Income Taxation Law Issues - Essay Example

? [INCOME TAXATION LAW] Part Problem Question Capital Gains Tax Implications on Sale of the Shoe Manufacturing Factory Premises A capital gain is the difference between the cost of asset acquisition and the proceeds realised from disposing the same asset1. Capital gains result from selling assets such as real estates and shares. Business goodwill also results into capital gains. There is no distinction between income on revenue account, which is referred to as business income and income on capital account, which is referred to as capital income. Any household required to pay tax on gains that result from disposition of financial and real property2. Whether the gains are speculative, from business income or passive, from capital income, they are subject to tax. On the other hand, investors may make capital losses when the proceeds realised from asset disposal are less than the costs of asset acquisition. Capital gains are only realised when assets are disposed, and not when they are leased. From the information that is provided, the net capital gain for Chloe from the sale of shoe manufacturing factory premises is $1,570,000. This is calculated by subtracting the costs incurred in the acquisition of the factory premises from the proceeds realised from sale of the factory premises as shown. $ $ Selling Price 2,000,000 Goodwill 400,000 Compensation 60,000 Compensation 30,000 2,490,000 Purchase Price 800,000 Goodwill 100,000 Renovation Cost 20,000 920,000 (920,000) Net Capital Gain 1,570,000 The capital gains tax implication for this transaction is that only fifty percent of the net capital gains will be subject to capital gains tax because the factory premise was owned for a period of more than twelve months. Gains arising from assets that were purchased after 21st September 1999 are calculated using the 50% discount method3. An asset purchased and sold more than twelve months later is taxed on 50% of the gain while gains on assets held for less than twelve months do not qualify for an increased base of the fifty percent discount. Therefore, an amount of $ 785,000 will be subject to capital gains tax. There should be proper recording of the business transactions regarding the factory premises, commencing the date of acquisition to avoid paying more capital gains tax than necessary. There will be no benefit of small business concessions. A company whose annual income is more than $2 Million is not a small business. On the other hand, if the aggregate turnover for the current year is less $ 2 Million, then the business is a small business4. Capital Gain Tax Implications on PKY Pty Ltd An expense was incurred in acquiring the company, PKY Pty. There should be appropriate recording of transactions and costs associated with the acquisition and running of this company to ensure that capital gains tax is equitable. It is imperative to note any income that will is to be realised from rent is subject to tax. This is because rental income is subject to tax. Secondly, the retail business’ net proceeds will be subject to tax. In case, the aggregate income per year does not exceed $2 Million, then Chloe can benefit from small business concessions because the company will be categorised under small businesses. Capital Gain Tax Implications on Residential House The $800,000 residential house with $400,000 mortgage is not subject to any tax because all residential properties are exempt from taxation. Personal assets such as personal use assets, home and car are exempted from capital gains tax. However, this does not apply to depreciating assets such as business equipment or fittings in rental property that are solely used for taxable purposes. To avoid payment of any tax there should be proper recording regarding the residential house cost. Also, the house should not be rented or be on more than two hectares of land, and must have a dwelling in it4. A dwelling is exempt from capital gains tax if it is used for residential purposes and is used for private or domestic purposes. Proper records regarding the home are required to know the full cost to avoid paying more capital gains tax than is necessary. Capital Gain Tax Implications on Holiday House in Lorne Victoria The holiday house in Lorne, Victoria worth $500,000 is subject to capital gains tax because it falls under the category of vacant land, business premises, rental properties, holiday houses and hobby farms, will are all subject to taxation. Therefore, proceeds realised from the holiday house in Lorne, Victoria will be taxed. Real estate, such as rental properties, business properties and holiday houses are subject to capital gains tax while main residence or family home is not, unless it is rented out for a time or if it is more than two hectares of land4. All assets that were bought or acquired since 20/09/1985, when tax on capital gains came into effect are subject to tax, unless exemptions are specified2. Capital Gain Tax Implications on