Taxation Law Case Studies

Capital Gain and Loss Calculation

Issue

Over the past 12 months Eric acquired and sold some of the assets. Will it lead to capital gain or loss for the year?

Rule

It was held in the case of Californian Copper Syndicate (Limited) v. Harris (Surveyor of Taxes) (1904) 5 TC 159 that those transactions held in the normal course of business will be subjected to tax.

Application

Net Capital Gain or Loss computation –

In the past 12 months there has been various acquisitions by Eric. As the date has not been given, it can be assumed that the assets have been held by Eric for less than 12 months.

Capital Gain tax arises where the sale consideration of the assets sold is more than the cost base of the said assets (Hopewell, 2012). Here the benefit of indexation will not be available as the assets have been held for less than 12 months period.

First of all the assets held should be classified under their respective heads as under:

Collectables- these are the items that are bought by the individual mostly for personal benefit or enjoyment. No capital gain arises on the sale of such collectible assets if the acquisition costs of these assets are $500 or less than that. In the given case, Eric has the following collectibles in hand with the acquisition cost given:

Antique Vase- $ 2000

Antique Chair- $ 3000

Painting- $ 9000

Personal Use Assets– these are the assets which are used by an individual for his own use or enjoyment but other than collectibles. Capital gain does not come into picture if there is a sale of the personal assets and where the acquisition cost of these assets was $ 10,000 or below (Nethercott et. al, 2013).

In the given case, Eric has the following personal use assets in hand with the acquisition cost given :

A home sound system- $ 12,000

Other than the Collectibles and Personal Use Assets, Eric had purchased shares in a listed company for $ 5,000 which come under the purview of capital gain tax.

Conclusion

It needs to be noted that as per Income Tax Assessment Act 1997, section 102-5 the income that is assessable will contain net capital gain. For calculation of capital gain tax for the assets held for less than 12 months, the following formula shall be used

Capital Proceeds – Assets as per the base cost

(Amounts in dollars)

Particulars	Cost Base of Assets	Capital Proceeds of Assets	Net Capital Gain/ (Net Capital Loss)
Antique Vase	2,000	3000	1000 Gain
Antique Chair	3,000	1000	(2000) Loss
Painting	9,000	1000	(8000) Loss
Home Sound System	12,000	11000	(1000) Loss
Shares in listed company	5,000	20000	15000 Gain
Total			5000 Net  Capital Gain

Hence, the total taxable capital gain for Eric for the year comes to $5,000.

Working Notes:

1. The overall collectibles have been acquired on an individual basis (cost ranks higher than $5000) therefore will attract capital gain
2. All the Personal use assets individually have been purchased at a cost more than $ 10,000, hence they are applicable for taxable capital gain.
3. Even the assets that are used personally are acquired at a cost that exceeds $10,000 and therefore capital gain is applicable
4. The process of set off has occurred between the capital gain and the loss to determine the net capital gain or loss (Hopewell, 2012).

Issue – Brain is a bank executive and the fringe benefit needs to be ascertained. Two different issue is considered that is what would happen if the interest was payable only at the end of the loan instead of monthly installments. Secondly, what would happen if the bank released Brain from the loan repayment?

Rule

It was held in the case of John Holland v. Commissioner of taxation [2015] FCAFC 82 that when the employees bear the costs directly then they are eligible for the tax deduction. Such costs must be borne by the employee directly

Taxable Value of Fringe Benefit

Application

A three year loan amounted to $1 million has been provided by the Brian employer and that too at a rate of interest which beats the market rate. Hence, such a loan falls into the division of loan fringe benefit.  A loan fringe benefit is one where the rate of interest provided to the employee by the employer stands less as compared to the market rate (Sadiq et.al, 2017). Therefore, this loan is a loan fringe benefit.

For computing the taxation on such a fringe benefit, it is vital to know the market rate of interest.

As per federal Commissioner of Taxation v. Cooke & Sherden when an income comes under the ambit of FBT it is not taxable to the employees. In this scenario, the loan was provided on As the loan was provided on 1^st April 2016, the rate to be considered is 5.65%. the following steps must be taken into consideration.

Step-1

Initially, the taxable value of the fringe benefit of the loan will be computed leaving apart the rule which is deductible. In tune to this, the interest on loan will be computed in tune to the interest rate that is actual and lessened from the interest on loan as per the statute.

