Taxation Law - GHTY- Michel - Assessment Answer

December 19, 2018
Author : Ashley Simons

Solution Code: 1ADAI

Question: Taxation Law

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Taxation Law Assignment

Case Scenario1

Gilbert, Holtzmann, Tolan and Yates (GHTY) are partners in a successful paranormal business enterprise. The business, located on the third floor in Downtown, NSW, has a workshop, a laboratory, a secured munitions room as well as a reception area and private offices for all the staff. As part of their business expansion GHTY have recently decided to employ a junior chemist, Lani as a lab assistant. As part of Lani’s employment package Lani will receive the following (in addition to her salary)

Case Scenario2

Michel, a successful government advisor, is getting close to retirement. Michel in 2008 purchased for $3,000,000 a very large, rural property in Googong (near Queanbeyan). For the past decade he has dreamt of retiring and making wine. On advice from a winemaker friend Helene, Michel arranged for two varieties of grapes (one red varietal and one white) to be planted. His brother in law, Stefan, who had just lost his job as a city banker moved onto the property with his young family and looked after the property including overseeing the grape growing in exchange for no rent. This suited Michel, who continued to live and work in Sydney, to have his extended family living on this property. The vines started to produce grapes of an appropriate standard for winemaking in 2011. In the autumn of 2011, Michel brought over Helene (the winemaker) and together with Stefan and their respective children they made their first batch of wine with some old equipment that Helene said Michel could use. The results of this were quite good and after reserving some of the wine for family use, some for later sales, the remainder was sold locally for $23,000 to passers-by and in local markets in the last half of 2011.

A slightly larger amount of wine was made and sold in 2012 for $56,000, and again some was kept aside for private consumption and also for later sales. A similar story for 2013 – however sales were up to $122,750. Michel thought sales were good because the winery had been mentioned in a national newspaper weekend magazine article about new Canberra region boutique wineries.

Helene declined to assist in 2014 and so Michel employed Giorgi, Helene’s oldest child (also a newly qualified winemaker) on a part time basis to make wines – paying a salary of $52,000. Michel approved Giorgi’s decision to upgrade the wine-making equipment instead of using Helene’s old equipment. The cost of the new equipment was $325,000. The 2014 batch sold for $234,200 and during school holidays Michel employed his oldest niece Chari at the cellar door at $15 per hour. For the first time in 2015 the local supermarket stocked the wine. At the beginning of 2015 Michel arranged to work only Tuesday to Thursday – spending his remaining time among the vines and in the wine cellars. At the start of 2015 Michel also put out the first of the cellared wine from 2011, which although it was only a small quantity fetched $25,000. At the end of 2015 Michel was approached by a large Australian winemaker who offered to purchase the winery for $4.2 million.

Assignment Task1

a) $1,000 paid on the last day of every month for “communication costs”. (see note 1 below)

b) $3,000 paid quarterly to Happy Kidz – a childcare provider (see note 2 below).

c) A pair of $250 steel capped boots, a $150 lead lined apron and a pair of $350 prescription safety goggles. Purchased from Safety and Uniforms R Us.

d) On the 1 September 2015 Lani borrowed $19,000 at 3.5% from GHTY. Lani used the money to purchase a car that she used to drive to and from work and on the weekends for private purposes.

Assignment Task2

Explain to Michel whether he has been carrying on business as a winemaker. Your answer  must cover when the business commenced and the income tax consequences of the sales of wine.

Discuss whether the $4.2m from the large Australian winemaker could be ordinary income  for Michel. His wife wants him to take the offer so that they can purchase a house in France for their retirement.

Assuming that the $4.2m is not ordinary income; calculate for Michel the capital gains consequences of accepting the $4.2m.

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Solution1:

The items mentioned in Part a-d have been examined with respect to the Fringe Benefit Assessment Act in order to determine if they form a part of the Taxable Fringe Benefit:-

The communication costs of $1000 that is paid by the employer cannot be considered as an expense payment fringe benefit as the employer is not paying any expense of the employee. Rather this is a fixed amount that is paid by the employer and it is at the discretion of the employee to use it for her mobile phone bills or internet expenses. This amount is paid irrespective of the expense that has been incurred by the employee. Therefore, this would not be considered as a fringe benefit.

As per subdivision A Division 5 –“ Expense payment fringe benefits” , Fringe Benefit Tax Assessment Act 1986, when the employer makes a payment or reimbursement whether in part or full in respect of a service that has been received by the employee or a relative of the employee then such payment or reimbursement would be regarded as a fringe benefit for the employee.

Here, GHTY has paid for child care services of Lani’s child, Aisha. This expense was to be paid by Lani but has been paid by GHTY on behalf of Lani therefore, it would be considered as a fringe benefit that is provided to Lani.

Since this service is GST free it would be classified under Type 2 Fringe Benefits.

