ACCT90016 Taxation Assignment - Final PDF

Preview

Summary

Assignment...

Description

Cover Sheet for Group Assignments ACCT 90016 Taxation for Business Decision Making Assignment – semester 2, 2017 Submitter details: ID Number: 847255

Name: Varun Malik

Words (body of assignment): 2960

Total words: 3015

Group Number: S01_Group_16 Group member details Student ID Number

Student Name

1.

847255

Varun Malik

2.

728526

3. 4.

Shuangqing Chen

Part (a) In this case, as Fashionista has entered into a contract where it is paid for not expanding its business into certain states/territories, such contract effectively formed a restrictive covenant. As a contractual right has been created, a restrictive covenant is capital instead of income nor fringe benefit1.

If there were no other CGT events (except for CGT event H2) aroused from the contract, the formation of restrictive covenant triggered CGT event D12. Consequently, Fashionista made a capital gain if proceeded capital minus input tax credits3 ($440,000 / (1+10%) = $400,000) exceeds cost base or a capital loss vice versa4. Cost base in CGT event D1 only consists of “the second element” or incidental costs, such as remuneration, transfer costs and stamp duty; nevertheless, if some of incidental costs has been claimed (or could have been claimed) for deduction, e.g. business-related capital blackhole expenditure, they are excluded from the cost base5. Note that CGT event occurred when the contract was entered into instead of when the payment was received6; in other words, on condition that the restrictive covenant was established before 1 July 2016, there would be no taxation implication in 2016/17.

Assume that Fashionista made a capital gain, the calculation can only use “other method”: since the contract was presumably formed after 21 September 1999, indexation method is unavailable7; as CGT discount does not apply to CGT event D1 and companies have a discount rate of 0%, discount method is practically and mathematically null 8 ; overall, owing to the fact that the formation of restrictive covenant is a creation of a new

1

Associated Portland Cement Manufacturers Ltd v Kerr [1945] 2 All ER 535. Income Tax Assessment Act 1997 (Cth) s 104-35(5). 3 Income Tax Assessment Act 1997 (Cth) s 103-30. 4 Income Tax Assessment Act 1997 (Cth) s 104-35(3). 5 Income Tax Assessment Act 1997 (Cth) s 110-45. 6 Income Tax Assessment Act 1997 (Cth) s 104-35(2). 7 Income Tax Assessment Act 1997 (Cth) s 110-36. 8 Income Tax Assessment Act 1997 (Cth) s 115-25(3). 2

asset, it is deemed to fail the 12-month ownership rule for either of the two methods9. In summary, the CGT payable is a plain $40,000 * 30% = $12,000. Besides, when the covenant expires on 1 January 2021, the asset is deemed to be disposed10; Fashionista will in turn have a capital loss at that time (over the assumption that the agreement resulted in capital gain in 2017) provided the company continues to operate as a going concern or the benefit of the restrictive covenant does not form part of goodwill on sales of business11.

As from the aspect of GST, despite being a monetary transaction, the restrictive covenant (dubbed as non-competition payment) in this case is not a financial supply as it does not involve provision, acquisition and disposal of an interest 12 . For the reason that (1) Fashionista is a GST-registered entity; (2) GST of $40,000 has included in payment; (3) the company has acquired it in carrying on enterprise as it is a industrial practice related to income-producing activities13, Fashionista is entitled to an input tax credit of $40,000 for equivalent GST paid.

Part (b) In this case, a car fringe benefit arises as a motor vehicle owned by Fashionista is available for private use14. Since the employee worked as Chief Financial Officer instead of being self-employed, the possibility that her home may represent as a home of employment is negligible thus we can assume that she had used the car for private purposes between home and work15.

9

Income Tax Assessment Act 1997 (Cth) s 114-10. Income Tax Assessment Act 1936 (Cth) s 160M(3). 11 Australian Taxation Office, Income tax: capital gains: does a person who acquires the benefit of a restrictive covenant incur a capital loss on the expiry of that covenant? TD 95/54, 27 September 1995, para 1-4. 12 A New Tax System (Goods and Services Tax) Act 1999 (Cth) s 40-5. 13 A New Tax System (Goods and Services Tax) Act 1999 (Cth) s 11-15. 14 Fringe Benefit Tax Assessment Act 1988 (Cth) ss 7-12. 15 Australian Taxation Office, Fringe benefits tax: private use of cars: home to work travel, MT 2027, 18 September 1986, para 23.

