The information provided related to the company has been thoroughly reviewed. The underlying case laws, tax rulings and legislation have been referred to for providing correct advice in relation to the taxation treatment of the various cash receipts and cash outflows. In order to reach the recommendation, various steps have been considered relating to identifying the issue, discussing the underlying law, applying the same on the basis of the facts provided leading to advice generation. The detailed discussion and recommendation can be found in the attachment.
In case of any issues that may be unaddressed or any queries related to the reply provided, please feel free to contact me.
The main objective in the context of the company is to provide advice related to tax for the year terminating on June 30, 2018. The various issues that are to be considered for further discussion are indicated as follows.
1) The appropriate revenue recognition basis for the company with regards to the two methods namely accrual and cash so as to opine on the appropriate tax treatment of cash proceeds from TCA Airways.
2) In light of the proceeds generated from land sale, the nature of the proceeds needs to be addressed coupled with the appropriate tax treatment.
3) With regards to solicitor and court fees that has occurred due to court case related to expansion of the training facility, the key issue is whether this expense would be deductible for tax purposes.
4) The CGT (Capital Gains Tax) implications in relation to the land sale ought to be indicated.
5) With reference to requisite legislation, the suitable tax treatment of the lease cash and non-cash incentives needs to be outlined that the company has obtained from Chandler Airport Corporation for shifting their base to Chandler Airport.
6) In relation to the special flight simulator that has been obtained from Flight Services, the deductibility for the lease payments paid annually ought to be outlined.
7) A sum of $ 350,000 has been incurred by the company in relation to restrictive covenant and deduction of same for the company needs to be highlighted.
8) The compensation payment obtained from the settlement of the contract with FlyHigh needs to be analysed from tax perspective to determine their underlying nature as revenue or capital.
9) Besides, the above cash receipts and payments, the deduction for the company in relation to the following expenses also needs to be determined.
Ordinary Income
Any income of the taxpayer which has been received from ordinary sources is considered as ordinary income of the taxpayer. This ordinary income would become part of the assessable income which would be taxed under s. 6-5, ITAA 1997. Further, ordinary income includes income resulted from employment, business, personal exertion and from investment (Barkoczy, 2017).
Income Recognition
As per the provisions highlighted in TR98/1, the taxpayer has the legal right to choose the suitable means for the derived income recognition in terms of accrual (as earnings) or cash (as receipts). However, it is essential that the taxpayer must select the income recognition basis in such a way that the income would be true representative of the income derived. Further, TR98/1 outlines that cash (Receipts) is considered to be an appropriate means for income recognition when the derived income is resulted due to the skill of the taxpayer or from the part of his/her work in terms of providing services to others. Further, the income derived from production operation or from trading is considered as accrual (earnings) (Gilders et. al., 2016). In accordance with the judgement announced in Carden v FCT (1938) 63 CLR 108 case, the selection of the base of the income recognition must not be based on the solely rigid rule and has to be made based on the business conditions and scenarios. The size of the business, type of the business is considered to be an imperative factor as when the business expands then the corresponding utilization of the other employees would also increase for the income generation and hence, the income recognition would be termed as accrual basis. The judgment of Henderson v. Federal Commissioner of Taxation (1970) 119 CLR case is the testimony of this aspect (Deutsch et. al., 2016).
Statement of Cash Receipts and Cash Payments for VFA Pty Ltd
Deduction
As per the provisions of s. 8-1, UTAA 1997 the deduction would be available when there is a business expenses. Further, when the outgoing or losses has been incurred in regards to derive the assessable income, then the general deduction would be available for taxpayer as per s. 8(1), ITAA 1997. However, it is essential that there must be significant relationship present between expenses and assessable income generation by the taxpayer. The three main negative limbs with respect to ss. 8-1(2), ITAA 1997 are listed below (Woellner, 2015).
The expense must not be capital expenditure rather revenue expenses. =.
The expenses must be business expenses because the expenses which are classified as domestic (personal) expenses would not be taken for any tax deduction.
The reason behind the expenses must be for assessable income generation because the expenses which are done for the act of the non-assessable income production would not be tax deductible.
