In the underlying scenario, the key objective is to outline the potential tax implications of the transactions that taxpayer Amber has entered in the given year in wake of the relevant legislation and relevant authorities.
1) The applicability of CGT (Capital Gains Tax) in relation to the liquidation of a capital asset i.e. shop sale.
2) To determine if the proceeds derived from restrictive covenant related contract would be capital or revenue which has significant implications for resultant taxation.
3) The applicability of CGT (Capital Gains Tax) in relation to sale of one bedroom apartment which Amber has inherited from her uncle.
The relevant law for the key issues identified in the given scenario is discussed below.
There are various capital assets which are listed in s.108-5 ITAA 1997 with one of these being goodwill and the sale of these assets could potentially give rise of CGT implications. Trading stock does not fall within the ambit of s. 108-5 as any capital gains or losses on this are ignored in line with s. 118-25 ITAA 1997 (Reuters, 2017). A potential reason for this differed treatment is that strictly speaking it is a raw material and consumed in the business and hence not a capital asset but a current asset whose sale produces ordinary income as per s. 6(5) (Barkoczy, 2017).
With regards to capital assets, the CGT implications would arise when a particular capital event takes place in accordance with s. 104-5 ITAA 1997. When a capital asset is disposal, a capital event named A1 occurs. This event highlights that computation of respective capital gains need to be carried out by deduction of underlying cost base of asset from the asset sales proceeds. With regards to capital gains computation, ITAA1997 provides two techniques for the same (Coleman, 2015). One of these relates to s. 115-25 ITAA 1997 and is called discount method. In this method, 50% rebate is offered on long term capital gains (Wilmot, 2016). Long term capital gains arise when a given capital asset has been possessed by the taxpayer for more than 1 year. Discount method is not applicable for short term capital gains. Also, the other method is indexation method where the capital gains are reduced by enhancing the cost base of the asset by applying the impact of inflation (Krever, 2016).
The critical issue with regards to restrictive covenant is to highlight is the underlying proceeds would be revenue or capital. This assumes significance in the backdrop of capital proceeds being exempt from any tax implications except any possible CGT for any capital gains or losses that may have been derived. A relevant case in the given scenario is Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 (Krever, 2016). This party related to compensation being paid to for waiver of right to sue which is a legal right. The discussion regarding the case highlighted that any proceeds arising from imposing restriction on a legal right would be considered as capital proceeds. This would be because the legal right is a capital asset capable of enduring advantage in the future and hence restriction on the same yields capital proceeds. This thought can be extended to restrictive covenant where also the seller of the business has the legal right to set up a new business at the place and time deemed suitable. However, by accepting restrictions on this right, the underlying proceeds ought to be capital which has also ben advocated in the discussion in tax ruling TR 95/35 (Nethercott, Richardson & Devos 2016).
Any asset which has been purchased before September 20, 1985 would be termed as pre-CGT asset and the CGT implications on such assets would not exist as per s.149-10 ITAA 1997 (Woellner, 2015). In relation to deceased estates, any capital loss or gains which must be levied for any ownership period of the dead owner would be ignored. Also, it is noteworthy that death of the owner is not a capital event as per s.104-5 (Krever, 2016). When the asset passes on to the legal heir, then for CGT computations, it is assumed that cost of acquisition of asset would be equal to the market value at time of death. This is despite the fact the legal heir has been provided the asset without any cost. Also, a crucial aspect in sale of capital assets is when the enactment of sale contract and obtaining of complete sales proceeds do not coincide or fall in the same tax year. In such cases, tax ruling TR 94/29 highlights that CGT implications would arise in the same tax year when the sale contract for the asset has been executed irrespective of when the resultant cash is received. Also, in case of house which the taxpayer uses as main residence, Division 118-B ITAA 1997 can be applied which provides 100% exemption from CGT implications (Nethercott, Richardson & Devos 2016). Further, partial CGT exemption may be availed based on partial period as main residence. It is critical not to earn any assessable income such as rent from the house and it must be considered as the main residence of the taxpayer (Hodgson, Mortimer & Butler, 2016).
