The following case study is based on the determination of the permanent establishment of the taxable entities that are looking forward to carry the business of land development. The taxpayer in this case study are the British resident and are assessed under the applicable taxable rulings and appropriate income tax acts. The study defines the definition of permanent establishment and also cites appropriate case legislations to arrive at the tax consequences of the taxpayers in the study.
The current case study is based on ascertaining whether Taite and Aramisa British resident planning to operate a business of land development, whether or not would be held liable for tax under the Permanent Establishment. The description of permanent establishment defined under subsection 6 (1) of the Income Tax Assessment Act 1936 is applicable for the purpose of ITAA 1997 and Schedule 1 of the Taxation Administration Act 1953 unless it appears different to the intention (Barkoczy, 2016). The ruling is applicable to the person who are resident of Australia and performs the trade abroad or is a non-resident of Australia carrying the business in Australia and seeking direction on having a place for the purpose under subsection 6 (1) of the definition. As evident from the case study, it is observed that Taite and Aramis are British resident and are planning to set up a parent company by make use of borrowed money with the help of corporation structure and finance the money borrowed at a commercial rate to an entirely owned auxiliary company.
As evident in the case study, the description of Permanent Establishment defined under Subsection 6 (1) of the concept is used in Australian tax treaties. For the purpose of subsection 6 (1) defined under Taxation Ruling TR 2002/5,Permanent Establishment is a place all the way through which an individual executes the commercial activities forms the reference to the place used that is used for carrying on the persons business activities (Braithwaite, 2017). As Taite and Aramis have plans to set up the parent company in Australia, the place forms the constituents of permanence both geographically and temporally. Permanence should be interpreted in context of this case study of particular business, which is a matter of truth and degree. Therefore, permanence in circumstance to the Taite and Aramis plan of setting up the business does not mean forever.
The nature of business adopted by Taite and Aramis is not permanent and involves the use of land for land development and selling the same. A place all the way through which an individual executes any business in context of the definition defined under subsection 6 (1) should be enduring but in the current scenario the nature of business is not permanent (Saad, 2014). The second criterion to conclude the place of carrying on the business is present under the description of PE under subsection 6(1) is temporal business. As Taite and Aramis nature of business involves the land development for five year only. Therefore, as defined under subsection 6 (1) of the PE the business should perform its functions for the period (Taylor & Richardson, 2013). This should be judged in the present circumstance of the particular trade and forms the subject matter of fact.
As stated in the case of Permanence in Applegate v. FCT 78 ATC 4054 at 4060; (1978), permanence does not represents everlastingly. In conversing, the denotation of permanent the expression permanent is used in the common sense of something, which is to be differenced, that is provisional and temporary (Woellner et al., 2016). It does not represent everlasting and this is only sense that is used in this ruling. Whether the temporary permanence prevails is the subject of truth and quantity. However being a guide, if Taite and Aramis functions at or throughout a place constantly for a more than a period of six months that place will be temporally permanent.
In relation to the circumstance under which the meaning of Permanence arise it is evident that subsection 6 (1) of PE under ITAA 1936 sustained in the preceding approach (Robin, 2017). The denotation of permanent establishment in the 1946 UK DTA denotes predominantly to introduce the force of law to the UK 1946 Double Tax Agreement.
The concept of Permanent establishment plays in important role in determining the tax liability both in the global and domestic tax law. In Australia, it was primarily used for the tax treaty with the United Kingdom marked in the year 1946 (Barkoczy et al., 2016). It specifically appeared in the domestic tax law of Australia out of the tax treaty context in 1959.
Permanent establishment plays an important role in determining Australia’s tax treaties that means a permanent position of trade from where the trade of an enterprise is entirely or partially carried on.
