Taxation Law - Investment Company Ltd - Assessment Answer

Taxation Law Assignment

Assignment Task

Question One

Peta bought a house which had two tennis courts in the back. The property was bought for the purposes of living for her family as well as building house units in the back where the tennis courts were situated and sell them at a profit. However she got an offer to restore the tennis courts and sell them whereby she utilised $100,000 on restoration and then sold them for $600,000.

According to the Income Tax Assessment Act 1997 Section 6-5, as per the ordinary concepts, this is referred to as ordinary income. Section 6-5(1) illustrates that assessable income includes the income according to the ordinary concepts which as illustrated is ordinary income.

Section 6-5(2) provides that as an Australian resident, assessable income involves all the ordinary income which is derived from all income sources whether directly or indirectly whether an individual is in Australia during the income year in question. Section 6-5(3) provides that if one is a foreign resident, assessable income includes ordinary income from income sources which are Australian in the income year and any other ordinary income which is provided to be included as an Australian source.

Further, Section 6-5 (4) provides that when deciding on whether an amount is derived from an ordinary income and once derived, it is taken to have been received when it is applied in a manner which is direct to you. There are no definitions provided on what ordinary concepts refer to but it is considered to be income which individual normally consider as their income fitting within the common law concept of income. Flynn (1999) argues that there are three major components of ordinary income; income derived from personal exertion such as salary; income from property such as rent or dividends and finally income derived from undertaking a business venture such as farming returns. Klonoski (2016) illustrates that while all are competent of assessable income, it is critical to distinguish between them as there are some which have deductions depending on which category they are from.

Flynn (1999) provides that there exist a difficulty in differentiating between income receipts and capital receipts. However, there are particular basic principles which have been applied in deciding whether a receipt was capital in nature or income.

The first consideration which needs to be made is the primary whereby the consideration given to the receipt is evaluated. This as illustrated in Federal Coke Co Pty Ltd v FC of T 77 ATC 4255 whereby Brennan J argued that when a recipient of money given consideration for payment, the consideration is the factor to consider when deciding whether it is a revenue or not. Further, Brennan argued that there is need to identify the element in regards to which purpose the payment has been received. In the case of Peta, The payment was made for the sale of the tennis courts. Peta has given up the advantage or right on the tennis court as part of a profit yielding structure and as such it is capital in nature as illustrated in JB Chandler Investment Company Ltd and Chandlers Rental Pty Ltd v FC of T 93 ATC 4810, 4810 and 4819.

As such, receipt need to be considered when analyzing a receipt is identification of the matter in regards to the amount that it is paid. If the individual receiving the money has parted with a particular asset or advantage which from parts of a profit making structure, then the receipt is argued to be a capital receipts as illustrated in Reuter v FC of T 93 ATC 4037, 4047. However if the assets or advantage did not form a part of a profit yielding structure, then the receipts is argued to be an income recipient in nature. In light of all this, with regard to this consideration, the 600,000 ought to be considered as a capital in nature.

The second test is evaluating whether the receipt is a representative of a flow which is produced through the item of capital. If the receipts are a flow, then it is revenue in nature. However if on the other hand the receipt relates to the sale of a capital asset which could have had a flow of income, then the whole of the receipts are on capital account. Flynn (1999) argues that income is a detached flow. The principle of income as a flow is illustrated in Pitney J inEisner v Macomber Eisner v Macomber [1919] USSC 119;(1919) 252 US 189 whereby his Honour provided that:

The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.

Flynn (1999) provides that this principle involves both an inclusionary and exclusionary operation. The inclusionary elements involve the context where the receipt is the natural result from a capital assesses whereby this is income. The exclusionary application of the principle is that gain which is actualised as a growth of principle Clowes v FC of T [1954] HCA 10;(1954) 91 CLR 209 and is not a detached sum is considered capital. In the case of Peta, the $600,000 receipt is not a receipt of the natural produce of a capital asset and rather is the sale of the asset thus a capital.

In conclusion, the Income Tax Assessment Act 1997 Section 6-5 provides that amounts derived from the ordinary concepts are reffered to as ordinary income. Section 6-5(1) illustrates that assessable income includes the income according to the ordinary concepts which as illustrated is ordinary income. Section 6-5(2) provides that as an Australian resident, assessable income involves all the ordinary income which is derived from all income sources whether directly or indirectly whether an individual is in Australia during the income year in question. Following the consideration principle and the income as a flow principles as discussed, the recipient made to Peta was a capital receipt as it involved parting with an profit yielding asset and was not a flow from a capital assets. As such, the receipt is not part of ordinary income.

Question Two

Part (a)

Employers provide benefit it to their employees as a way of recognising as well as rewarding the contributions of the employees to the firm. However, there are some benefits which are subject to the Fringe Benefit Tax (FBT). FBT is a tax which employers pay on particular benefits they provide for their employees. In addition to a salary of $300,000 for Alan, ABC provides phone bill benefits of $220 per months which is inclusive of GST, a mobile phone handset which costs $2000 inclusive of GST, a dinner of $6600 inclusive of GST and school fees benefits for his children for $ 20,000 per year with the school fees being GST free.

The taxable value involves the mobile phone bill of $220 monthly, school fees of $20,000, Alan’s handset at $2000 and $6600 for dinner. However for the dinner, the company needs to calculate the dinner cost for each employee in order to get Alan’s. This can be done through dividing the total cost and the number of employees. The total taxable value of benefits which the company can claim GST credit includes the phone bill benefits, the handsets and the dinner costs. The entertainment costs are calculated using the actual method approach whereby the entertainment costs are calculated per the number of employees who attended the party.

In the event that the pre-grossed up taxable value of the benefits rewarded to the employees exceeds $2000 within the Fringe Benefit Tax financial year, the grossed up taxable value of these benefits needs to be included in the payment summary for the financial years. There are some fringe benefits however which do not need to be reported in the employer’s payment summaries. Only lower gross up rate is used for the reporting on the employees’ payment summaries.

Part (b)

ABC would have a different FBT liability if they had five employees. This is because the benefits which Alan would get would be more when the total amount is divided by five employees rather than 20. The social function cost per employees would be greater as illustrated in the calculated below. With 20 employees, the cost per employees is 330 while with five employees, the cost per employees is 1320. The calculation of FBT liability involves calculating the entertainment costs using the actual method approach.

Part (c)

When an employer holds a party for the employees and clients, it is important to be aware of the fringe benefits tax as well as income tax impacts on the provision of this entertainment to employees as well as clients. Employees need to choose a method on how to calculate their FBT entertainment liability with majority using either the actual method or the 50/50 method. The actual method involves the entertainment costs being split up between the employees and their families if they are present and the non employees who include suppliers as well as clients.

Using the actual method the expenditure for the non employees is not liable for the Fringe Benefit Tax and neither is it for tax deductibility. On the other hand the 50/50 method does not consider where the party is held or who attends the party. Using this method, 50% of the total expenditure is subjected to Fringe Benefit Tax and 50% of this total expenditure is subject to tax deductibility. Barnes and McClure (2009) notes that even if the function is undertaken on the employer’s premises, the food and drinks which is provided to the employees is not exempted from Fringe Benefit Tax.

ABC as such can choose whether to sue the actual method or the 50/50 method. If the company utilises the 50/50 method, the expenditure subject to FBT is 50% of the total expenditure which $ 3300. On the other hand, the actual method involves the expenditure on employees is the only one liable for FBT. The following illustrates the calculation of the FBT liability whereby entertainment is determined using the 50/50 method.

As such, when calculating the FBT liability, it is important to consider those elements and costs which are provided by FBT liability and those which are not.