Taxation Consequences Of Business Sale And Property Disposal

Key Issues with Amber’s Transactions

1.

Taking into consideration, the transaction enacted by Amber, the potential tax implications need to be highlighted with special reference to CGT (Capital Gains Tax) but not limiting the purview to only CGT. The key issues pertaining to the transactions that Amber has enacted are mentioned as follows.

1) The tax implications of the various assets which comprise the shop particularly in relation to potential CGT liabilities.

2) Another key issue is to highlight if the receipts on account of restrictive covenant would be revenue or capital in nature.

3) The potential tax implications in relation to the proceeds obtained from liquidation of apartment in inner city which was inherited after Amber’s uncle died in 2013.

The applicable law in relation to the key assets has been presented below.

A key question which arises is whether goodwill would be a capital asset or not. This can be answered using s.108-5 ITAA 1997 which besides listing other capital assets also highlights goodwill as a capital asset. This is critical since proceeds from the sale of capital assets are capital proceeds which are not subject to taxation. Only the capital gains that are derived by the taxpayer on account of disposal of these assets may be put to tax in the form of CGT. One exception in this regards is trading stock which as per s. 118-25 ITAA 1997 would not consider the underlying capital gains (Barkoczy, 2017).

For CGT implications to arise, it is required that as per s. 104-5, capital event has to happen. The capital event that related to the capital asset disposal is termed as A1 event. Each of the events listed in s. 104-5 ITAA 1997 tend to also highlight the respective mechanism for computation of capital gains (Coleman, 2015). For event A1, this involves deduction of the cost base of the asset under consideration from the proceeds derived from selling the asset.  Once this capital gains is computed, it can be reduced using either the indexation method or discount method whichever provides a lower taxable value.  Rebate to the extent of 50% is available under s. 115-25 ITAA 1997 if the underlying capital gains are long term in nature (Krever, 2017). The indexation method relies on reducing capital gains by increasing the cost base by multiplying it by the inflation index adjustment factor. The more common of the two methods is discount method which is particularly useful when the capital gains are quite high.

Tax Implications of Goodwill and Other Assets

The most important issue that needs to be answered in context of restrictive covenant is to decide the nature of the proceeds. This is critical as no tax is levied on the capital receipts but the same is not true for revenue receipts. Revenue receipts would be reflected in the assessable income of the taxpayer. In case of proceeds being capital, potential impact would be in form of CGT on any capital gains that are derived. To highlight the nature of proceeds, a case that merits discussion is Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 (Reuters, 2017). In this case, compensation was given to the party which allowed not exercising the right to sue. It was highlighted during the case discussion that putting restrictions on available legal rights for proceeds would result in proceeds being capital. This is because the right is essentially a legal asset which can potentially bring future inflows for the individual. The concept in the above case can also be replicated for restrictive covenant. This is because the business seller has the right to establish business without any restrictions in terms of time and geography and this new business can provide future profits. Hence, by restrictions on setting up business, right is being curtailed resulting in capital proceeds for the taxpayer. The above treatment also is supported by TR 95/35 which also terms these proceeds as capital (Nethercott, Richardson & Devos, 2016).

CGT exemption is available for any asset which has been acquired by the taxpayer in the pre-CGT era i.e. when there was no capital gains tax. This period corresponds to the time before the threshold date of September 20, 1985. This is as per s.149-10 ITAA. Also, it is essential to note that death does not result in capital gains or tax computed on the asset since it is not a capital event in accordance with s. 104-5 ITAA 1997 (Wilmot, 2016). However, the CGT implications would arise for the legal heir who would dispose the asset which would lead to an A1 event. It is noticeable that the cost base of asset for the legal heir is the asset’s market value when the asset is transferred in the name of legal heir. Additionally, in capital asset sale especially involving property owing to larger denomination involved, there tends to be a time lag between signing of the sale contract and settlement of the same. This time difference can result in the two events being present in different tax years and thereby posing a dilemma for the taxpayer (Sadiq, et. al., 2015). TR 94/29 provides help in this regards, since it states that CGT related liability ought to be levied on the taxpayer in the same year when the property sale is concluded in terms of agreement and does not depend on the actual cash being received. Besides, in case f residential properties, a particular CGT exemption worth discussing is the main residence exemption  (Wilmot, 2016). This exemption arises when the taxpayer has used the property as permanent residence and not for income generation. This is in accordance with subdivision 118-B ITAA 1997. Further, partial exemption under main residence clause can also be availed depending on the income derived, years of main residence and other factors (Nethercott, Richardson & Devos, 2016).