Capital Expenses/ Revenue Expenses
It is essential to segregate the capital and revenue expenses considering the fact that majority of the deductions available are for revenue expenses. Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 33 highlighted that the enduring nature of the advantage derived from expenditure is a proof that the expenditure is capital as the gains are not limited to the current year but would be extended into the future (Coleman, 2015). This can be applied on restrictive covenant related proceeds which would be termed as capital expenditure. This is because the restrictive covenant is typically for multiple years and hence provides gain of lower competition for multiple years (Gilders et. al., 2016).
For capital expenditure, s. 40-880 related deduction can be claimed if no other deduction is possible. However, it is essential that the underlying expenditure is business related and realised in five equal annual instalments (Krever, 2017).
Capital Gains Tax (CGT)
When the taxpayer has sold any capital asset, then the received income would be termed as capital proceeds and this proceed would not be considered for any tax as per s. 116-5 ITAA 1997. However, if the taxpayer has received any capital gains or losses from the sale of the capital asset, then the CGT implications would be raised on the taxpayer (Barkoczy, 2017). The computation of capital gains for the CGT consequences is based on the aspect when the transaction incurs for asset sale, a CGT event triggers under s. 104 (5), ITAA 1997. The CGT event of category A1 provides the procedure for the capital gains computation for the proceeds derived from the disposal of the capital asset (Reuters, 2017). According to this procedure, the cost base of the asset would be subtracted from the net proceeds from the sale of the asset. The cost base is computed based on the provision highlighted in s. 110(25), ITAA 1997. Further, the cost base is a combination of the five main elements as per s. 110-25 (1), ITAA 1997 which are highlighted below (Sadiq et. al., 2015).
Notes Regarding AFS Pty Ltd
In accordance with ss. 110-25(2), the total amount spent by the taxpayer to purchase the asset.
In accordance with ss. 110-25(3), the incidental costs that are incurred and paid by the taxpayer in the process of buying and selling of the asset.
In accordance with ss. 110-25(4), cost associated with the ownership of the asset which includes payments of taxes and interest on the loan and so forth.
In accordance with ss. 110-25(5), capital expenses which are paid by taxpayer in order to increase the net worth of the asset.
In accordance with ss. 110-25(6), capital expenses which are incurred in regards to protect the title of the asset.
The capital gains derived would be first taken into account to settle capital losses from current year or from past years. Further, the net capital gains would be discounted for the implication of CGT by using an appropriate method which is either discount method or indexation method. The discount method would provide a flat 50% discount on the derived capital gains which means only 50% of the capital gains would be taken for CGT consequences (Deutsch et. al., 2016). However, this method is applicable only for the case when there the holding period of the asset is more than 1 year which results long term capital gains. Further, the 50% discount method is applicable only for the individual and hence, cannot be applied on the companies. The indexation method has limited usage and is applied on the capital proceeds which are derived from the asset which has been acquired earlier than September 1999. The net capital gains would be taxed as per the CGT rate which is flat 30% (Krever, 2017).
Fringe Benefit Tax (FBT)
Fringe benefits are those non-cash personal interest benefits of the employee which are extended by the employer. These benefits are utilized by the employee and are taxed on the part of employer. A benefit given by the employer to their employee so as to complete the professional duties is not termed as fringe benefit and no FBT liability would be raised on employer. The relevant provisions of fringe benefits are highlighted in Fringe Benefits Tax Assessment Act 1986 (Woellner, 2015). The main aspects of fringe benefits based on the current scenarios are listed below.
Car fringe benefit
When an employer provides car to its employee that the employee can use for his/her own personal work, then it would be classified as car fringe benefit as per s. 7, FBTAA 1986.
The amount of car fringe benefit would be determined based on the statutory formula defined in s. 9, FBTAA 1986 and is shown below (Krever, 2017).
Electronic items
In accordance with s. 58X, FBTAA 1986, the extension of any electronic items such as mobile phone, laptop, tab and so forth would be considered as fringe benefit only when these items are provided to employee for their own personal work. Further, the bill of these items which are paid by the employer would also attract FBT liability on employer (Barkoczy, 2017).
