Understanding UK Australia Double Tax Agreement And Tax Assessment Of Net Capital Gain

Calculating Dale’s net capital gain and its tax assessment

1.

1. Double taxation agreement is entered effected between two countries to provide tax benefits to the tax payers of two countries. A fixed place from the business of an organization is carried on can be termed as Permanent Establishment (Becker, Reimer & Rust, 2015).
2. The business profits to the extent earned by business operations in Australia shall be taxed in Australia as per the applicable tax rate for such profit in the country.
3. An organization said to have a permanent establishment in a contracting state if any person is working on behalf of the organization in the contracting state. However, one of contracts made through an independent would not result in permanent establishment in the contract state (Reimer, Schmid & Orell, 2018).

Determining the residential status of Andrew for tax purposes in Australia.

To determine the residential status of a person under Income Tax Assessment Act 1997 in Australia, the following tests are conducted:

A person is said to be an Australian for taxation purposes in the country if he has a permanent home in the country (Perry & Rowe, 2015).    

If the person has stayed for 183 days or more in the previous year then the person shall be considered an Australian resident for income tax purpose in the country the next financial year.

Australian Government employees even is posted in overseas will be considered Australian residents for tax purposes under the superannuation test (Sharkey, 2015).

Bell v. Kennedy [1868] L.R.1 Sc.& Div. 307 (H.L.) :

In this case the importance of residency test for income tax purposes was specified along with the interpretation on the word Domicile in determining the residential status of an individual. 

The discussion in the above case in and Arnold Mann v James Joseph O’Neill (HCA, 31 July 1997

A professional player, Andrew McSwington travels the world to play in different leagues across the globe. He has signed a contract to play in America for 15 months for a combined Fees of $145,000 and has also received rental income from America as he has purchased a home there.

Andrew McSwington was born in Adelaide. Though nothing has been specified about his permanent home in Australia but it can be very much assumed that he has a permanent home in Australia (Richardson, Taylor & Lanis, 2015).   

Conclusion:

Assuming Andrew has a permanent home in Australia he is an Australian resident for tax purposes and a resident of the country is liable to pay on all his income whether earned in Australia or not. Thus, the fees of $145,000 as well as rental income received from America shall be taxable in Australia as he is an Australian resident for tax purposes.

To determine the source of Andrew McSwington’s income of $145,000.

As per Australian Taxation Office (ATO) the source of income is the place from where the income has been generated and earned by a person.

Henderson v. Henderson [1965] 1 All E.R.179:

The importance of source of income on determining the tax implications was mentioned in this case along with residential status importance of the income receiver in determining his tax liability.

Business deduction for interest paid on a loan during preparatory stages

In this case Andrew has received the fees of $145,000 to play in minor league in America. Thus, the professional fees is to play in America. Hence, the source of such income is also America as the income is generated there (Chardon, Freudenberg & Brimble, 2016).

Conclusion: 

The source of income of $145,000 is United States of America.

To determine if he is liable to pay tax for the income of $145,000 in Australia.

As per the Income Tax Assessment Act 1997 a person if resident of Australia then he is liable to pay income tax on all income earned by the person including incomes which have earned or received outside the Australia (Dixon & Nassios, 2016).

As Andrew is an Australian resident he is liable to pay income tax on all of his income.

Conclusion.

Yes, Andrew must pay income tax on the professional fees of $145,000 earned by him in America. 

Is there any income tax liability in Australia for the rental income from America?

A resident individual of Australia will have obligation to pay taxes on all of his income even if the source of income is a place outside Australia.

During the 15 months period when Andrew was playing in America for a minor league team he purchased a home in America. He rented the house when he was playing games away. The rental income has been received by Andrew for renting the house (Auerbach & Hassett, 2015).

Conclusion:

Andrew is liable to pay income tax in Australia on the rental income received from America as he is resident of Australia having a permanent home in the country.

In FC of T v The Myer Emporium Ltd, it was held that the profit from isolated transactions would not be considered as assessable income for taxable purpose. The profit from transactions would be assessable as income as per 25(1) of Income Tax Assessment Act 1936 if the transactions were in the nature of ordinary business activities. The intension and the purpose behind entering into such transactions shall also be considered in determining whether the profit from such unusual transactions would be income taxable or not under sub section 25(1) of the act (Millar & Moon, 2016).   