a $300 Holiday House in Queenscliff, Victoria Similarly, this house being a holiday house will be subject to capital gains tax it is in the category of vacant land, business premises, rental properties, holiday houses and hobby farms. Since the house was rented to friends and guests, rent that is realised from such business is subject to capital gains tax. Capital gain tax is only exempt on personal assets. These assets include personal cars, homes and personal use assets. This exempt does not apply to apply to depreciating assets such as business equipment or fittings in rental property that are mainly used for taxable purposes. Capital Gain Tax Implications on Investment Property, Superannuation, INV Pty Ltd and TRN Pty Ltd The investment property worth $ 450,000 on which there is a $200,000 mortgage owed, is subject to capital gain tax. The mortgage owed is tax exempt, but the proceeds realised from the investment are subject to taxation. As for the dividends that may be paid from INV Pty Ltd, there is a 50% deduction on the capital gains tax because this investment has been owned for six years. A dividend is unit that represents income that is earned from shares and other income assimilated to income from shares by the taxation law of the Contracting State of which the company making the distribution is a resident5. Similarly, the dividends that may be realised from the 65% investment in TRN Pty Ltd will be subject to tax. However, there is a 50% deduction because the investment has been owned for ten years. Chloe may benefit from a franking credit tax offset, if the dividends realised are franked6. There is need to adjust the cost and reduced cost base of the shares owned for capital gains tax purposes. Small businesses and individuals can discount a capital gain by 50% if the asset is held for more than one year4. Capital gains of households would not be taxed unless gains of a given type are targeted in the tax code 2.Where capital gains have been made tax free, a taxpayer may convert such taxable income into exempt capital gains so as to avoid taxation. Where an asset was acquired at or before the start time and the CGT event took place at or before start time, then indexation may be available in calculating the cost base if the asset was owned for a year, while there is no CGT discount2. Also where an asset was acquired at or before the start time and the CGT event took place after start time there is indexation and 50% discount for individuals. If the asset was owned for a period that is less than twelve months, there is no indexation or CGT discount option7. Also, where the asset is an active asset and the taxpayer and their associates hold less than $6 Million in assets, excluding personal use assets and superannuation, then the business owner may utilize small business CGT concessions. They can claim an exemption given that they hold an interest of 20%. If the business owner is less than less than 55 years, then he or she can rollover the CGT exempt amount into superannuation fund8. Given this, Chloe can use small business concessions to reduce the amount of tax payable on her capital gains because her assets are worth $2,707,500, as much as she has not owned the business for fifteen years. She can also roll over her CGT exempt into superannuation because she is 44 years old. A person satisfies a “condition of release” where he or she attains the retirement age or preservation age, which is from 55 to 60, depending on the date of birth9. There can be a deduction of tax on superannuation at specified reduced rates. Part 2- Policy Based Essay Question The Law is regarding Self-Education Expenses Currently, the amount deductible for self-education expense cannot be greater than the excess of the net amount of expenses of self-education10. A deduction for the first $250 of work related education expense is available for certain kinds of self-education expenses while it is not available for others. The first $250 of a course in education expense is not deductible. The taxpayer has a right of claim all their deductible expenses if they are employed. Expenses of self education are not restricted to amounts that are deductible under section 8-1, but they do not include depreciation. The limit does not affect deductions for expenses that do not fall under the category of expenses of self-education such as short term refresher courses. It does not affect deductions under specific deduction provisions such as computer repairs. For instance, Kimberly paid tuition fees of $2,000, child care fees of $200, computer repair expenses of $150, car travel from home to campus expense of $250. Her computer’s depreciation amounted to $ 150. In this case the expense of self education consists of tuition fees, child care, travel, and computer repairs. This amounts $2,600. Under the $250 rule, the maximum amount allowable is $2,350 ($2,600 - $250). However, she can only claim $2,000. Child care is not deductible while repairs, depreciation