Nature of Restrictive Covenant Proceeds

Sale of shop

The shop comprises of various assets which are capital assets and therefore the underlying proceeds derived would be capital and hence non-taxable. Therefore, the potential tax implications would arise owing to any capital gains that are realised on sale of shop. The shop in the given case is an asset which is comprised of several assets and hence the treatment of these individual assets needs to be considered.

A pertinent asset is goodwill whose disposal would lead to enactment of A1 event and the resultant capital gains computation. The respective cost price and sale proceeds related to goodwill have been offered in the question which can be used for finding the capital gains. Besides, discount method would be applicable to reduce the capital gains which are subject to CGT as these are long term capital gains.

With regards to the equipment, the underlying capital gains computation would consider the sales proceeds and the asset book value. This would be considered since depreciation has been charged by the company with regards to equipment thereby reducing the book value. Hence, capital gains would arise only if the sale value would exceed the book value. However, in relation with the stock available, no CGT implications would arise since any capital gains or losses on this asset are not considered for application of CGT.

It is apparent that restrictions have been put on Amber with regards to geography and time for which business cannot be opened. This clearly impairs her earning capability and imposes constraints on the same thus causing loss of potential cash inflows in the future. As a result, the underlying proceeds that have been derived from this contract enactment would be considered as proceeds of capital nature and would not be subject to any taxation. However, it is possible that capital gains can result from restrictive covenant on which CGT could be applied.

The given apartment has not been purchased by Amber but infact is a deceased estate which has been inherited owing to death of uncle. Amber’s uncle had used the apartment as main residence from the time of purchase in 1992 till the time of death in 2013. This apartment since the time of inheritance has been used by Amber as her permanent residence. This can be concluded since no income producing activity has been related to the apartment and also the taxpayer has used it for staying during the period of ownership. As a result, the main residence exemption which Sub Division 118-B provides would apply in this case and full exemption on CGT related liability would be available. Since apartment is a capital asset, hence the proceeds from sale would be capital and therefore non-taxable. The other issues are not significant in the case of this apartment as it is a CGT exempt property.

Capital Gains Tax Exemptions

Conclusion

On the basis of the discussion carried out in the previous section, it has been found that Amber would have to pay CGT on any capital gains realised from the sale of equipment and goodwill. However, the treatment extended to stock would be different where no CGT would be applied irrespective of gains or losses. In case of restrictive covenant, the proceeds would be capital and hence non –taxable. But these may be subject to CGT if there are some capital gains realised. The sale of deceased estate would not result in any tax liability for Amber as the proceeds from sale are capital in nature while in accordance to main residence exemption, no CGT would apply to any possible capital gains or losses.

2.

The issue is to determine tax implications for employer House R Us and employee Jamie for various transactions incurred during the tax year. The main aspects in relation to the transactions are given below.

• Whether amount provided by House R Us to its employee Jamie will be considered as assessable income for him as per s.6-5 or s.6-10, ITAA 1997.
• Whether Jamie would get tax deductions on interest payments.
• Whether tax deduction will be available on the account of payment made by House R Us as per s. 8-1
• Computation of Fringe Benefit Tax (FBT) levied on Jamie and House R Us on the account of extended benefits in the form of car and low interest rate loan.

Salary and Commission

In accordance of s. 6-5, ITAA 1997 income received by employee from ordinary sources such as personal exertion (salary, commission) would be termed as assessable income from ordinary sources.  This assessable income would be taken for tax treatment and personal tax would be levied on the taxpayer. Further, any cash outflow of revenue nature would be categorised for tax deductions only if it has been incurred in regards to derive assessable income under s. 8-1 ITAA 1997. Further, capital expenses that are used to derive assessable income would not be considered for any tax deduction under ss. 8-1(2) ITAA 1997 (Barkoczy, 2017).