Yes, the court applied the first stand in Westfield Ltd v FC of T 91 ATC 4234 in deciding that the resultant profit from sale of land at Mount Gravatt.

Determining residential status of Andrew for tax purposes in Australia

In FC of T v The Myer Emporium Ltd, the court considered the nature of transaction and the objective of the entity in entering into the transaction. It was specifically provided that even if profit from isolated transactions would be assessable as income under subsection 25(1) ITAA 1936 if the transaction is in nature of ordinary course of business. In explaining isolated transactions, the court mentioned those transactions which are not in the ordinary course of business of an entity and entered into by non-business tax payers. The court ruling also provided that the objective of the person entering into a transaction shall be given due emphasis in determining whether profit from such transaction would be considered for calculating taxable income of the person to calculate income tax liability of the person as per the Income Tax Assessment Act 1997 (Braithwaite, 2017).

On the other hand the honorable judge in Westfield Ltd v FC of T 91 ATC 4234, provided that the transactions even though not regular in nature for a particular business however, entered into with the objective of generating profit from such transaction would be assessable income of the person entering into such transaction. The honorable judge mainly emphasis on the motive of the person in entering into a contract to determine whether a particular income would be assessable as income in calculating taxable income. Thus, even if the transaction is not in the ordinary course of business for an entity as long as the motive of the entity was to generate profit from such transaction the resultant profit from such transaction would be assessed as assessable income of the entity (Murray & Wright, 2015).

Thus, the primary difference between the decisions in in FC of T v The Myer Emporium Ltd and decision in Westfield Ltd v FC of T 91 ATC 4234 is that in the former the honorable judge considered both the nature of transactions and the motive of the person entering into the transaction whereas in the later it was primarily the motive of the person entering into a transaction to determine the taxability of resultant profit from any transactions.

The distinction between income and capital as enumerated in the Australian Taxation System has been upheld and followed to the tee by the honorable judge in making the decision in The Myer Emporium Ltd vs. FCT. However, it would be wrong to say that the decision in Westfield Ltd v FC of T 91 ATC 4234 was against the distinction made between income and capital in the Australian Taxation system. However, the ATO provides that income from sale of capital assets is capital gain and not assessable income from business (Ioannou, 2017).

Tests conducted to determine residential status

4.

Particulars	Amount ($)	Amount ($)
Sale proceeds from rental property	340,000.00
Less: Cost basis	180,000.00
Capital gain before applying discount	160,000.00
Less: CGT discount of 50% available to individual tax payers	80,000.00
Capital gain after applying CGT discount		80,000.00
Proceeds received from stamp sale is not taxable as it is regarded as collectible and acquired for less than $500
Proceeds from sale of boat	9,000.00
Less: Cost basis of boat	17,500.00
Capital loss		(8,500.00)
Sale proceeds from sale of shares	2,000.00
Less: Cost basis	10,000.00
Capital loss		(8,000.00)
Personal asset is not subjected to capital gain and diamond ring sold was a personal asset
Shares acquired before 1985 is not liable to capital gain tax
Sale proceeds from sale of shares	18,750.00
Less: Cost basis of shares	18,000.00
Capital gain before CGT discount	750.00
Less: CGT discount	375.00
Capital gain after CGT discount from sale of shares		375.00
Net capital gain (long term)	63,875.00

   

Note:

As per section 104-5 of Income Tax Assessment Act 1997 explains the sets of events which give rise to capital gain and resultant capital gain tax liability to a person. In Australia capital gain tax was introduced on September 20, 1985 thus, assets acquired after September 20 1985 are only liable to capital gain tax in the country (Harrison & Keating, 2014).

In this case, the property (rental) was sold by Dale will be liable to capital gain tax as the property was rental and not main resident of Dale. 

Australian Taxation Office has made it clear that sale of collectible which were acquired for less than $500 will not be liable to capital gain tax. In this case the stamp was acquired for a price of $5 hence, the sale of stamp would not attract capital gain tax as it falls in the category of collectibles.

