Discuss About The Taxation Theory Practice Law Assignment?

Capital Gains Tax and Computation

Question:

Discuss About The Taxation Theory Practice Law Assignment?

Net capital gains and net capital losses are as a result of the capital gain tax legislation. When a tax payer disposes of a capital asset, they usually realise either a capital loss or capital gain. When preparing annual tax returns, the tax payer must report the capital gains and capital losses. The capital gains tax forms part of the tax payer’s income tax (Austrian Taxation Office, 2017a). Losses arising from the disposal of capital assets cannot be offset by the income tax; this can only be offset by the capital gains. The computations of capital gains or capital losses are done upon the disposal of capital assets such as real estate, share and related investments, collectables and personal use assets.  Net capital gains and Net capital losses can be calculated as follows

Net Capital Gain = Gains from disposal of Capital Assets during the fiscal year – Losses from the disposal of Capital Assets realised in the current or prior periods – Any allowable discounts

When computing capital gains and capital losses there are special rules. For collectables (these are items meant for the comfort and personal use of the taxpayer. Collectables include items such as antiques, jewellery, paintings, and photographs)  whose value is less than or equal to  $500 upon disposal any capital gains or capital losses are disregarded (Australian Taxation Office, 2017a). accounting losses on collectables can only be offset by capital gains from collectables. Similarly for personal assets (for example electric items, household fittings and furniture, and boats) whose values are less than or equal to $10,000 the capital gains loss or capital gain realised upon disposal are not taken into consideration. The net capital gain and capital loss are computed as follows

Total Acquisition Costs of Collectables = $2,000 + $ 3,000 + $ 9,000 = $ 14,000

Total Disposal Value of Collectables = $ 3,000 + $ 1, 000 + $1,000 = $ 5,000

Disposal Costs less Acquisition Costs of Collectables = $ 5,000 – $ 14, 000 = – $ 9,000

Disposal Value Less Acquisition Cost Personal Use Item = $ 11,000 – $ 12,000 = – $ 1,000

Disposal Value Less Acquisition Cost of Shares= $ 20,000 – $ 5,000 = $ 15,000

A net loss of $9,000 is realised on the sale of collectables.  The personal use item had a value greater than $ 10,001 therefore the resulting loss of $1,000 is applied to the gain of $ 15,000. The net capital gain is $ 14,000.

Loan Fringe Benefits and Taxable Value

The loan given by the bank to Brian is what is commonly referred to as a fringe benefit. A fringe benefit is defined as a means of paying for the performance of services by the employer to the employee (Internal Revenue Services, n.d.).  The award of the fringe benefit can be extended to non-employees such as independent contractors, the members of the board of directors of the company, future employees, and retired employees. There are different types of fringe benefits including unemployment insurance, life insurance, loans, healthcare insurance, disability payments, retirement schemes, travelling concessions for former employees, free meals, accommodation, recreation allowances (Human Resource Management, 2017).

According to the criteria set out by the  Australian Taxation Office, the loan provided to Brian is not simply just a loan but a loan fringe benefits because it is given at a rate that is less than the benchmark rate determined by the monetary authorities (the Reserve bank of Australia) [Australian Taxation Office, 2017b]. The benchmark interest rate in Australia as at 1 April 2016 was 5.65%.  The taxable value of the loan fringe benefit is computed as the difference between the benchmark interest less the actual interest rate. When computation of the taxable value, the deductible rule provided by the Fringe Benefits Tax Assessment Act of 1986. s.19(1)(b) is taken into consideration. The deductible arises because Brian used 40% of the funds for income generation purposes.

Value of Taxable Loan Fringe Benefits = (Value of loan x Benchmark Rate) –

(Value of loan x Actual interest rate)

= (5.65% x $ 1, 000, 000) – (1% x $ 1,000, 000)

=  $ 56,500 – $ 10,000

= $ 46,500

Interest Rate Deductible   =  40% (5.65% x $ 1,000, 000) –

 40% (1% x $ 1,000, 000)

= $22, 600 – $ 4,000

=$ 18,600

Taxable Value = $ 46,500 – $ 18, 600

 = $ 27,900

In situations where the employee is allowed to pay the interest on the loan less frequently than every six months, the loan is treated as having been separately loaned at the end of six months (Australian Taxation Office, 2017b).

The taxable value of the debt waiver fringe benefit is the value of the amount that was waived. In the case of Brain this is the amount of the interest waived on the loan.

In legal parlance, the term joint tenancy refers to a unique form of property ownership whereby two or more individuals have ownership of the same property (Farlex, n.d.). In the arrangement, the persons who are joint tenants have equal ownership in the given property, and equal right to retain or dispose of the property. The joint tenancy agreement creates the right of survivorship which stipulates that when one tenant dies, the dead tenants’ rights in the property are transferred to the surviving member. The joint tenancy has four main features namely (i) Each tenant has an undivided interest in the entire property, the share of each tenant is equal with no tenant being able to have a larger share than the others; (ii) The property of the persons in the joint tenancy are fixed for the same period of time; (iii) The joint tenants have only one title; and (iv) the individual joint tenants have similar rights.

Joint Tenancy

For the purposes of computing tax obligations, the legislation maintains where two or more persons own a property as joint tenants, then the net loss or gain is divided amongst them in line with their legal interest in the property (Australian Taxation Office, 2017c). Any arrangement by the joint tenants to divide the income and expenses in proportions that are not equal has no effect for tax purposes. Therefore, Jack and Jill will divided the net loss between them in an equal ratio.