10

In calculating car fringe benefit, the company may use either statutory formula method or cost basis method and make choices depending on computed taxable values. In terms of statutory formula method, as the car was held by Fashionista for less than four years (thus not subject to decline in value) and the fringe benefit was provided after 10 May 2011, suppose that the employee did not make any additional payment upon receipt of benefit, taxable value of the car FBT in FBT year 2016/17 was $132,000/1.1 * 0.2 * 365/365 = $24,000.

In terms of cost basis method, it contains two special variables: operating cost and business percentage. For operating cost, apart from car expenses, it also includes deemed vehicle depreciation of $120,000 * 25% * 365/365 = $30,000 and a deemed interest of $120,000 * 0.0565 * 365/365 = $6,780 in FBT year 2016/17. As for business percentage, it is measured by logbook method that requires similar substantiation standards in claiming for car expense deduction16. If the employee does not qualify for substantiation, for instance she did not keep a logbook for at least 12 weeks nor have written evidence of car expenses, business percentage is destined to be ‘nil’17. With other things equal, if car expenses remained relatively low and/or the employee can prove that she had travelled in the vehicle for (Fashionista’s) employment-related activities for a considerable percentage within the 48,000km distance, it is possible that FBT payable under cost basis method would be less than $24,000.

As for the second benefit, it remains obscure whether Fashionista’s payment towards Jane Jackson constitutes as an expense fringe benefit. The main question here is whether the proclaimed “reimbursement” in description is a real reimbursement or an alternative name for allowance. If such a payment is a definite predetermined amount to cover an estimated expense, regardless of whether the recipient incurs the expected expense, it is

16 17

Income Tax Assessment Act 1997 (Cth) s 28-90. Fringe Benefit Tax Assessment Act 1988 (Cth) s 10A-B.

an allowance; if it is a compensation exactly for expenses already incurred (e.g. Fashionista made the payment only after Jane Jackson provided with receipts from educational institutions), it is a reimbursement 18. On condition that the payment is an allowance, no FBT occurs as it is subject to income taxes linked to the employee’s account19.

Suppose that the payment is reimbursement as suggested, it is an expense fringe benefit as the employee’s children can be treated as associates20. In calculating expense fringe benefit, since it is an external fringe benefit as Fashionista is a clothing manufacturer who is unlikely to operate in educational sectors21, while the subtraction from other deductible rule is nil given the fact that the employee cannot claim deduction from installed repayments of HELP loans22, taxable value equals reimbursed amount of $40,000.

Finally, it is important to select gross-up factors depending on the nature of benefits provided for GST purposes when calculating FBT payables. For car fringe benefit, since the purchase for motor vehicle is a creditable acquisition, FBT payable in FBT year 2016/17 equals $24,000 * 2.1463 *49% = $25,240.49; for expense fringe benefit, because education (including both elementary and tertiary one) courses are GST-free 23 , the company would use “type 2” gross-up factor that FBT payable in FBT year 2016/17 reaches $40,000 * 1.9608 * 49% = $38,431.68. Hence the total amount of FBT payable sums up to $63,672.17.

Part (c)

18

Australian Taxation Office, Income tax and fringe benefits tax: the difference between an allowance and a reimbursement, TR 92/15, 5 November 1992, para 2-4. 19 Income Tax Assessment Act 1997 (Cth) s 15-2. 20 Fringe Benefit Tax Assessment Act 1988 (Cth) ss 20-24. 21 Fringe Benefit Tax Assessment Act 1988 (Cth) s 23. 22 Income Tax Assessment Act 1997 (Cth) s 26-20(1). 23 A New Tax System (Goods and Services Tax) Act 1999 (Cth) s 38-C.

The lump sum of $500,000 as well as the offer of rent-free period was a lease incentive where lessor made a payment to potential lessee as an enticement into lease contract; as stated in FCT v. Myer Emporium Ltd, such payment is income accordingly to ordinary concepts. 24 The $500,000 payment may have been distributed in cash or non-cash methods (e.g. interest-free loan and free fit-outs); while in Cooke and Sherden’s case, non-cash benefits that were not convertible into cash was dismissed as assessable income25, certain acts have clarified that any non-cash business benefits provided after 31 August 1988 should be treated as assessable income at arm’s length value.26

There are exceptions to the claim of lease incentive as assessable income, summarized as otherwise deductible rule. If Fashionista would have been able to deduct costs which now forms as part of lease incentives on once-only basis, the total taxation consequence would be nil27. Therefore, if the company can prove that during rent-free period (February to June 2017) it has used the building for taxable purposes (as specified in second limb of general deduction28), the net tax effect would be zero (i.e. non-assessable). Similarly, if schemes such as interest-free loan are included in lump sum payment, they are effectively tax-free so long as it is a genuine business loan29.