Sale of boat would attract capital gain tax as it is a capital asset. 

Al shares would be liable to capital gain tax except 1000 shares acquired on 3/4/1984 as these were acquired prior to September 20, 1985 (King, 2016).

5. Deducibility of interest on loan during the preparatory stages of business shall be dependent on the use of loan. Thus, in which use the borrowed funds was put in shall determine whether interest shall be deductible for tax purposes. In Softwood Pulp and Paper v FCT 1976, the court ruling specifically mentioned that the use of borrowed funds shall be considered in determining the deductibity of interest paid prior to ncomencemnet of business.

It is important that the funds has been used to earn asessable income in order to be eligible as deduction in computing taxable income of business. In Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47, the court emphasize on the importance of incidental and relevant test, i.e. the expenses must be for gaining assessable income in order to be allowed as deduction.

The decision in FC of T v. Brown 99 ATC 4600; (1999) 43 ATR 1 is that the interest paid on loan is not allowed as deduction after the business has ceased its operations. The honourable judge explains the reasons for not allowing deduction of such expense as section 8-1 of ITAA allow deduction of all expenses and outgoings to the extent used for gaining business income. Since, the business has ceased to operate thus, there is no question of expenses incurred for gaining assessable income.

6. As per the decision in In Ronpibon Tin NL v. Federal Commissioner of Taxation (1949), in it is clear that interest incurred in earning assessable income shall be deductible from assessable income.

Similarly, it was mentioned by the honourable judge in Softwood Pulp and Paper v FCT 1976, that interest paid on borrowed funds used for gaining income assessable for tax purposes would be allowed as deuction.

Taking into consideration the ruling in the above cases, it can be said that since the rental income from the property is assessable income for tax purposes hence, interest paid to acquire the nrental property shall be allowed as deduction as per section 8-1 of ITAA. 

References:

Auerbach, A. J., & Hassett, K. (2015). Capital taxation in the twenty-first century. American Economic Review, 105(5), 38-42.

Becker, J., Reimer, E., & Rust, A. (2015). Klaus Vogel on Double Taxation Conventions. Kluwer Law International.

Braithwaite, V. (2017). Taxing democracy: Understanding tax avoidance and evasion. Routledge.

Chardon, T., Freudenberg, B., & Brimble, M. (2016). Tax literacy in Australia: not knowing your deduction from your offset. Austl. Tax F., 31, 321.

Dixon, J. M., & Nassios, J. (2016). Modelling the impacts of a cut to company tax in Australia. Centre for Policy Studies, Victoria University.

Harrison, J., & Keating, M. (2014). The deductibility of Sarbanes-Oxley costs incurred by Australasian companies. Accounting Research Journal, 27(1), 52-70.

Ioannou, J. (2017). Income from property, partnerships and planning. Taxation in Australia, 52(4), 198.

King, A. (2016). Mid market focus: The new attribution tax regime for MITs: Part 1. Taxation in Australia, 50(10), 590.

Millar, R., & Moon, L. (2016). Designing a Simple and Fraud-Proof Tax System: Australia.

Murray, I., & Wright, S. (2015). The taxation of native title payments for Indigenous groups and resource proponents: convergence, divergence and reform. UW Austl. L. Rev., 39, 99.

Perry, M., & Rowe, J. E. (2015). Fly-in, fly-out, drive-in, drive-out: The Australian mining boom and its impacts on the local economy. Local Economy, 30(1), 139-148.

Reimer, E., Schmid, S., & Orell, M. (Eds.). (2018). Permanent establishments: a domestic taxation, bilateral tax treaty and OECD perspective. Kluwer Law International BV.

Richardson, G., Taylor, G., & Lanis, R. (2015). The impact of financial distress on corporate tax avoidance spanning the global financial crisis: Evidence from Australia. Economic Modelling, 44, 44-53.

Sharkey, N. (2015). Coming to Australia: Cross border and Australian income tax complexities with a focus on dual residence and DTAs and those from China, Singapore and Hong Kong-Part 1. Brief, 42(10), 10.