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Case Study

Case Study One

In order to make a comprehensive discourse on case Study one CSI Ltd, a look at the “grund norm” is imperative. Australia’s Revenue Law is necessarily buttressed by the Constitution of Australia. Accordingly, a reflection on matters taxation must be in light of the same. The Constitution bequeaths the Commonwealth with the power to impose taxes and make the relevant taxation laws regime.1 From this background, it is important to note that there is a notable difference between how natural persons as against how corporate persons are taxed. The present scenario presents a corporate person. In cases of companies, the imposition of tax is on the basis of taxable income applicable to that particular year of income. This regime is governed by the Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Act. The Act defines a “Company” to include bodies corporate or unincorporated and associations but excludes partnerships.2

Section 6 of the Act defines “year of income” to mean the next financial year preceding the “year of tax” or the accounting period. The year of tax means the financial year for which the tax is levied. Companies are, therefore, taxed on a preceding year basis. Section 46 of the Assessment Act provides that where a company receives a dividend paid from profits having an outside source, and the dividend has been taxed in the country of the company paying the dividend, there will be no credit. In this instance, Section 46 provides that there will be a full rebate of tax on the said dividend.3 A broad look at the various relevant provisions of the Assessment Act, with keen regard to taxable income, brings about the following conclusion:

  1. A taxpayer of Australian residence is liable for income tax on income from all sources with the strict exemption of such income being from another jurisdiction and the same being taxed in that particular jurisdiction.

  2. A taxpayer that is not resident in Australia is liable to income tax on all income that has an Australian source.

It is important to note that a company is a resident of Australia for the purposes of taxation if the company is either incorporated in the country or if not incorporated, carries on business in Australia and voting power control is with shareholders who are residents of Australia.4 The case of Sydney Water Board Employee’s Credit Union Ltd illustrated that there is no difference between an incorporated and an unincorporated body.5 Furthermore, under the provisions of section 117 of the Assessment Act, for a company to be liable for taxation, it has to be one that in a year of income is established for the purpose of carrying on any business having its primary object or objects (various objects listed). In the authoritative decision of Brookton Co-operative Society Ltd, the High Court interpreted the above definition.6

According to the above brief discourse, it is clear that CSI Ltd would not be considered a resident of Australia for tax purposes for the income year ended 30 June 2016. This is because it is neither incorporated in Australia nor does it have its centre of management there or have the majority of shareholders controlling voting power as Australian residents. The only taxable income would be the one derived from Australian sources.

For the purposes of taxation, a partnership is understood to be an association of persons who come together for the purpose of conducting a business as partners or earn income jointly. Basing an argument on this, the business conducted by Luke and Linda Lucky may be said to be a partnership. The next limb of this section seeks to briefly underscore whether Luke and Linda are carrying on a business for taxation law purposes in the year 2015 and 2016 income years.

Division 5 part III of the Assessment Act renders a partnership a taxable entity. Section 90 of the Act envisages the calculation of taxable income for a year of income with the partnership as the taxpayer. Section 92 provides for the taxable income being one that is derived from each partner’s income. Under section 90, the net income of a partnership is what is to be determined and taxed. This was partly in issue in the case of Pascoe.7

From the foregoing discussion it may be concluded that Luke and Linda’s business is worthy to qualify as a taxable venture within the Australian tax regime.

To answer the second limb of the question,
whether any amounts received in relation to the sale of the design are ordinary income, this paper proceeds thus: Section 68A of the Income Tax Assessment Act contains provisions in this regard.8 The import of the above-cited section of the law is that if a taxpayer incurs expenses in seeking to obtain an item that is a revenue asset of his venture, those expenses would be deducted first before determining the assessable income. The same provision is envisaged under section 8-1 of the Assessment Act. The section provides that if the item constitutes trading stock of the business, then the expense of obtaining it will be deducted before ascertaining the assessable income.

An understanding of what the salient economic objectives of a business are is a significant consideration of how intellectual property is structured, owned and used.9 Accordingly, knowing the following factors is an important prerequisite to determine the structure of intellectual property:

  1. Whether the purpose of the intellectual property is to generate an annuity

  2. Whether the IP will be disposed off in the future; and

  3. Whether there is an anticipation of disposing the business plus the IP in the future.

Understanding the above objectives as to the holding, usage and structuring of intellectual property has a massive gearing on the tax implications. The extent to which designs are taxed is governed by the provisions of Division 40 of the Income Tax Assessment Act. The provisions of the said section of the law, for instance, that gains acquired in the disposal of IP assets will not attract any capital gains tax concessions. The provisions of section 152-10 of the Act provide other conditions to be satisfied in order to attract CGT concessions in the sale of intellectual property.

From the above discourse, it is clear that the proceeds sale of a design is considered as ordinary income for taxation purposes.