Employee (Jamie): He has received a monthly salary along with 10% commission on the sales as per his employment contract with House R Us. Therefore, the amount contributes to the assessable income of Jamie from ordinary sources as per s. 6 (5) ITAA 1997.

Employer (House R Us): They have given salary and commission amount to employee that contributes to the generation of assessable income and therefore, the expenses would be revenue expenditure and would be considered for tax deductions under s. 8-1 ITAA 1997.

According to Division 2, Part III Fringe Benefit Tax Assessment Act 1986, when an employer makes a car available to employee for personal use, then it will be termed as car fringe benefits. Further, the employee does not need to pay any FBT tax on the received benefits and hence, would not be liable for FBT liabilities. Also, the employer who has provided car to employee would be held accountable for FBT liabilities under s. 9 FBTAA 1986 (Coleman, 2015).

Tax Advice for a Real Estate Agent

Employee (Jamie): He has received a Toyota Kluger car from House R Us that he can use for personal work along with the office work and hence, it can be concluded that House R Us has extended a car fringe benefit to Jamie. Further, no FBT liability will be imposed on Jamie for car fringe benefit.

Employer (House R Us): They have provided car fringe benefit to Jamie and thus, FBT liability will be imposed on House R Us. Three steps would be used to find the FBT liability for car fringe benefit.

Step 1: Taxable value of car

The taxable value of car is would be calculated from statutory formula under s. 9. FBTAA 1986 as highlighted below  (Woellner, 2015).

Step 2: Grossed up value of car

Gross up rate depends on the type of goods under GST Act 1999.

Step 3: FBT liability for car fringe benefit

FBT rate would be 47% for TD 2017/3 and would change as per the respective FBT year.

House R US will also claim for the deductions on the account of given car fringe benefits and extent of car used for personal purpose or business purpose under s. 8-1, FBTAA 1986.

Any electronic portable items such as laptop, mobile and so forth provided by employer to their employees for office work purpose during the employment period will be exempted from FBT implications under FBTAA 1986 (Hodgson, Mortimer & Butler, 2016).

Employee (Jamie): Jamie is using mobile phone and laptop only for office work and not for personal work and hence, no fringe benefit has been extended to Jamie from employer. No FBT liability will be raised on Jamie.

Employer (House R Us): House R Us has provided mobile phone and laptop to Jamie only for office work and hence, no FBT liability will be raised on House R Us. Further, the expenditure incurred in buying these devices will be capital expenses and therefore, s. 8-1 will not be applied here and no deduction will be availed under this section. Further, the deduction can be claimed by House R Us for the decline in value of the depreciating devices.

Employee must derive significant economic profit to derive assessable income under TR 92/15. Tax deduction will be applicable on the expenditure incurred in subscription fees under s. 8-1, ITAA 1997 for employer owing to nexus with assessable income production (Coleman, 2015).

Employee (Jamie): Jamie is not getting any monetary benefit due to the subscription of professional magazine. This is because the amount actually paid has been reimbursed  hence, no tax liability will be raised on Jamie.

Employer (House R Us): Annual professional subscription of magazine is an expense for House R Us which contributes to the assessable income generations. Hence, tax deduction will be applicable for House R Us under s. 8-1, ITAA 1997.

This entertainment allowance is a type of expense that would be provided to the employees on the part of employer irrespective of the scenario the concerned employees are using the allowance for entertainment or not as per TR 92/15  (Wilmot, 2016).

Employee (Jamie): The entertainment allowance provided to employee is $2000 p.a. This amount would be the part of the assessable income of Jamie as he will get this allowance per years irrespective of the scenario that whether he is using it for entertainment or not. Therefore, the economic benefit is derived and hence this allowance would be taken for tax implication for Jamie.

Employer (House R Us): Providing entertainment allowance to employees is a type of revenue expense and also, is contributes to the assessable income of employees and therefore, the deduction can be requested by House R Us as per s. 8-1, ITAA 1997.

Statutory income is a part of assessable income under s.6-10, ITAA 1997. The non-cash benefits will be termed as statutory income only when they are directly connected with the income generation of the taxpayer. According to s. 21 A, ITAA 1997 these non-cash benefit will not be cash convertible but it has been presumed that they can be converted to cash and thus, will contribute to assessable income of taxpayer in the form of statutory income (Woellner, 2015).    