The suitable tax treatment of the various transactions conducted by Amber is offered in this section based on the applicable law discussed above.
The underlying asset is a capital asset and therefore the proceeds from the shop sale would not be taxed owing to them being capital receipts. However, for any capital gains that may arise because of the sale would be taxed in accordance with the CGT. The shop as an asset is composed of other assets and the individual nature of these assets must be considered before computing capital gains and the associated CGT consequences.
One of the assets is goodwill which as per s. 108-5 is a capital asset whose sale is recognised as an A1 capital event. In the given case, the cost and sale amount of the goodwill has been provided separately facilitating computation of respective capital gains arising from the transaction. This capital gains would be long term since the ownership period of shop exceeded 1 year and hence s. 115-25 discount would be applicable for goodwill.
In relation to equipment, the capital gains or losses derived from the sale can be found by deduction of the book value of the equipment from the proceeds of sales generated. A critical aspect to note is that for capital gains on equipment, the cost price is not utilised which is because tax deduction would have been derived by the shop in relation to the decline in value of the equipment owing to their depreciable nature. Again the capital gains would be categorised as long term which would allow the discount method rebate on capital gains. For trading stock, as per s. 118-25, any resultant capital losses or gains would not be considered for CGT computation.
Based on the given scenario, the contract enacted by Amber whereby temporal and geographical restrictions are imposed on her clearly restricts her right that she legally possesses of being starting a business without any temporal and geographical restrictions in Australia. It is apparent that the proceeds of $ 50,000 which are paid as compensation for this restriction would be regarded as capital proceeds and not as revenue proceeds. Owing to the receipts being capital, they cannot be constituted as assessable income for Amber. However, resulting capital gains on this clause may be levied CGT.
The given details with regards to the apartment highlight that it has been inherited from her uncle by Amber in October 2013. Since the apartment was bought by her uncle in 1992, hence the given apartment is not a pre-CGT asset and not exempt from CGT on that ground. It is known that her uncle used the apartment as the main residence right from the time of purchase to his death. Further, the same has been continued by Amber since from October 2013 or the inheritance time, she has continued to stay in the house and has not used for generation of rent or any assessable income. Therefore, it would be appropriate to consider the given house as main residence of Amber with regards to Division 118-B. Considering. that the house has been used as main residence by both Amber and her uncle, no CGT would be levied on any capital gains or losses that would arise from the sale of this apartment.
Conclusion
It may be concluded on the basis of the above discussion that in relation to the shop CGT is only payable on goodwill and equipment. The same would not apply to trading stock. The proceeds obtained by Amber from the restrictive covenant are capital in nature and hence non-taxable even though related CGT implications may arise. In relation to the one bedroom apartment, CGT exemption would be extended owing to main residence exemption and there both the proceeds and the resultant gains would not have any associated tax liability.
References
Barkoczy, S. (2017) Foundation of Taxation Law 2017 (9th ed.). North Ryde: CCH Publications.
Coleman, C. (2015) Australian Tax Analysis (4th ed.). Sydney: Thomson Reuters (Professional) Australia.
Hodgson, H., Mortimer, C. & Butler, J. (2016) Tax Questions and Answers 2016 (6th ed.). Sydney: Thomson Reuters.
Krever, R. (2016) Australian Taxation Law Cases 2017 (2nd ed.). Brisbane: THOMSON LAWBOOK Company.
Nethercott, L., Richardson, G., & Devos, K. (2016) Australian Taxation Study Manual 2016. (8th ed.). Sydney: Oxford University Press.
Reuters, T. (2017) Australian Tax Legislation 2017 (4th ed.). Sydney. THOMSON REUTERS.
Wilmot, C. (2016) FBT Compliance guide (6th ed.). North Ryde: CCH Australia Limited.
Woellner, R. (2015) Australian taxation law 2015 (8th ed.). North Ryde: CCH Australia.
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