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INCOME TAX

Oct 24, 2018 | 0 comments

Oct 24, 2018 | Essays | 0 comments

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INCOME TAX

QUESTION 1A

Question a

The issue in this question is to discuss whether Clara receiving $25,000 constitutes assessable income. Under section 6-5(1) ITAA 97, assessable income is defined as an income that can either statutory income or ordinary income or even both. Assessable income includes all the wages, commissions, salaries along with awards, bonuses, contributions to compensation plans, cost of living allowances, and employee fringe benefits.[1]

From the case involving Clara, she was appointed as an income tax manager to deal majorly with income tax matters. However, her role was changed to another one that predominantly dealt with GST even though her job title remained unchanged. From the case study, it can be concluded that the compensation was made to Clara for her to relinquish her rights. This case scenario is similar to the case of Bennett v FCT[2] where the original contract of the director was terminated and he got another appointment with the same salary scale. The court held that the amount provided by the company was for relinquishing his rights from the original contract.

As elaborated by ATO,[3] when calculating assessable income, one must include compensations such as compensation for workers, or payments for business interruptions, trading stock losses, or cancellation of stocks. Therefore, from the case study, the $25,000 Clara received as compensation for the change of her position constitutes assessable income.

Question b

From the case study, the essay thinks that $15,000 received by Clara does not constitute ordinary income. Ordinary income is an earned income from the provision of services or the sale of goods. Clara was not paid $15,000 for any sale of goods or provision of services. However, the amount paid to her to leave her private business of completing tax returns from different members of the public can be categorized as capital gains because she was more of selling her private business or ceasing operation of her business for over five years for personal purposes. This scenario is similar to the case of Higgs v Olivier[4] where Olivier was paid to prevent him from directing or appearing in any film. The English court held that such payments were made for giving up his performing rights and was less capital income and not assessable

QUESTION 1B

Capital loss or capital gains on an asset according to Woellner et al[5] is the difference between what the asset cost and what an individual will receive when they disposed of it. People pay tax on their capital gains and is referred to as the capital gains tax. Woellner et al[6] indicated that if an individual makes a capital loss, he or she cannot claim it against their income but can use it in reducing capital in the same year’s income. However, if the capital losses are more than the capital gains of an individual in an income year, they can carry the loss forward generally and make deductions against capital gains in the future.

ATO[7] pointed out that all the acquired assets since the start of tax on capital (20th September 1985), are subject to the capital gains tax unless it is specifically excluded. From the case studies, Tanya acquired all her assets from 2007 and had been operating them till the year 2015. This falls into the bracket of the period covered and is liable to taxation.

As advised by ATO[8] when Tanya is acquiring capital gains tax assets, she needs to begin by keeping records of every transaction, circumstance, or event that may be relevant that will be relevant in calculating whether she had made a capital loss or capital gain. Her records will be helpful to her when calculating her capital loss or capital gain to ensure she doesn’t pay more capital gain tax than necessary. Tanya needs to establish exactly when they acquired their capital gain tax assets because the tax does not apply if they were owned before the commencement of capital gain tax on September 20th, 1985. Tanya also needs to keep good records on exactly when she acquired the assets because the rules on working out the cost base of the capital gains tax over time have changed.

From the presented facts in the case scenario, acquiring or purchasing assets does not create any tax liability. However, the tax liability will come about when assets are disposed of in form of selling them. Therefore, when Tanya sells her assets, the tax liability will arise. The following will be her tax liabilities from her activities

  1. She sold her shop and land for $900,000, which she acquired from $400,000 ($115,000+5000+280,000). $900,000 will be considered capital receipts.
  2. another $150,000 for restraint in trade for four years will also be considered as a capital gain tax and is taxable
  3. The sofa set she was using in her shop was bought at $20,000 and sold at $15,000. Moreover, ATO[9] indicated that capital gains tax does not apply to assets that depreciate such as the fittings in a rental property or business equipment. Therefore, this will not be tax liable because it’s deprecating
  4. Her residence valued at $1,400, you will not have any CGT event since it is under an exemption from CGT
  5. Shares are considered capital gains tax but until they are sold, they do not create a CGT event. Therefore, Tanya’s shares at Invest PTY Ltd worth $975,000, and her shares at commonwealth bank worth $600,000 has no capital gain since they have not been sold or transferred
  6. The motor vehicle of $30,000 was being used as a business asset but was a depreciating asset. Furthermore, she plans to use it as a personal vehicle hence does not has any CGT liability since it has not been sold
  7. A mortgage of $50,000 on a rental property valued at $550,000 has no CGT liability since it has not been transferred.