For the purposes of capital gains tax, the joint tenants are taken to have common equal shares and rights in the property. Therefore, each of the joint tenants has an equal share in the capital gain or capital loss upon disposal of the property (Australian Taxation Office, 2017d). When Jack and Jill sell the property, the capital loss will be shared equally between them.

In the case of the Inland Revenue Commissioner v. Duke of Westminster [1935] it was established that the Duke of Westminster executed deed with people in his employment that included his gardener in which he made a covenant to pay the employees a given weekly sum for a period of seven years or during the lives of the parties in the covenant. The amount to be paid was equivalent to the wages that the employees were receiving. Under the tax provisions that prevailed at that time, the arrangement made by the Duke of Westminster enabled him to reduce his tax burden.

The issue raised by the Inland Revenue Commissioner (IRC) was that the amount paid under the deed during the period of time when the employees were in the service of the Duke amounted to remunerations for services rendered thus they were not allowable deductibles in the liability for surtax. The IRC maintained that the arrangement by the Duke was meant to avoid the full tax obligations.

The court found in favour of the Duke of Westminster stating that the taxpayer has the right to take actions or make provisions to reduce their tax liability in line with the given laws that prevail at the time. This case established the principle of tax avoidance that is every individual is entitled to arrange their affairs so as to reduce their tax liability as long as their actions are in line with the law (Murphy, 2012).

The ruling by the court is attractive for individuals hoping to reduce their tax burden by formulating complex transactions and contracts. However, over the years, the courts have weakened the principles of tax avoidance, limiting the legal methods available to avoid taxes.  In their rulings, the courts have established what is known as the Ramsay principle. This principle states that where a transaction does not make sense without the tax benefit, the proper approach is to tax the entire transaction (W T Ramsay Ltd v Inland Revenue Commissioners [1981]). Additionally, subsequent amendments to the tax legislation in Australia have been geared at reducing tax avoidance and increasing the revenue collected. Allowing taxpayers to pay lower rates would essentially lower the governments revenue which would reduce the quality and quantity of services offered to the citizens. The principles established in the IRC v. Duke of Westminster [1935] are relevant in Australia. However, the taxation authorities are taking measures to reduce the degree of applicability.

Tax Avoidance and the Principle of Duke of Westminster

The Australian Taxation Office has established Taxation Ruling 95/6 (TR 95/6). This ruling sets out the degree to which receipts realised from the sale of timber can be treated as assessable income, irrespective of whether or not the taxpayer’s key business is related to the forestry industry (Australian Taxation Office, 2017e). Section 22 of the ruling indicates that the receipts realised on the disposal of trees owned by the taxpayer irrespective of  whether or not the taxpayer is in the forestry business is assessable income in the year in which the sale occurred. The taxable value depends on the market value prevailing on the day of disposal or where there is no sufficient evidence of the market value, the value which the Commissioner deems reasonable (paragraph 36 (8) (a)). Therefore, Bill would be assessed on the sale of timber to the logging company.

A royalty is defined as income derived from the use of the taxpayers’ property (University of Richmond, 2017). The payment of royalties is related to the use of a valuable right.  By granting the logging company the right to cut down the tree, the income earned will be considered as a royalty. According to TR 95/6 royalties obtained by the taxpayer by giving the right to fell trees on land owned by the taxpayer are considered assessable income of the taxpayer.

References

Australian Taxation Office (2017a). Capital gains tax. Available at: https://www.ato.gov.au/General/Capital-gains-tax/ (Accessed 11 September 2017).

Australian Taxation Office (2017b). Chapter 8 – Loan and debt waiver fringe benefits. Available at https://www.ato.gov.au/law/view/document?DocID=SAV/FBTGEMP/00009&PiT =99991231235958/?  page=3#8_3_What_is_a_loan_fringe_benefit_ (Accessed 11 September 2017).

Australian Taxation Office (2017c). Co-ownership of rental property. Available at: https://www.ato.gov.au/Forms/Rental-properties-2013-14/?page=5

Australian Taxation Office (2017d). Joint tenants. Available at: https://www.ato.gov.au/individuals/tax-return/2017/in-detail/publications/guide-to-capital-gains-tax-2017/?page=94 (Accessed 11 September 2017).

Australian Taxation Office. (2017e). TR 95/6. Income tax: primary production and forestry. Available at https://www.ato.gov.au/law/view/document?docid=txr/tr956/nat/ato/00001

Farlex (n.d.) Joint Tenancy. Available at: https://legal-dictionary.thefreedictionary.com/joint+tenancy  (Accessed 11 September 2017).

Fringe Benefits Tax Assessment Act of 1986. s.19(1)(b).Sydney: Australian Government Publishing Services.

Internal Revenue Services. Fringe Benefits. Available at: https://www.irs.gov/publications/p15b/ar02.html#en_US_2017_publink1000193623 (Accessed 11 September 2017)

IRC v. Duke of Westminster [1935] All ER 259 (H.L.) London: HMSO

Human Resource Management. (2017). Types of fringe benefits. Citeman, 12 January. Available at: https://www.citeman.com/1359-types-of-fringe-benefits.html. (Accessed 11 September 2017).

Murphy, R. (2012). The duke of Westminster is dead: Long live the Duke of Westminster. Tax Research UK, 10 August. Available at: https://www.taxresearch.org.uk/Blog/2012/08/10/the-duke-of-westminster-is-dead-long-live-the-duke-of-westminster/ (Accessible 11 September 2017).

W T Ramsay Ltd v Inland Revenue Commissioners [1981] HL 12. London: HMSO