As for the $20,000 payment, it may be deductible following either general or specific deductions though no double deduction is permitted30. From the perspective of general deduction, such payment is damages caused by breach of contract by Fashionista. Suppose that Fashionista has utilized the building for income-producing activities, the payment is deductible following positive limbs in ITAA 1997 s 8-1 as discussed above. From the perspective of specific deduction, the company may claim a deduction so long

24

FCT v. Myer Emporium Ltd 87 ATC 4363. FCT v. Cooke and Sherden 80 ATC 4140. 26 Income Tax Assessment Act 1936 (Cth) s 21A(2). 27 Australian Taxation Office, Income tax: lease incentives, IT 2631, 8 August 1991, para 17-22. 28 Income Tax Assessment Act 1997 (Cth) s 8-1(1). 29 Australian Taxation Office, Income tax: lease incentives, IT 2631, 8 August 1991, para 23-24. 30 Income Tax Assessment Act 1997 (Cth) s 8-10.

25

as the proposed repair to roof was a notional repair and the $20,000 outgoing was a payment due to tenant’s failure in complying with lease obligation to make certain repairs for taxable purposes.31 Since the case points out that there was a contractual obligation for Fashionista to repair the roof, what remains unclear is that whether such an act could qualify as notional repair. As is described in FCT v. Western Suburbs Cinemas Ltd, if work to the roof was in fact part of the improvement on the whole construction, such “repair” is of a disguised capital nature; if the work is only one of the objectives, which can be reasonably segmented and quantified, in restoring the construction into serviceable condition, it is normal repair where Fashionista cannot claim a deduction under ITAA 1997 s 25-1532.

Part (d) It is important to determine the source of interest expense prior to further discussion, as the term “foreign bank” in the case may refer to a financial agency located either inside or outside Australia. Normally, a source of interest is where the loan agreement is formed and the money is lent33. Therefore, it would be of Australian source if the contract and each payment was made within Australia. However, they are not decisive factors; as illustrated in FCT v Mitcham, where the court believed that the actor’s personal skills outweighed the place where service was rendered34, additional information regarding the nature of the loan (e.g. the location of newly-established facilities and the type of currency each payment is using) might lead to reversion in judgment.

If the source of interest is in Australia and both parties are Australian residents for taxation purposes, Fashionista can claim a deduction over interest payment so long as the loan was borrowed for producing assessable income (in this case, an increase to

31

Income Tax Assessment Act 1997 (Cth) s 25-15. FCT v. Western Suburbs Cinemas Ltd (1952) 86 CLR 102. 33 CIR (NZ) v NV Philips Gloeilampenfabrieken [1955] NZLR 868. 34 Commissioner of Taxation v. Mitchum (1965) 113 CLR 401. 32

manufacturing capacity)35. Note that interest payments need to be a revenue rather than capital outgoing: several cases have shown that if Fashionista has used the loan for meeting regulatory requirements36 or maintaining its profit-making structure37 (e.g. the facility mentioned cannot continue to operate as a going concern and is the only factory Fashionista has as a manufacturer), claims on deduction will be denied as it is an outgoing of capital. Nonetheless there are exceptions to capital outgoings known as business-related blackhole capital expenditure; as an instance, suppose that Fashionista was going to increase capacity by setting up a new facility and interest payment was made to cover expenditure on obtaining advice or services related to the proposed operation of business, such expense may become deductible over five years38.

Moreover, if the source of interest is in Australia yet the lender is a non-resident, in addition to all arguments in the last paragraph, Fashionista is obliged to withhold the amount of $40,000 * 10% = $4,000 and forward it to the commissioner39, though the exact withholding rate might vary considering public offer exemption 40 and/or special deduction from DTA revisions 41 . If the source of interest is outside Australia, any implication will subject to legislation of related foreign jurisdiction(s), which may or may not result in changes to foreign income tax offset (FITO).