To sum it up, the calculation for capital gain for Tanya will be:

$900,000- $400,000= $500,000

$500,000+$150,000= $650,000

Therefore, the capital gain for Tanya is $650,000

Some assets are exempted from the capital gains tax, such as car and home, and other depreciating assets solely sued for taxable purposes. Small businesses and individuals can discount by 50% a capital gain, generally, if they hold onto an asset for more than one year.[10] Furthermore, in some situations, a capital gain one capital gain tax event can be rolled over (deferred) until another capital gain tax event happens. When an individual sells or disposes of an asset, it is referred to as a capital gain tax event. This is the point where an individual makes a capital loss or capital gain.

ATO[11] further pointed out that if an individual owns an asset that is active in a small business (aggregated annual turnover less than $2 million), the person may be eligible for a variety of concessions that allow him or her to defer or disregard all or some of capital gain on the asset. From the case study, Tanya ran and owned a store with an annual turnover above $2 million ($2,800,000-$2,900,000) making her business a large business and cannot be termed as a small business. Her store is not eligible for a variety of concessions that will allow her to defer or disregard all or some of her capital gain on the asset.

However, from the same case study, Tanya may be allowed to roll over a capital gain from the CGT events until another capital gain tax event happens. Tanya’s assets were disposed of or transferred in the following circumstances making her eligible for rollover; she transferred a CGT asset to another wholly-owned company. From the case study, it is indicated that Tanya entered into a contract where she will not compete with the buyer of the business for the next four years. However, ATO[12] indicated that if an individual disposes of his or her CGT asset, the CGT event normally occurs when they enter into the contract for transfer or disposal. The CGT event happens when both parties enter into a contract (date of the contract and not when both parties settle). Therefore, it is evident the CGT event when Tanya entered into a contract and, therefore, the assets are being disposed of making her legible for rollover.

Also, ATO,[13] the following concessions may allow Tanya to defer or disregard all or some of the capital gain from an active asset being used in a small business. The first is rollover that is when an individual sells an active asset; rollover allows deferment or part of or all of the capital gains for two years.

PART 2: POLICY USED ESSAY QUESTION

The current tax policies impacting the affordability of housing

Housing is one of the taxation revenue sources for the government during all the ownership stages that are buying, selling, and retention, through a partnership or by an individual. By making adjustments on how much tax should be charged and when levying is done, both state and federal governments can shape the decisions the investors and owners make concerning housing. This reinforces the reality that issues of tax influence the production and uses of the private rental or owner-occupied housing in Australia. Several tax policies are impacting real estate prices and investment and housing affordability, and they include stamp duty, land tax, negative gearing, and capital gains tax.

Stamp duty

According to AHURI,[14] nearly every time a property changes owners or is sold, the buyer pays tee stamp duty to the territory or the state governments. Stamp duty is worked out from the value of the building or the land, although the charged amount varied from different territories and states. Additionally, stamp duty can be applied at different rates for investors or owner-occupiers. AHURI[15] indicated that stamp duties affect housing affordability by making purchasing of homes more expensive particularly for the buyers purchasing for the first time. For instance, the average stamp duty in 2006 paid by the buyers of land and houses in Victoria was about 5% of the average prices of the property.[16] Similarly, stamp duty can also result in inefficient housing use by constraining the capacity of an individual to move and take advantage of new opportunities of employment r to downsize to a sized home that is more appropriate

Land tax

These apply to lands used for private rental and commercial housing but not for owner-occupied housing. As the landholding value increases, the charged land tax increases. For instance, AHURI[17] pointed out that in 2013 in NSW, an investor with a total landholding assessable below $406,600 do not pay any land tax. However, $100 was paid for and holdings between $406,000-$2,482,000 in addition to 1.6% of the valued land above $406,000 as well as 2% on the total valued land above $2,482,000.

According to AHURI,[18] land tax discourages financial institutions and property funds from investing on large scale in the market of private rental housing. This is one of the potential significant factors that contribute to the shortage of rental housing that is affordable. Because the land tax is an investor’s cost, it is subsequently passed to the tenants at higher costs if rents, and this reduces the affordability of housing.