2. Assuming that the taxable entities involved are resident of Australia for taxation purpose the Taxation Rulings TR 2004/4 takes into the considerations the deductions for interest occurred before the beginning of, or subsequent to the termination of, important revenue earning actions (Berg&Davidson, 2016). As evident from the case study, the business model comprises the deal of subsidiary company by shares to competent the application for tender and its successive refinancing from the company’s existing loan needs significant initial borrowing including interest expenses (Dunne et al., 2016). As per the Taxation Rulings TR 2004/4 it takes into the considerations the deductibility of interest expenditure occurred before the commencement of the activities of income earning and interest expenditure that is incurred following the income earning capacities have come to an end.
The ruling is applicable to income years that begin both prior to and after the date of issue. The deductibility of interest in the present case study of Taite and Aramis is characteristically determined based on the assessment of borrowing and the use to which the borrowed funds are put into use (Fry, 2017). As held in the case of Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 normally the purpose of borrowing was determined from the use to which the funds that are borrowed were used. Outgoing of interest is referred as the recurring expenditure. The piece of evidence that borrowed funds might be put into use to acquire a capital asset but does not represent that interest outgoing are based on capital account.
Following from the case of Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 interest that is occurred during the period, which is before the origin of the significant taxable income, will take place in attainment or production the taxable income (Miller & Oats, 2016). It is not introductory to the revenue earning actions and it does not lead up to those actions.
As held in Kidston Goldmines Ltd v. Federal Commissioner of Taxationthe judgement provided the explanation on the concept that the use to which the funds are used and of individual purpose were important in assessing the deductibility of the interest in the form of tool to help in assisting the resolution. The statutory issue surrounding the present case ofTaite and Aramis is whether the interest outgoing took place during the income generating activity or in circumstances of the second limb of the section 8-1 of the ITAA 1997. In deciding the existing case, the interest expense was considered as an outgoing, which took place in gaining or generating the taxable income (Kabinga, 2015). It is not necessary to remain engaged in addressing the differences between the objective of the taxpayer at the time of borrowing the money and the usability borrowed funds.
The financing principle defined in the case of FC of T v. Roberts states that borrowing to refinance funds employed in business will be considered for deductions given the funds represents in the form of partnership capital.
Referring to the case of Texas Company (Australasia) Limited v. FC of T (1940) 63 CLR 382 the Australian taxation system considers interest on borrowed funds to safeguard capital in relation to the present income producing activities (Jacob, 2016). Interest paid in regard to the attainment of capital asset, which in the later stages used in income generating activities, is an enduring asset and will be available for use for the planned activity. Therefore, in the present context of Taite and Aramis the implication is that the interest expenditure is treated as the capital expenditure or it is of capital in nature. As evident from the present case that a capital asset is being created and the payment of interest is recurring. Interest is normally a recurring or cyclic payment that does not takes into account an enduring advantage instead the usability of the borrowed throughout the term of finance.
The deductibility of the loss consisting interest defined under section 8-1 of the Income Tax Assessment Act 1997 is largely dependent on satisfaction of words of the above stated section. The taxation rulings of TR 95/2 represents that the anticipated loss or outgoing occurred by the taxpayer in attaining the taxable income of the taxpayer and the loss does not represent capital in nature (Burkhauser et al., 2015). The present case study of Taite and Aramis clearly reflect that whether or not the taxpayer incurs the loss or outgoing interest, it meets the needs of section 8-1 depending on the information and materials related to the loss that is occurred by the taxpayer in query.
As held in the case of FC of T v. Smith 92 ATC 4380 interest on borrowing to fund the repayment of money which was initially advanced by the associate and used as capital in partnership firm will be considered for deductions under subsection 51 (1). Interest on borrowing will be deduction to the degree where the capital was engaged in the business that was carried on with the objective of producing or acquiring the taxable income (Wilkins, 2015). Concerning the case of Taite and Aramis at the time of assessing whether the interest is deductible considerations must be given to the commercial context during which the business borrowed the funds.
On implementing the analysis of the federal court in FC of T v. Roberts, interest on borrowing by the company might be considered for deductions. It may be under situations where the borrowed funds is used for refunding the reimbursement of share capital to the shareholders and the capital that is repaid was used as capital or working capital in the business performed by the company with the objective of generating taxable income (Faccio&Xu, 2015). Expenditure will be considered for deductions under section 8-1 given that the necessary feature .of expenditure has appropriate association with the functions and activities, which are more directly results in gaining or producing the taxable income of the taxpayer.