Employee (Jamie): Jamie has received home entertainment system from House R Us as a part of his professional work as he has recorded sales among the other employees. Therefore, it would be assumed to be cash –convertible and hence, would be assessable income in terms of statutory income.    

Employer (House R Us): House R Us has provided home entertainment system to Jamie and thus, expenses occurred while purchasing home entertainment system would be considered for tax deductions as per s. 8-1, ITAA 1997 as it contributes in the assessable income of employer.

Employer issues loan to employees in regards to extend financial help. Any loan which is issued to employee at concessional rates inferior than the rates decided by the Reserve Bank of Australia (RBA) would result in loan fringe benefit. There are numerous factors associated with the calculation of loan FBT implications for employer. Further, no liability would be raised on employee in scenario of loan fringe benefit. Further, tax deduction would be claimed by employer taxpayer only if the loan payment given to employee would be used for assessable income production (Hodgson, Mortimer & Butler, 2016).

Employee (Jamie): Jamie has received a loan of $100,000 with a rate of interest 4% per annum from House R Us. Further, the rate of interest decided by RBA is 5.25% as per TD 2017/3. It can be shown that House R Us has used inferior interest rate (4.0% << 5.25%) and therefore, it can be said that House R Us is issuing loan fringe benefits to Jamie. Hence, there will be no FBT implication that will be levied on Jamie for loan fringe benefit.

Employer (House R Us): As highlighted above, House R Us has chosen inferior interest rate as compared with the rate decided by RBA for the FY2017/18 and hence, the loan fringe benefit is offered to Jamie. Therefore, House R Us would have to bear the FBT liability raised due to the loan fringe benefits to Jamie. Further, the interest payment paid to House R Us will be considered for tax deduction by Jamie only if the house purchased from loan will derive assessable income in terms of rent amount. Further, it has been pre-assumed that Jamie is not renting the home and uses it for her own dwelling and therefore, the deduction would not be present for House R Us on the account of received interest amount as per s. 8-1, ITAA 1997  (Woellner, 2015) .

Conclusion

The following conclusions would be made based on the above analysis.

Base salary and commission	Assessable income of Jamie as per s. 6-5, ITAA 1997	Deduction will be available for House R Us as per s. 8-1, ITAA1997
Car benefit	Car fringe benefits, No FBT liability on Jamie	FB liability on House R Us and deduction will be available for House R Us as per s. 8-1, ITAA1997
Mobile phone and laptop	FBT will not be applied as devices are used for office (professional) work only	Deduction will be available on the depreciation on the assets
Annual subscription reimbursement	No tax liability on Jamie	Deduction will be available for House R Us as per s. 8-1, ITAA1997
Entertainment allowance	Assessable income of Jamie as per s. 6-5, ITAA 1997	Deduction will be available for House R Us as per s. 8-1, ITAA1997
Home entertainment system	Assessable income of Jamie as per s. 6-5, ITAA 1997	Deduction will be available for House R Us as per s. 8-1, ITAA1997
Loan fringe benefits	No FBT liability on Jamie	FBT liability on House R Us No deduction will be available as Jamie is using home for self-dwelling not deriving assessable income.

Reference

Barkoczy, S. (2017) Foundation of Taxation Law 2017 (9^th ed.). North Ryde: CCH Publications.

Coleman, C. (2015) Australian Tax Analysis (4^th ed.). Sydney: Thomson Reuters (Professional) Australia.

Hodgson, H., Mortimer, C. & Butler, J. (2016) Tax Questions and Answers 2016 (6^th ed.). Sydney: Thomson Reuters.

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

Nethercott, L., Richardson, G., & Devos, K. (2016)  Australian Taxation Study Manual 2016. (8^th ed.). Sydney: Oxford University Press.

Reuters, T. (2017) Australian Tax Legislation 2017 (4^th ed.). Sydney. THOMSON REUTERS.

Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., & Ting, A. (2015) Principles of Taxation Law 2015 (7th ed.). Pymont: Thomson Reuters.

Wilmot, C. (2016)  FBT Compliance guide (6^th ed.). North Ryde: CCH Australia Limited.

Woellner, R. (2015) Australian taxation law 2015 (8^th ed.). North Ryde: CCH Australia.