Entertainment fringe benefit
The expenses incurred for the entertainment of the employee would be termed as entertainment fringe benefits. According to s. 8(1), ITAA 1997 the deduction would be claimed by employer when the expenses are incurred in the entertainment of the employee or on their associates (Deutsch et. al., 2016). However, the expenses are not tax deductible when the receipts of the entertainment fringe benefits are the business personnel (clients) of the employer. Moreover, the expenses incurred in Christmas part would also impose FBT liability on employer if there is no exemption of minor benefits clause (Gilders et. al., 2016).
Compensation Receipts
As per TR 95/35, the compensation receipts nature is the similar to the loss that they seek to compensate for. Therefore, if the receipts are given as compensation for loss or ordinary income or assessable income, then even the receipts would be categorised as assessable income on part of taxpayer (Krever, 2017).
Incentives for entering lease
IT 2631 tends to highlight the appropriate tax treatment of lease incentives (cash and non-cash). As per this, incentive received in the form of cash would be assessable income at the end of taxpayer. A relevant case law in this regards is F.C. of T. v. Cooling 90 ATC 4472 in which it is advocated that if the incentives tend to arise during the activities constituting as normal business, then the same would have an income character. With regards to incentive not in form of cash, an essential aspect to consider if whether the same results in some cash related benefits for the taxpayer or not. If there are cash related benefits, then this would also be treated as assessable income for the taxpayer (Sadiq et. al., 2015).
Application
Nature of Income
The company (VFA) is in the business of acting as the service provider of training services to host of airlines and hence any income received due to these services being extended would be recognised in the form of ordinary income under s. 6-5 ITAA 1997. Hence the amount given by TCA Airways is ordinary income for the company. In view of the business scale and underlying size, it would be correct to assume that accrual basis must be used for deriving income. Hence, during the tax year the complete receipts that are received in the month of October will not be ordinary income but the amount derived on the basis of the services already provided to the clients would be ordinary income. Also, the amount which is due to be received would also be recognised as ordinary income since the accrual basis is used for deriving income.
Treatment of Compensation Receipts
The company has received a settlement amount of $ 750,000 from FlyHigh Ltd. This compensation has been received with regards to the future loss of ordinary income that the company could have earned if the contract had not been unexpectedly terminated. Since the loss has been of revenue receipts, hence the proceeds of compensation would also have revenue nature and considered as assessable income under s. 6-5 ITAA 1997.
Incentives for entering into lease
It is apparent that for entering into lease with regards to changing the operational base has resulted in both cash and non-cash incentives for the company. It is apparent that the lease has been entered in normal business course as the company can expand operations to a new base or shift the base. Hence the cash incentives would contribute to assessable income under s. 6-5 ITAA 1997. A similar conclusion would be drawn for the rent free premises for a period of 12 months since it would enable the company to save cash related to rent payment which otherwise the company would have to bear.
Sale of Land
As per s. 116-5 ITAA 1997, the proceeds from liquidation of land would be capital and hence tax free. However, the capital gains need to be computed to ascertain if any CGT would be applicable. In relation to the company, it is noteworthy that neither of the discount or indexation method is applicable. Discount method cannot be availed by company business structure and also the underlying land has not been bought before September 1999.
Land related cost = $ 6 million
Treatment of Expenses
The suitable treatment in relation to the host of expenses is mentioned as follows.
- Solicitor and Court Fees (Related to Land conversion) – It is clearly apparent that underlying legal expense would have a capital nature since if the land conversion would have been permitted, the same would have allowed the company to enjoy a higher assessable income in the future years, thereby confirming the enduring nature of benefit. Complete deduction over a five year period is permitted as per s.40-880 ITAA 1997.
- Simulator related lease payment (Flight Services) – The simulator is required to provide training services and hence the underlying nature of the expense is revenue coupled with close nexus with assessable income production making this eligible for deduction as per s. 8-1 ITAA 1997.
- Restrictive Covenant related payment – The underlying benefits that are obtained on making this payment are enduring since there would be lower competition for a period of four years. Thus, the expenditure is capital. Complete deduction over a five year period is permitted as per s.40-880 ITAA 1997.
- Bank charges – These charges have been incurred in normal business course and thereby are referred to as revenue expenses with close nexus with assessable income. Hence, permitted deduction under s. 8-1 ITAA 1997.
