Tax Deductible Expenses And Capital Gains Tax Implications

Scenario 1: Advising the Directors of Ruby Pty Ltd about Tax Deductible Expenses

The potential tax deduction for taxpayer (Ruby Pty Limited) is as discussed below.

 (a)  In the given case, the taxpayer has incurred expense with regards to replacement of kitchen fittings. This replacement has been done after incurring damage and through replacement the original character has been restored and no change in layout has been done. Considering the given aspects, it would be fair to consider the given expense as repairs as per TR 97/23 (Krever, 2017).

With regards to expenses related to repairs, 100% tax deduction in the year of incurring the expense in available under the aegis of two sections.

1) Section 8-1 ITAA 1997

2) Section 25-10 ITAA 1997

One of the common requirements for both these sections is that the underlying expenditure must not be capital. (CCH, 2013). A unique feature of kitchen fittings is that a large amount of components are in the form of permanent fixtures which are essentially part of the property and cannot be detached. Potential examples include sink, plumbing, cupboard and possibly stove if fixed. Owing to the above aspect, any expenditure even on repair of kitchen fittings would be termed as capital in nature as per TR 97/23 and the amount would be reflected in the property cost base. Therefore, it may be concluded that Ruby Pty Ltd would receive no deduction on tax in the given case (Sadiq et. al., 2016).

 (b) General deduction of expenses is permissible under s. 8-1 ITAA 1997 provided these are incurred in the process of deriving assessable income. An additional requirement is that the nature of this expense must be necessarily revenue and not capital (Gilders, Taylor, Walpole, Burton & Ciro, 2016).

Various case laws are relevant to allow differentiating between the two type of expenses. One such case is British Insulated and Helsby Cables Ltd v. Atherton [1926] AC 205. The crucial aspect highlighted in this case is that the type of expenditure would be driven by the advantage that arises from the outflow. The advantage in case of capital expenditure would be expected to be enduring unlike revenue expenditure which would lead to an advantage limited to the current period (Deutsch, Freizer, Fullerton, Hanley  & Snape, 2016).

It is apparent that the given expense is a normal business expense considering the nature of business where these claims do arise. Also, the advantage that the case settlement would provide does not impact the future of the business and is not ensuring since the impact would be limited to the given year when the result is announced. Thus, the nature of expenditure is revenue and hence general deduction can be availed since it is in relation to a income producing property (Woellner, 2014).

Scenario 2: Calculating the Net Capital Gains or Losses for Betty

(c) The past business of the company was manufacturing parts related to engine. In such a business, litigation can arise on account of faulty goods being provided.  In normal course of business, the future business of Ruby would have been impacted, however, since the company has already sold the business, hence the  reputation damage in the automobile sphere is not more of significance for the company (Gilders, Taylor, Walpole, Burton & Ciro, 2016).. Hence, the nature of advantage cannot be termed as enduring and thereby the revenue nature of expenditure is apparent. This allows for s. 8-1 ITAA 1997 general deduction in the current year (Barkoczy, 2015).

Question 2

Taxpayer: Betty (Investor and collector)

In the present case Betty has performed three transactions for the disposal of capital assets (shares, painting and violin). The aim is to analyse the transactions and compute the net capital gains or losses on account of these disposals.. 

Painting

In accordance with s. 149 (10) ITAA 1997, all the respective assets of the taxpayer which are bought before September 20, 1985 would be termed as pre-CGT asset and Capital Gains Tax (CGT) liability would not be raised on the derived capital gains/losses. In other words, capital gains that are produced from the disposal of the assets which are bought by taxpayer before September 20, 1985 are 100% exempted from CGT implications (Woellner 2014).

It is apparent from the relevant facts of the case that Betty has purchased an asset in the form of painting on May 2, 1985. Considering that the date lies before September 20, 1985 hence, painting is categorised as pre-CGT asset. Therefore, the CGT implications would be exempted on the capital gains/losses raised from the selling of the painting.

Shares

It is evident from the purchasing date of shares (after 2011) that these are not referred as pre-CGT assets as the respective purchase dates are after September 20, 1985. It implies that CGT consequences would be applied on the taxpayer on the account of the disposal of shares. The sale of capital asset is considered as CGT event which belongs to A1 category under s. 104(5) ITAA 1997. Thereby, income received from the sale and cost base of the asset would be considered for the calculation of net capital gains/losses.  The cost base of asset includes five factors as per s. 110-25(1) ITAA 1997 (Sadiq et. al., 2016).

Previous year’s capital losses would be adjusted against the assessment year’s capital gains. Further, it is essential to note that assets have holding period of atleast 1 year will derive long term capital gains and hence, discount method would be used to find the net capital gains as per s. 115-25 ITAA 1997. According to this method, only 50% of capital gains would be taken into account for CGT implications. Further, the CGT rate 30% would be imposed on the net capital gains in order to find the CGT liability of the taxpayer (Krever, 2017).

Violin

In accordance with s. 118(10) ITAA 1997, violin is categorised as collectibles. In present scenario, it can be concluded that violin is an asset of private use of Betty as she used to play violin on daily basis. Also, violin is not termed as pre-CGT asset as it has been purchased after September 20, 1985 (Barkoczy, 2017). Hence, CGT consequences would be levied on Betty. Further, there is an essential condition for CGT liability on taxpayer in case of personal use asset that needs to be checked for validity of CGT Liability. In accordance with ss. 108-20(1) ITAA 1997, the purchasing cost of the asset must be higher than the threshold value which is $10,000 (CCH< 2013).

It is evident from the facts of the case that Betty has paid just $5,500 so as to purchase the violin and hence, it can be said that essential condition for the validity of CGT liability has not been satisfied. Therefore, no CGT implication would be raised on taxpayer on the account of selling of the violin. 

References

Barkoczy, S. (2015) Foundation of Taxation Law 2017. 9^th ed. Sydney: Oxford University Press.

CCH (2013), Australian Master Tax Guide 2013, 51^st ed., Sydney: Wolters Kluwer.

Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., & Snape, T. (2016) Australian tax handbook.  8th ed. Pymont: Thomson Reuters.

Gilders, F., Taylor, J., Walpole, M., Burton, M. & Ciro, T. (2016) Understanding taxation law 2016. 9^th ed.  Sydney: LexisNexis/Butterworths.

Krever, R. (2017) Australian Taxation Law Cases 2017 2^nd ed. Brisbane: THOMSON LAWBOOK Company.

Sadiq, K, Coleman, C, Hanegbi, R, Jogarajan, S, Krever, R, Obst, W, & Ting, A (2016) , Principles of Taxation Law 2016, 8^th ed., Pymont: Thomson Reuters

Woellner, R (2014), Australian taxation law 2014 7^th ed. North Ryde: CCH Australia.