and car travel are deductible under specific provisions10. Only the work-related expense element of the expense will be claimed as a deduction as apportioned. However, there are exceptions where expenses are claimed in full, especially where the primary purpose of incurring that expense is work or business-related. In Javatilake v FC of T (1964), the taxpayer was an employee of the Commonwealth Public service. She was later employed by the Victorian Public service. Her employers offered her a study leave to complete a Bachelors degree in Computer Science and a Master of Business Administration degree. The taxpayer had to arrange for her son’s child care. Therefore, the son was placed in a day nursery when the taxpayer left Australia. The taxpayer claimed the child care costs as deductible self-education expenses for income years of 1982, 1983, 1984 and 1985. Other expenses associated with her program of self-education include books, institutional fees, photocopying, stationery, fares, repairs and depreciation of a personal computer and a proportion of room running expenses. It was accepted that the motive of the taxpayer was to undertake studies to attain advancement in her employment. The studies were instrumental in her obtaining the promotions that she achieved, initially as a computer systems officer and as a manager. The commissioner allowed all the deductions that the taxpayer claimed apart from the child care costs. It was ruled that child care expenses were not self-education expenses that were incurred in the production of assessable income. Instead, child care expenses are expenses of private or domestic nature that lacked a sufficient connection with the income earning activities of the taxpayer. Therefore, they were not deductible11. Other expenses that are not deductible include living expenses, which are considered to be private or domestic in nature and purchasing and maintaining conventional clothing, unless such clothes are part of a recognised work uniform6. The $250 rule states that only expenses relating to the current financial year can be claimed in case of prepaid expenses. Prepaid expenses for future years can be claimed during such income years. If the employer provides education to an employee directly or through reimbursement of costs, then the employer can claims deduction for their business expenses. If education is work related, then the employer will not be liable to fringe benefits tax. This is because the expense will be deductible by employees. Employers do no pay for fringe benefits tax for educating and training their employees. But in cases where employees use their salaries to get such benefits, then employers will be liable to tax. How the Proposed Amendments would change this Law As from 1st July 2014, a $2,000 cap on work-related education expense deductions will be introduced for taxpayers12. This will apply in a particular financial year if the expense is incurred so as to gain a taxpayer’s assessable income. Also, the expense should not be private or capital in nature. Taxpayer’s educational expenses are tax deductible if the taxpayer is employed. All the expenses incurred in educational activities will be subject to the cap. This will apply to both formal and informal education. Some of the expenses that will be subject to the cap include tuition fees, textbooks and journals, registration fees for seminars, conferences and workshops. Others include computer expenses, photocopying and stationery, travel, accommodation meals and running expenses12. As far as the requirements for claiming educational expenses are concerned, there will be no change pertaining to the types of expenses that can be claimed. To be able to claim deduction on self education expenses, the education expense must relate to the current income producing activities of the taxpayer or employee. The current rules of apportionment and prepayment of expenses will continue to apply. Applying the $ 2000 cap while retaining the $250 no-claim threshold, implies that some taxpayers will only be able to deduct $ 1750 of their education expenses. The proposed amendments will reduce the amount of self-education expenses that are deductible. Currently, there is no limit on the amount of deductible, self education expenses. Introducing the $2000 cap implies that taxpayers whose self-education expenses exceed $2000 will only claim deductions up to an amount of $2000. Those whose courses are so expensive that they will incur more than $2000 will not benefit from the deductible self-education expense, as much as those whose self-education expense will be less or equal to $2000. Taxpayers whose professional training expenses are high will be disadvantaged. Secondly, taxpayers will not opt for expensive courses and expensive residents while undertaking their self-education. In addition, self employed taxpayers will disadvantage because they might not take the courses that they wish to, as the cost will be too expensive for