- Car expenses – The information provided clearly states that personal usage is permissible and thereby car fringe benefit has been provided. In accordance with the relevant rule, the FBT liability on the car fringe benefit would be computed. Also, to the extent that the operating expenses related to car are used for business (i.e. 77%), s. 8-1 ITAA 1997 deduction is permissible.
- Education Expenses – It is imperative that these expenses are incurred as the instructor needs to have requisite qualification and also administrative training is critical. Deduction under s. 8-1 ITAA 1997 is provided to the company.
- Employee Remuneration – This is a direct expense which contributes to assessable income generation for the company and hence deduction for these expenses under s.8-1 is allowed.
- Lunches and Christmas – It is apparent that fringe benefits have been extended to employee in the form of meal and entertainment related fringe benefits. If the per person taxable FBT is less than $ 300, then exemption is possible or else FBT would have to be paid. Deduction for these employee related expense are permissible under s. 8-1 ITAA 1997.
- Furniture – Furniture is a capital asset and hence the underlying expenditure would be capital thereby non-deductible as per general deduction. But, depreciation would be charged on the furniture and this can be deducted by the taxpayer.
- Fuel and Airplane Maintenance cost – Consider the pilot training business, these are integral costs which would be incurred in extension of services and thereby earning income. Hence, these expenses are deductible as per s. 8-1.
- Marketing and advertising costs – The objective of this cost is to assist in enhancing the revenue of the company and gain new contracts. Considering that these could potentially lead to higher income generation, hence under s. 8-1. These expenses would be deductible.
- Mobile Device – No FBT would be payable by the company and any depreciation applied on this can lead to deduction for the company.
- Solicitor fees (Simulator Lease) – Since simulator is part of the normal business operations, hence the underlying legal expense also has a revenue character making it deductible under s. 8-1.
- Travel Expenses (Dale Wise) – These expenses would be considered capital as the impact of the learning from the travel and related encounters would be enduring and hence deduction would be available over a five year period under s. 40-880 ITAA 1997.
Conclusion
The above discussion regarding various issues highlights that income realisation for the company should be carried out on accrual basis and not receipts basis. As a result, the contractual amount received from customers would be realisable to the extent of services provided during the year. Further, ordinary income would also contain the payments not yet received but services have been provided. Also, the lease incentives would also contribute to assessable income for the company. Besides, the receipts received as a result of compensation from contract cancellation has revenue nature and would be assessable income.
The land sale proceeds would be capital and hence non-taxable. However, a CGT liability of $217,878 has been derived in relation to the sale of land. Also, the loan charges are reflected in the cost base computed for land. The company has incurred certain capital expenditure in the form of restrictive covenant proceeds, land related legal expenses but the same would attract deduction at the rate of 20% per year for five years. In regards to furniture along with mobile phone, the expenditure is capital and non-deductible but depreciation can be charged and deducted from taxable income provided use of these is for business.
The company will have to pay FBT on account of fringe benefits being given to client. These include meal and entertainment fringe benefit besides car fringe benefit. Relevant deductions for these benefits would also be available to the company. The other expenses that have been not been highlighted are those on which general deduction as per s. 8-1 is applicable as there exists a close connection between the incurring of these expenses and generation of assessable income
References
Barkoczy, S. (2017) Foundation of Taxation Law 2017 (9th ed.). North Ryde: CCH Publications.
Coleman, C. (2015) Australian Tax Analysis (4th ed.). Sydney: Thomson Reuters (Professional) Australia.
Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., & Snape, T. (2016) Australian tax handbook. 8th ed. Pymont: Thomson Reuters.
Gilders, F., Taylor, J., Walpole, M., Burton, M. & Ciro, T. (2016) Understanding taxation law 2016. 9th ed. Sydney: LexisNexis/Butterworths.
Krever, R. (2017) Australian Taxation Law Cases 2017 (2nd ed.). Brisbane: THOMSON LAWBOOK Company.
Reuters, T. (2017) Australian Tax Legislation 2017 (4th ed.). Sydney. THOMSON REUTERS.
Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., & Ting, A. (2015) Principles of Taxation Law 2015 (7th ed.). Pymont: Thomson Reuters.
Woellner, R. (2015) Australian taxation law 2015 (8th ed.). North Ryde: CCH Australia.
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