Negative gearing

This is the process where a property investor can deduct the expenses on the property (such as despeciation costs, loan interests required to purchase the property, rates, land taxes, and costs of maintenance) from both the received income as rent from the property and other income sources (such as other non-housing investments or their salary), hence reducing their tax bill in overall. Apart from lowering their taxable income, the investors benefit if the prevailing prices rise since they will make profits when they make a sale. AHURI[19] stated that the outcome is that negative gearing encourages people to own investment rental properties to charge rents that are below the buying costs and property management costs, even though the actual cost of purchase is not claimable.

According to AHURI,[20] while it may seem that negative gearing benefits tenants by keeping down the rents, the reality is that it distorts the market of housing, by encouraging investors to take bigger loans and purchase properties. This makes properties more expensive to products they were unable to develop. The investment was directed at building a new brand name. The more than two billion dollar investment is allowed Tata to purchase hence more expensive to rent. As a result of competition from investors who are geared negatively, higher prices implies homes are less affordable for the individuals purchasing their home

Capital gains tax

Capital gain is realized when a property is sold more than the price it was bought. AHURI[21] pointed out that there is no tax to be paid on the capital gain if the property has been the owner’s residence. However, if the investor has owned the property for more than 12 months, only 50% of the nominal capital gain is included as assessable income for taxation as the rate of taxation of the individual.

Whether it is desirable to change any of the tax laws currently contributing to making housing less affordable

This section of the essay will propose some reforms to the tax system on the prices of houses. In conjunction with other changes and reforms in improving the supply of housing, these proposed changes should improve the affordability of housing by making the supply of housing more responsive to demand. The proposed changes to the specific tax laws will consider the context of economic efficiency, fairness, government revenue protection, and other considerations relevant.

Eliminating stamp duty

In a recent report by Daley and Brendan,[22] the report suggested territory and state governments that are cash strapped could generate A$7 billion extra annually by switching to low rate annual land tax from stamp duties. This would help these governments in filling their holes in revenue and create a more efficient economy. ACT is leading and is slowly making the transition for the next 20 years in slow increments.

Eliminating stamp duty will improve housing supply in addition to reducing many other adverse impacts on the market for housing. Stamp duties reduce effective housing supply by suppressing the number of undertaken transactions in the housing market. More transactions in the market mean a more improved matching of people to housing. This implies that a given stock of housing can house more people effectively

Stamp duties should also be removed because it is an added cost to the cost of moving to a bigger house hence it encourages people not to relocate but rather renovate. This implies that more investment resources are used in making the existing houses larger instead of newer and affordable housing. Because of stamp duty on people’s personal costs, people continue living in houses that are not suited to their needs.[23]

AFTS[24] also indicated that stamp duties should be removed because it discourages new housing stock development since they are paid twice in the new housing construction supply chain. That’s is when a developer purchases the property from the initial owners and also when the final property owner purchases the land. Moreover, they impose a higher rate of tax when the property is held for a very short period. Therefore, they heavily fall on people holding the property when it is redeveloped or developed into housing over a short period. Therefore, the essay thinks that removing the stamp duty would support the supply of housing

AFTS[25] stated that stamp duties are also a tax on the buildings as well as a taxing turnover. Stamp duties compare to land tax; discourages new building construction, which has a higher likelihood of reducing the housing supply and increasing its cost.

Land tax reforms

Using the use of land and the size of holdings in determining land tax liabilities has negative impacts on the housing market. Therefore, changes in land tax based on the land’s value should reduce these effects. AFTS[26] indicated that all states except ACT calculate land tax levy based on the aggregate landholdings. This approach, in combination with progressive rate sales, creates a significant bias to the landholdings that are of large scale. When combined with the negative gearing tax advantage that is available to the individual investors, this explains the reason the market for residential property is dominated by the small scale investors

According to AFTS,[27], the policies discouraging large-scale investors from investing in the housing market have a higher likelihood of having adverse effects on the rental housing supply and its affordability to the renters. The housing investment is favoring small investors, and it forgoes lower costs potential from economies of scale in the supply of housing. For instance, small landlords share tenancy management services effectively by purchasing them from the property agents. However, large-scale housing investors have the ability to bring the tenancy arrangement supervision in-house, hence reducing their overall cost of housing. Furthermore, large-scale investors according to AFTS[28] are more likely to make investments over a long period of time since they are less likely to have capital problems or the need for diversification of portfolio that can force a sale by the housing market small scale investors.