As held in FC of T v. Riverside Road Pty Ltd 90 ATC 4567 the court summarizes the applicability of the principles concerning deductibility under section 51 (1) of the Act. It is noteworthy to denote that the expenditure should have sufficient connection with the functions that directly generates assessable income to meet the statutory criterion in executing the business (Austin et al., 2014). In determining, the deductibility of loss forTaite and Aramis considerations must be paid on the purpose surrounding the event of loss. The existing scenario of Taite and Aramis evidently satisfies that the taxpayers requirements of section 8-1.
4. Capital gains tax refers to the tax that is paid on capital gain on the annual income tax return. If an individual acquires a vacant land for the private purpose or for the purpose of investment, it is generally considered as the capital asset that is subjected to capital gains tax. However, if an individual purchases the land for the use of business activity dealing in land it will be considered as trading stock (Awasthi, 2017). Land is usually treated as trading stock for the purpose of income tax instead of considering as capital asset since both Taite and Aramis were involved in the activities of land dealing and hold the land with the objective of resale. Business activities that involves dealing in land consists of acquiring land to develop or subdivide and selling the same. It is noteworthy to denote that the acquisition of land should is not required to be repetitive. A single acquisition of land with the objective of development, subdivision and sale by the taxpayer in the present case would result in land being treated in the form of trading stock. For land that is used as trading stock capital gains is not applicable. Proceeds from the land would be treated as the ordinary income and would not be treated as the capital gain, with associated cost shall be deductible.
There are certain type of business risk that is associated with this plan which are as follows;
Increase in interest rate resulting in higher holding expenditure:
It is seemingly good to service loan and make repayments when the rate of interest is at all time low. However, the taxpayer must always consider the factor in the possibility of increase in rates over the period of land development (Glendon et al., 2016). There are instances where seasoned land developers have fallen into the trap of increased interest rate when they borrowed large sum of money on lower interest rate.
This is another type of trap where land developer fall into. The consist of set of contraction costs in their budget at the time of beginning their project without any kind of contingency plan in place for the probable rise in cost, occurring on annual basis in the business of land development. Either the developers are forced to borrow money or they are compelled to sell their unfinished project and bear the loss.
Variations in demand and supply causing adverse fluctuation in real estate price:
As most of the land developer understand the different principles that runs the property market it is also necessary for them to determine the changing level of supply and demand during any time (Lam, 2014). Social changes in the form of immigration and higher interest rates means decrease activity of buyer and this may ultimately result in falling consumer demand.
Sensitivity analysis: One of the most systematic approaches of risk analysis is sensitivity or scenario analysis. Sensitivity analysis helps in evaluating the impacts on profitability relating to any valuable variables. The sensitivity analysis objective is to analyse the combination of changes in the development variables to appraise the impact of the outcome. The sensitivity analysis will help the appraiser in advancing from the identification of range of results for control variables by allocating the probabilities to each of these variables.
Risk assessment: Risk assessment can be defined as the process of assessing the identified risk along with the interrelation between risks. During the process of risk assessment the particular risk situation of any given risk portfolio is mapped and forms the foundations of subsequent risk control (Chance & Brooks, 2015). To arrive at the solution of over viewing the appropriate actions of the risks recognised these risk are in the second step are analysed and evaluated. The method put into the use of risk assessment is largely dependent on the quality of information and supply sufficient risk specific data for both quantitative methods and qualitative methods.
Conclusion:
To conclude with the study has effectively with the help appropriate legislation and relevant taxation rulings determined that the Taite and Aramis were involved in the activities of land dealing and hold the land with the objective of resale. Furthermore, the study highlights that the nature of business adopted by Taite and Aramis is not permanent and involves the use of land for land development and selling the same. The study has also laid down the risk assessment determinations and methods of identifying the business risk with appropriate method of mitigating the risk.
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