.
Salary – $60,000
Rent – $50,000
Total – $110,000
7. Taxable income – $505,000 – $110,000 = $395,000.
The Duke of Westminster’s case was is often looked upon as a way of tax avoidance. The complete name of the case was the Inland Revenue Commissioners v. Duke of Westminster [1936] AC 1. The Duke of Westminster, who was alleged of avoiding tax payment, employed a gardener and paid the gardener from the money which was actually his post-tax income. His post-tax income was very substantial (Monroe, 1982). In order to avoid or reduce the taxes on the money, the Duke of Westminster decided not to pay the gardener’s wage at once and instead drew up a covenant, in which they agreed to pay a lump-sum of the same amount at the end of every period of a few months.
During the time, when the tax laws weren’t advanced enough, the Duke of Westminster happened to claim the expenses of the wage as a deduction in his taxes, which thus led to reduction in his taxable income and also in his liabilities towards the income tax and the surtax. Sometime later, the Department of Inland Revenue happened to know about the Duke of Westminster and decided to challenge this arrangement as Tanta mounting to the tax evasion and hence dragged the Duke of Westminster to the court (Stacey, 2013). The case was carried out in the court for a few months which later on resulted in disappointment for the Department of Inland Revenue as they lost the case against the Duke of Westminster.
“Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure that result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax” (IRC v Duke of Westminster [ 1936 ] AC1 (HL)).
The final verdict was given by the judge, Lord Tomlin, who famously said in the case that every man is entitled to align his affairs in order to make sure that the tax, as according to the appropriate acts would be lesser than it. If the individual satisfies this criteria, making sure the result is secured, then the government cannot force him to pay any extra tax (Passant, 1994).
This verdict, although had a negative influence in the society and later on attracted others seeking to avoid tax legally by creating complex structures. When the number of people trying to escape the tax payment increased in numbers, the Department of Inland Revenue again had to intervene and since then, the tax laws have been improvised by subsequent cases where the courts have looked at the overall effect (Fullarton, 2003). One of the many examples in which the court was a lot more serious and had a more restrictive approach which was the Ramsay principle in which, if a transaction had come up with any out-of-law steps that had no reason for the individual to escape the tax pay in advance, then an appropriate approach was taken towards the tax to make a change in the transaction as a whole.
The companies including the ones which had made a substantial capital gains had later on, after the implementation of the Ramsay principle, entered into a very complex type of transactions that had been the reason for artificial capital losses, for the reason similar to these, that is, about escaping the capital gains tax (Petrin, 2018). The House of Lords, which is a legislative function in the United Kingdom, which also was known as a judicial function at the time, confirmed that wherever a transaction had a pre-arranged artificial step that served no commercial purpose to the person authorized other than to save tax, the proper approach had to be taken which was to tax the transaction as a whole. This particular decision by the House of Lords are applicable to all the types of direct taxation, not just the capital gains tax (Fullarton, 2003). The Ramsay principle was also brought into the Australian court. The objective of this was to bring the principle in Australia. The judges had many opinions about the principle did not agree on many parts of it. It took long for the Australian judges to imply the principle in Australia. After many trials, it was decided that the Ramsay principle will be applied to the Australian laws too. Though, the principle is not considered in many of the cases in Australia till date.
4. When Joseph and his wife Jane borrowed the money to purchase a rental property as joint tenants with a written agreement which described the shares that Joseph and his wife jane will be sharing in the profit and loss, they had to also agree on the terms which defined the reduction in the amount of the taxes applied in case of any capital loss. Since Joseph and Jane had an agreement which entitled Joseph to 100% of the loss, his wife Jane would not be paying off any amount directly in case of the loss.
When the rental property was sold and some revenue was generated from the selling of the property had to be shared into equal halves since it wasn’t the part of the profit. The revenue generated by selling the rental property gave Joseph half of the revenue from which a sum of $40,000 had to be deducted since Joseph and his wife Jane faced a loss of $40,000 last year. Joseph also has an option to repay (Whiteford et al., 1989 p.15) the loss amount in terms of the tax returns in the next year if the amount of loss occurred is out of the limits of the deductible amount. The tax rate on the net capital gain generally depends on the profit that a person gains in a year (Australian Taxation Department, 2017). The max capital gain rate that can applied on a person is 20% of his total income and thus can be filed in terms of the tax returns 9 (Kakwani, N.C 1977 p. 72). Also, the tax benefits depend on the share that the person holds in a property. That is, if Joseph had a share of 20% on the rental property, he is also eligible for a gain of 20% on the tax returns while his wife will be having a share of 80% on the tax returns.
The husband and wife who were taxpayers and owned the rental property, in a written agreement, the pair also had agreed to share the profits from the rental property 20/80 and that all losses would be given on to the husband. The effect of this agreement might to stream income to the wife as she might have a little income and stream losses to the husband to offset other income (Stamsø, 2015). The court should be holding that the husband was would entitle to 50% of the share losses was merely a partner of little notion for the tax purposes and not a partner at general law which also represented his individual interest in the partnership (Australian Taxation Department, 2017). Therefore, Joseph and Jane would be held to be in a statutory partnership as per s 995-1 ITAA97. Joseph will only be entitled to a deduction for the loss to the extent of his ‘individual interest’ in the partnership. That is, his ownership interest of 50%. So, Joseph and his wife Jane will need to share the loss of equally (Murphy, K., 2008 p.113). On the sale of property, any capital gain or loss will be made by Joseph and Jane personally rather than at the partnership level. Any capital gain will not be included in the net income of the partnership (s 106-5 ITAA97), but will be assessable to each partner to the extent of their ownership interest in the property.
On the chance that the property, if the couple has decided to sell, be a personal residence, then the loss cannot be calculated as a deductible expense. The couple may be allowed to claim the losses for the properties that they have used for commercial purposes, or may be as an investment (Mirams, 2018). To counteract this, the couple may first make the personal property into a rental one, then sell it for a cost lesser than that of the original amount, to count it as a deductible loss, which is not a sure plan to work. On the other hand, the couple may improve on the features of the house, and list it out as such expenses (English et al., 2003 p. 498)
References
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