References List

AHURI, AHURI Evidence Review 031: Why Tax Policy Is Housing Policy (Part 1 Of 2) – AHURI (2013) Ahuri.edu.au http://www.ahuri.edu.au/housing_information/review/evrev031

ATO, Acquiring And Owning CGT Assets | Australian Taxation Office (2015c) Ato.gov.au 

ATO, Capital Gains Tax | Australian Taxation Office (2015b) Ato.gov.au https://www.ato.gov.au/Individuals/Capital-gains-tax/

ATO, CGT Exemptions, Rollovers, And Concessions | Australian Taxation Office (2015d) Ato.gov.au 

ATO, Small Business CGT Concessions | Australian Taxation Office (2015e) Ato.gov.au 

Australian Future Tax System, Part 2: Detailed Analysis – Chapter E: Enhancing Social And Market Outcomes – E4. Housing Affordability – Australia’s Future Tax System: Final Report (2015) Taxreview.treasury.gov.au 

Australian Taxation Office, What to Include in Your Assessable Income | Australian Taxation Office (2015a) Ato.gov.au 

Bennett v FCT, Barnet Jade – Find Recent Australian Legal Decisions, Judgments, Case Summaries For Legal Professionals (Judgments And Decisions Enhanced) (2015) Jade.barnet.com.au 

Daley, John and Brendan Coates, Property Taxes (2015) Grattan Institute http://grattan.edu.au/wp-content/uploads/2015/07/826-Property-Taxes.pdf

Higgs v Olivier, [ARCHIVED CONTENT] BIM80240 – Miscellaneous Income: Particular Sources: Restraint Of Trade (2015) Webarchive.nationalarchives.gov.uk http://webarchive.nationalarchives.gov.uk/+/http://www.hmrc.gov.uk/manuals/bimmanual/bim80240.htm

IRS, Income Tax Glossary – IRAS (2015) Iras.gov.sg https://www.iras.gov.sg/irashome/Individuals/Locals/Learning-the-basics/Basic-Guide-for-New-Taxpayers/Income-Tax-Glossary/

Woellner, R. H et al, Australian Taxation Law 2014

  1. IRS, Income Tax Glossary – IRAS (2015) Iras.gov.sg https://www.iras.gov.sg/irashome/Individuals/Locals/Learning-the-basics/Basic-Guide-for-New-Taxpayers/Income-Tax-Glossary/.
  2. Bennett v FCT, Barnet Jade – Find Recent Australian Legal Decisions, Judgments, Case Summaries For Legal Professionals (Judgments And Decisions Enhanced) (2015) Jade.barnet.com.au <https://jade.barnet.com.au/Jade.html#!a=outline&id=64490>.
  3. Australian Taxation Office, What to Include in Your Assessable Income | Australian Taxation Office (2015a) Ato.gov.au 
  4. Higgs v Olivier, [ARCHIVED CONTENT] BIM80240 – Miscellaneous Income: Particular Sources: Restraint Of Trade (2015) Webarchive.nationalarchives.gov.uk <http://webarchive.nationalarchives.gov.uk/+/http://www.hmrc.gov.uk/manuals/bimmanual/bim80240.htm>.
  5. R. H Woellner et al, Australian Taxation Law 2014.
  6. Ibid, 32.
  7. ATO, Acquiring And Owning CGT Assets | Australian Taxation Office (2015c) Ato.gov.au 
  8. Ibid, 1.
  9. ATO, Capital Gains Tax | Australian Taxation Office (2015b) Ato.gov.au https://www.ato.gov.au/Individuals/Capital-gains-tax/.
  10. ATO, CGT Exemptions, Rollovers, And Concessions | Australian Taxation Office (2015d) Ato.gov.au 
  11. Ibid, 1.
  12. Above 1.
  13. ATO, Small Business CGT Concessions | Australian Taxation Office (2015e) Ato.gov.au
  14. AHURI, AHURI Evidence Review 031: Why Tax Policy Is Housing Policy (Part 1 Of 2) – AHURI (2013) Ahuri.edu.au http://www.ahuri.edu.au/housing_information/review/evrev031.
  15. Ibid, 1.
  16. Above 1.
  17. Above 1.
  18. Above 1.
  19. Above 1.
  20. Above 1.
  21. Above 1.
  22. Daley, John and Brendan Coates, Property Taxes (2015) Grattan Institute http://grattan.edu.au/wp-content/uploads/2015/07/826-Property-Taxes.pdf
  23. Australian Future Tax System, Part 2: Detailed Analysis – Chapter E: Enhancing Social And Market Outcomes – E4. Housing Affordability – Australia’s Future Tax System: Final Report (2015) Taxreview.treasury.gov.au Ibid, 1.
  24. Above 1.
  25. Above 1.
  26. Above 1.
  27. Above 1.