Deriving of interest in consideration to Statutory Rate of Interest Rate= $ 10,00,000 ($ 1m) x 5.65%= $56,500

Interest in consideration to the  Actual Rate of Interest Rate= $ 10,00,000 ($ 1m) * 1%= $10,000

Taxable value = $ 56,500- $ 10,000= $ 46,500

Step-2

The computation of interest on loan in tune to the statutory interest rate will be done considering that it was the only amount to be paid by Brian.

Statutory Rate of Interest Rate – interest = $ 10,00,000 ($ 1m) * 5.65%= $56,500

Step-3

The utilization of funds by Brian constitutes to 40% of the funds that is borrowed for the purpose of income production and ensuring the interest payment are done properly. The figure of interest expense that is subjected to tax deduction is as follows:

$ 56,500 * 40% = $ 22,600

Step-4

The borrowed funds are used to the capacity of 40% and this ensures the interest payments are obliged. The tax deductible interest expense is as follows:

$ 10,000 * 40% = $ 4,000

Step- 5

Now, we shall deduct the actual deductible amount from the hypothetical deductible amount

$ 22,600 – $ 4,000= $18,600

Step-6

The final taxable amount shall be calculated by deducting amount in Step 5 from the amount in Step 1

=$ 46,500 – $18,600= $27,900

Conclusion

If the interest was payable at the end of the loan rather than monthly installments then the deemed period of this loan would have been treated from the period when interest will be paid or will become payable.

In case the Bank released Brian from repaying the interest on the loan, the calculations will be done as above mentioned steps keeping the actual interest rate as zero.

Issue

Jack incurred loss in the property and the determination of tax will be done for the purpose of tax. The case determines how capital gain or loss will come into the picture?

Allocation of Loss for Tax Purposes

Rule

Money is being borrowed by Jack and Jill to purchase a rental property. As per the agreement made between Jack & Jill to borrow money to purchase a rental property as joint tenants, the agreement was that Jack shall be entitled to 10%of profits against 90% profits to his wife Jill. In case loss took place, Jack agreed to bear the entire loss. As in last year, there has been a loss of 10000$ and as per the agreement agreed among Jack & Jill, the entire loss shall be borne by Jack. Similar case was observed in the case of Bowden v Los and Ors [1998] NSWSC 216.

 This loss shall be added along with Jack’s other income if any and shall help in reduction of total income and tax as well. In case there is no other income this loss can also be allowed to be carried forward (Thorpe, 2012).

Application

Two situations can crop up when there is a talk of selling the property. In case of a gain, the same shall be distributed among Jack and Jill in the ratio of 10: 90 respectively. Jack shall be able to set off his loss of $ 10,000 of last year against the gain arising out of selling of the property. On the other hand, in case there is a loss by selling the property, the entire loss shall be born by Jack and it shall be set off or allowed to be carried forward to next year to be adjusted with other incomes (Kenny, et. al, 2017).

Conclusion

So, the net result is that Jack shall be able to set off his loss of last year in the current year only if there is some gain against selling of the property but in case the selling of property does not provide any gains as per their agreement, Jack shall bear the entire loss and Jill shall not be required to bear any loss (Kobestky, 2005). Hence, tax treatment shall not affect Jill in any way while Jack shall have to book the loss in his books of accounts.

Issue

Relevancy of the principle of IRC v Duke of Westminster [1936] AC 1

Rule

As per the case of IRC v Duke of Westminster [1936] AC 1, the principle that came into view is as follows:

Every person has a right to manage his accounts and affairs in such a manner that the tax on his total income can be minimized to the maximum possible. And if he succeeds in doing so legally then no matter what the commissioners of the Inland Revenue may find inappropriate he cannot be compelled to increase his tax amount payable (Saunders, 2015).

Application

This rule was only applicable if the taxpayer arranges his accounts and affairs in only such manner which is compliant with the laws laid down in the income tax rules and by the courts.

And if the documents and transaction details provide by the taxpayer are genuine, then the courts shall not go behind these details on the basis of some underlying substance.

Principle Established in IRC v Duke of Westminster

It means that the case has given following principles:

1. Every person has the right to manage his books of accounts in every possible manner in order to reduce the tax payable to the minimum.
2. If no window dressing or fault is found from the accounts, then there will be no additional tax (Renton, 2005).
3. No one can question the transactions if these are legally effective on the ground that the substance of the transaction is different from that interpreted by the taxpayer (Fullerton et. al, 2017).