them. Implications of implementing the Proposed Change to the Law The Australian government took this move so as to prevent extravagancy. Some taxpayers make large claims for expenses that they incur such as fare, accommodation and expensive courses13. In an effort to protect government revenue from such expenses, the government introduced the $2000 cap. Therefore, introduction of the $200 cap will discourage taxpayers from incurring lavish cost for the purpose of self-education and claiming deductions from the government on such expenses. Secondly, since the fringe benefits tax will still apply under the proposed amendment, employers will have the opportunity to invest in the skills of their workers. This means that they will seek to train their workers to enhance efficiency and productivity. In turn, the country’s economic efficiency will be enhanced, to some extent. The amendments may not affect majority of the taxpayers because they have self-education expenses that are below $2000. On the other hand, implementation of the proposed amendments will have adverse effects. First, the government is likely to lose revenue that would have been collected in form of tax because postgraduate students will reduce and productivity will go down. This is because it will become expensive for some taxpayers to undertake self-education courses. Consequently, productivity will go down because people may not be willing to improve their skills. The amount of revenue will reduce drastically. Secondly, the $200 cap will be unfair because it will negatively affect low income earners and women. Also, people from rural areas and regional communities, and the self employed will be disadvantaged. This is because postgraduate education may be extremely expensive for them, especially those who wish to take costly courses like architecture and aviation. Another negative implication of implementing the proposed amendments is that many of the taxpayers will be unable to claim self-education expense deductions because the requisite nexus to their employment does not exist. For instance, a biochemistry graduate working in a retail shop may not be able to claim self-education expense deductions to study her masters, while an accounting graduate working in a tax consultancy firm can claim self-education expense deductions to study his masters in accounting. Some taxpayers may obtain large deductions, depending on their career. It is desirable to implement the proposed changes to the law because fringe benefits tax will apply to training and education provided or reimbursed by an employer. This will remove the barrier from employers investing in the skills of their workforce12. Also, the amendment will aid in government revenue protection. As much as the implementation may reduce productivity and efficiency in the economy, the effect will not large because majority of the taxpayers incur self-education expenses that are below the $2000 proposed cap. The benefits that accrue from the implementation of the proposed amendments to the law are desirable efficiency in the economy. References Abbott, G. 2008. Self Managed Superannuation Funds Strategy Guide. Sydney: CCH Australia Press. Australian Government Treasury. 2013, May. Reform to Deductions for Education Expenses . Retrieved August 30, 2013, from http://www.treasury.gov.au/~/media/Treasury/Consultations%20and%20Reviews/2013/Reform%20to%20deductions%20for%20education%20expenses/Key%20Documents/PDF/Discussion_Paper.ashx Australian Tax Office. 2013, June 28. Capital Gains Tax. Retrieved August 30, 2013, from http://www.ato.gov.au/General/Capital-gains-tax/ Australian Tax Office. 2013, July 25. Meeting the Basic Conditions for the Concessions. Retrieved August 30, 2013, from http://www.ato.gov.au/Business/Small-business-entity-concessions/In-detail/CGT/Guide-to-capital-gains-tax-concessions-for-small-business-2012--13/?default=&page=8#Meeting_the_basic_conditions_for_the_concessions Backoczy, S. 2010. Australian Tax Casebook. Sidney: CCH Australia Press. BDO Australia. 2013. Work-Related Self-Education Expenses Limited to $2,000 Per Year. Retrieved August 30, 2013, from http://bdo.com.au/resources/publications/federal-budget-2013/personal/work-related-self-education-expenses-limited-to-$2,000-per-year CCH Australia. 2009. Australian Master Family Law Guide. Sydney: CCH Australia Press. CCH Australia. 2012. Australian Master Tax Guide 2012. Sidney: CCH Australia Press. Clark, W. S. 2006. Taxation of Capital Gains of Individuals: Policy Considerations and Approaches. Paris: OECD Press. Crowe Horwath International. 2009. International Master Tax Guide 2009/10. North Ryde: CCH Australia Press. Leow, J., Murphy, S., & Hooper, G. 2009. Australian Master Superannuation Guide 2010/11. North Ryde: CCH Australia Press. Maisto, G. 2012. Taxation of Intercompany Dividends Under Tax Treaties and EU Law. Amsterdam : IBFD Press. Prince, J. B. 2010. Tax For Australians For Dummies. Hoboken: John Wiley & Sons Press. Read More