As for bad debts, they are generally deductible so long as they were included in the taxpayer’s assessable income for current or previous periods42, though there are numbers of prerequisites to such assertion. To qualify as a deductible bad debt, one must exist43,

35

FCT v Munro (1926) 38 CLR 153. Macquarie Finance Ltd v FCT 2005 ATC 4829. 37 Sun Newspaper Ltd v FCT (1938) 61 CLR 337. 38 Income Tax Assessment Act 1997 (Cth) s 40-880(2). 39 Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 (Cth) s 7. 40 Income Tax Assessment Act 1936 (Cth) s 128F. 41 UK/Australia Double Taxation Convention, signed 21 August 2003, [2003] ATS 22, (entered into force 17 December 2003), art 11. 42 Income Tax Assessment Act 1997 (Cth) s 25-35(1). 43 GE Crane Sales Pty Ltd v FCT 71 ATC 4268. 36

have become bad (instead of merely “doubtful”) and been written off44. Many of those qualifications are on case-by-case basis, nevertheless. For example, while a debt can only become completely “bad” when a creditor drains out of cash pool or assets in common sense, Anderson and Halstead Ltd v. Birrell has considered that a business can determine the status of debt based on reasonable estimation, particularly over its effect upon profit and loss account 45 . In Fashionista’s case, if such debts have been extinguished or compromised, yet remain “doubtful” regarding all relevant facts or are claimed for deduction in financial period(s) after being written off, the company’s entitlement to deduction will not be justified.

In addition, there are special rules for corporate bad debts, known as continuity of ownership test and same/similar business test. For Fashionista, firstly it must maintain the same owners, judged by more than 50% voting power, dividends and capital distributions upheld, over the test period (i.e. from the start of loss year to the income year where losses are deducted)46. If not, it must carry same business before and after the change of ownership and the source of income and transaction shall remain unchanged47. Following recent amendments to ITAA 1997 s 165-211, If Fashionista fails continuity of ownership test and any of its bad debts incurred after 1 July 2015, the company may use ‘similar’ instead of same business test so long as it can meet four new standards (e.g. the identities of former and current business are in proximity); however, it must stick to same business test for bad debts incurred before 1 July 201548.

Part (e)

44

Point v FCT 71 ATC 4014. Anderson and Halstead Ltd v. Birrell (1932) 16 TC 200. 46 Income Tax Assessment Act 1997 (Cth) s 165-123. 47 Income Tax Assessment Act 1997 (Cth) s 165-210. 48 Income Tax Assessment Act 1997 (Cth) s 165-211(1), later amended by Treasury Laws Amendment (2017 Enterprise Incentives No. 1) Bill 2017 (Cth) sch 1-15. 45

Whether an item should be regarded as an independent depreciating asset is a question of fact 49 , which leads to divergent judgments over the roof and knitting machine in Fashionista’s case. The roof, on the one hand, is an indispensable part of a building whose deterioration or removal would hamper the integrity of an infrastructure. In contrast, despite being a critical component for manufacturing, the machine had a different effective life compared to the building and as stated in description, can be disposed separately. Therefore, Fashionista may treat roof works as part of the building asset and the knitting machine as an independent one.

For the roof repairs, while repair costs to premises are deductible in general50, it does not apply to initial repairs that, as stated in this case, were conducted to make the asset readyfor-use51. It is only a rule of thumb, however, since for an “initial repair” to fully qualify for being capital works, all associated defects, damage or deterioration must have come into existence at the date of acquisition 52. If Fashionista could provide evidences that damage to the roof took place only after the acquisition or the deterioration was a gradual process over an extended period, the $60,000 repair cost (net of GST) may be classified fully or partially as (repair) deductibles.

Assume that construction on the roof is indeed an initial repair, the repair cost becomes an expenditure on capital works that is deductible under Division 43 because like other items in the category, the roof is a structural and irremovable element of the factory building. However, such deduction is unavailable before the completion of construction53. Based on the presumption that the construction (that began well after 26 February 1992) finished on 31 December 2016 and Fashionista has used the complex

49

Income Tax Assessment Act 1997 (Cth) s 40-30(4). Income Tax Assessment Act 1997 (Cth) s 25-10. 51 The Law Shipping Company Ltd v Inland Revenue Commissioners (1924) 12 TC 621. 52 Australian Taxation Office, Income tax: deduction for repairs, TR 97/23, 3 December 1997, para 63-66. 53 Australian Taxation Office, Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements, TR 97/25, 17 December 1997, para 14-15. 50

totally for taxable purposes, the company can claim a deduction of $60,000 * 0.5 * 0.04 = $...