This rule was not overruled but with the passage of time and other new case laws coming into effect, the said case lost its worth somehow. And now the perspective of viewing the accounts has been differentiated.

Relevance of the rule in present scenario-

Conclusion

In the present scenario, this rule holds true as it not only restricts businesses from manipulating facts and figures but also gives them a right to legally do business genuinely. For example, if a business is undergoing losses and not able to repay the debts, the business can alter the figures of the balance sheet and the fixed assets can be written off to the extent of the carrying value.

In this case, even if the business does not have any valid document to prove this transaction, continuous losses and inability to pay dues and debts, it will be appropriate and justified enough to write off fixed assets, but in case of business tries to manipulate and hide substantial facts from the stakeholders, the above law shall restrict the business to hide or manipulate things (Fullerton et. al, 2017). Any decision or transaction which helps in running a business effectively in a legalized manner not evading any taxes it shall be absolutely perfect to do so.

 Issue

Whether Bill will be assessable for the receipts received for the arrangement?

Rule

A piece of land is being owned where there are many tall pine trees. His intention is to use that land for grazing sheep but for this, he has to clear the entire pine trees. He shall receive $ 1000 for every 100 meters of timber from a logging company. So now the question is that whether there arises any tax on receipts from the logging company. As there is not mentioned in the question that what is the total amount of receipts out of clearing of timber. We can treat this as a revenue receipt and there shall not be any capital gain tax issue in this matter. These receipts shall be treated as revenue receipts of the bill (Barcokzy, 2010). Similar instance was held in the case of case of Hastle Group Limited v Commissioner of Taxation 2009 ATC

Application

If Bill paid a total sum of $50000 that grants a right to the logging company to eliminate timber from the land, this can be treated as a capital receipt as it is an overall payment and there is no receipt of a recurring nature. Lastly, it appears due to the fact that providing or selling timber is from the own land hence, capital in nature. Moreover, in the second case, it will be considered as lump sum receipt and put under the capital gain taxation (Pratt & Kulsrud, 2013).

Conclusion

In both the cases, Bill shall receive the sum of money. In the first case, the receipt shall be small but recurring while in the second case, where he agrees to give his right to cut as much as timber to the logging company against a lump sum of $ 50,000,it is a big but one time receipt because once the timber has been removed, it shall take a long time to grow again. So as Bill is in receipt of huge money against giving his right, this may be treated as selling of an asset to the company and selling of asset incurred capital gain tax (Barcokzy, 2010). While in the first case it shall be treated under normal tax rates.

References

Barcokzy, S 2010, Australian Tax Casebook, CCH Australia Ltd

Fullerton,I.G,  Deutsch, R, Friezer, M.L, Hanley,P &  Snape, T 2017, The Australian Tax Handbook Tax Return Edition 2017, Thomson Reuters: Australia

Hopewell, L 2012, Australia tax inquiry opens submissions, viewed 27 August 2017, www.zdnet.com.au.

Kenny, P, Blissenden, M, & Villios, S 2016, Australian Tax 2017, Thomson Reuters: Australia

Kobestky, M 2005, Income Tax: Text, Materials and Essential Cases, Sydney: The Federation Press

Nethercott, L,  Richardson, G & Devos,K. 2013, Australian Taxation Study Manual, Sydney.

Pratt, J. W &  Kulsrud, W N 2013, Federal Taxation, Oxford university press.

Renton N.E 2005, Income Tax and Investment, 2nd edition, Sydney

Sadiq, K, Coleman, C , Hanegbi, R,  Jogarajan,S,  Krever, R, Obst, R, Teoh, J & Ting, A 2017,  Principles of Taxation Law 2017, Law book Australia

Sadiq, K, Coleman, C, Hanegbi, R., Jogarajan,S, Krever, R.,Obst, W.,& Ting, A 2014,  Principles of Taxation Law, Sydney.

Saunders, C 2015, The Australian Constitution, Carlton: Constitutional Centenary Foundation

Thorpe, C 2012,  Tax Pack dumped online returns encouraged ABC News, viewed 25 August 2017 https://www.abc.net.au/news/2012-07-09/tax-pack-dumped-online-returns-encouraged/4117784.