As per subdivision 5E Division 3 – Employee’s individual fringe benefits amount of Fringe Benefit Tax Assessment Act 1986, if a benefit is provided to an employee to address a security concern where the safety is related the employee or an associate of employee and it arises in connection with the employment of the employee then the value of fringe benefit that is provided to the employee is considered as exempt.

In the given case, GHTY has provided Lani with steel capped boots worth $250, lead lined apron of $150 and prescription safety goggles worth $350. However, we can observe that she has been appointed as a lab assistant therefore, these equipments have been provided to her in order to ensure her safety and it is arising out of her employment. Therefore, the fringe benefits given to Lani would be considered as exempt benefits.

As per subdivision A Division 4– Employee’s individual fringe benefits amount of Fringe Benefit Tax Assessment Act 1986, if the loan has been given by an employer to an employee then it would be considered as a benefit that has been provided to the employee up to the year till which the employee is under an obligation to repay the loan. If the loan has been given to an employee and the sole purpose of the loan is to enable the employee meet his expenses that have been incurred in the course of performing his duties then such a loan would be considered as an exempt benefit. If the loan has been given to the employee at a subsidized rate then the difference between the standard rate and the subsidized rate would be considered to be the fringe benefit that has been provided to the employee.

Here, the employer has given loan to Lani at a subsidized rate of 3.5%. However, it will not be considered as an exempt purpose as Lani uses the car that she has purchased from the loan for her private use as well and therefore, the sole purpose of the loan to enable her to meet the expenses incurred for performing her duties is not present. Since she has been given the loan at subsidized rate, the difference between the standard rate and subsidized rate would be considered as fringe benefit for Lani. This would be classified under Type 2 Fringe Benefit.

Solution2:

Part A – Part 2

Computation of Fringe Benefit Liability for GHTY

Note:

  • Since communication cost was an allowance it has not been considered for FBT calculation.
  • The equipments given to Lani were to ensure her safety and therefore, have been considered as exempt fringe benefit and have not been included in the above computation.

Part A – Part 3

Computation of Taxable Salary of Lani

Part B – Part 1

In order to assess whether Michael is carrying on a business as a winemaker the following criteria have been applied in order to determine if an activity would be considered as a business

  • At the time of execution of the activity profit-making intention is important but it is not essential,
  • A business involves regulations and series of repetitive activity but keeping in mind the nature of activity a single activity may also be regarded as a business and all the businesses commence with a single activity,
  • The activity that is being carried on is being executed in a business-like approach like the recordkeeping etc.,
  • Even if the person has another source of income it would preclude any activity from being considered as a business,
  • The size and operation of the activity has to be considered keeping in mind the nature of activity in which the person is involved.

In the given case we can observe that the profit was not the intention of Michel when he had acquired the property in 2008. He wanted to make wine after his retirement as a hobby. However, he started producing wine in the year 2011 with the help of Helene, the winemaker. He sold the wine to the local passerby in the year 2011. It can be assumed that recordkeeping was also present for the activity as the amount of sales for the year has been given for the case. However, if we observe the manner in which the activity is being conducted in the year 2011 it will not be considered as a business. The activity started operating in a business-like manner from the year 2014 because as Michael started employing employees on a salary basis from this year. Therefore, the business started from the year 2013 and the income that is being earned from the sale of the wines from this year would be subject to the income tax.

Part B – Part 2

As per the Taxation Ruling 92/3 of the Income Tax Assessment Act 1997 states about the manner in which the isolated transaction would be treated keeping in mind the factors and circumstances of a given case. In order for a transaction to classify as ordinary income the following factors should be present:-

  • There should be a profit- motive for the taxpayer who has entered into the transaction however, it is not essential that it should be the sole intention of the person. If the purpose of the transaction was to earn profit it would be sufficient.
  • The profit that has been earned by the person has been earned in the regular course of carrying the business or is arising out of transaction which is of a commercial nature.

In the given case, the intention of Michel was not to earn a profit at the time of acquisition of the property. Moreover, the transaction of sale though it is an isolated transaction would not be executed in a regular course of working of the business.

Therefore, the income arising out the sale in the given case would not form a part of ordinary income.

Part B – Part 3

If the sale of the land is not considered as an income from ordinary source and is regarded as capital gain for Michel then he would be eligible to claim CGT discount on the asset. As per Section 115.25 of the Income Tax Assessment Act1997, in order to claim CGT discount the following criteria have to be fulfilled:-

  • The asset should be held for a period exceeding 12 months,
  • The taxpayer should be an individual.

Since Michel satisfies both the condition he will be eligible for CGT Discount. In CGT Discount Method, the capital gain that is earned by the taxpayer as a result of sale is reduced by 50% for computing the taxable value of capital gain.

The capital gain arising for Michel in the above transaction has been computed hereunder:-

Computation of Capital Gains for Michel

 

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