The last part of the question requires a determination of the basis of accounting that would apply to Luke and Linda between the cash or the accrual basis of accounting. Cash accounting can be understood to represent the accounting regime that realizes income and expenses in their physical payment rather than by invoice or receipt. The accrual accounting system recognizes expenses and income by receipt of invoices or bills even though they are not due for payment yet. This particular system creates creditors and debtors and even shows what one owes and when it is due and what one is owed. In the modern business environment, it is imperative to keep an eye on the debtors of a business and have in place a good system that reduces the days of waiting for profit, or in the worst case scenario, incurring a bad debt that has to be written off. It is important to note that what a business includes in its assessable income largely depends on its accounting system.

In calculating the income earned during an income year, all the amounts earned are included using the accruals system even though payment has not been effected. The fact pattern presented by Luke and Linda’s case reveals that up to 30 June 2016, 20,000 items had been sold by the retail company, with payment due to be received in July 2016. The accruals method of accounting, therefore, is the most expedient since it will enable the business to include the amounts unpaid into the income for the year ending 39th June 2016. Also, since the accruals scheme enables a business to keep tabs on its debtors, it would be the best method in Linda and Luke’s scenario.

Case Study Two

Taxation Ruling TR 97/23 was the ruling that explains which expenses incurred by a taxpayer in repairs are allowable deductions under the regime of section 25-10 of the Income Tax Assessment Act. Most of the previous rulings on repairs are consolidated within this particular one and, as such, is very authoritative. According to the ruling repairs are construed to be partial and occasional.10 It involves restoring the efficiency of the functioning of the repaired property without altering its character and may involve restoring it to its former form, condition or appearance. A repair, therefore, functions merely to replace what was already there but has become dilapidated or worn out. In the context of section 25-10, repairs should be held or used for the purposes of making income.11 Under paragraph 22 of the ruling, if the work transcends what is normally construed to be a repair (e.g. changing the character of the property or doing more than restoration of its efficiency) then any expenditure is non-deductible.

It is important to note that repair expenditure of a capital nature is not a deductible expense in the meaning of the Assessment Act. The work should for example not be for the purpose of increasing the profit-making potential of the business, reconstruction in the form of an “entirety” or repairing a property to increase its suitability.

Based on the foregoing, it may be concluded that the costs incurred by Baby Warehouse ($110,000 to replace the gravel and $200,000 for the new concrete) fall squarely within the ambit of what is jurisprudentially considered to be repairs worthy of deductions.

However, based on the foregoing presentation, the $42,000 paid to replace the whole roof does not constitute deductible expense. This is because the fact pattern reveals that the cyclone only caused damage to several parts of the roof and guttering as opposed to the entire roof. The work done to refurbish the whole roof may not fall within the jurisdiction of section 25-10 as it changes the character of the building and goes beyond restoring the roof to its efficiency. However, the building is said to be four years old and the materials used were the ones previously used. Based on this fact, the work done still falls under the ambit of ‘repairs’ as envisaged under the Assessment Act section 25-10.

The issue of legal expense is one of judicial discretion and as such is determined on a case to case basis. In the case of John Fairfax & Sons Pty Ltd, the legal fees were associated with acquiring controlling interest in another company. This was held not to be a deductible expense. Allowable deductions are handled under section 8-1 of the Assessment act. In general, the issue to do with whether legal expenses expenditure is deductible is usually objectively determined without regarding the purpose of the taxpayer. In the case of Magna Alloys & Research Pty Ltd v FCTthe Federal Court authoritatively held that neither motive nor purpose are criterion for deductibility.12 The courts have instead adopted the “essential character” criteria in determining this issue. Essentially, the expenditure must be incurred as a business expense in order for it to qualify as a deductible expense. If the advantage to be obtained is of a capital nature, then courts have held that the legal fees would not be deductible.

Basing an argument on the foregoing it may be concluded that the legal fees expended by the Baby Warehouse were not of a capital nature but were incurred as a business expense. Therefore, the legal fees qualify as deductible expenditure.

Case Study Three

A capital gain may be understood to refer to the increase in value of a capital asset net of transaction costs and brokerage.13 A capital loss on the other hand is when an asset depreciates in value. These gains and losses in Australia are usually only realized for taxation when an asset has been sold. This means that CGT may also be unrealized. Capital gains or losses on a particular asset held by an individual for more than a year are considered to be long-term and are normally subject to an exclusion rate of 50%. Losses are generally deductible against capital gains but the exception to this is that losses exceeding capital gains are usually not deductible from income.14

Certain categories capital gains are exempted from taxation and among these are assets which were acquired before 20th of September, 1985.15 The reason for this is the afore-mentioned year was the year that CGT was introduced in Australia. This means therefore that the vacant block of land in Ipswich QLD purchased by Mary is exempted from CGT.

In the year 1999, a 50% discount was introduced by the Australian government on Capital Gains Tax if the asset has been held by an individual for more than twelve months. Based on the foregoing, it can be concluded that the capital losses incurred by Mary can be utilized to bring a reduction in the capital gains. Since capital losses may be from the current year or a previous year, both of these two can be used to subtract from the gains of the current year in order to determine the taxable CGT of a particular year. It is important to note particularly that even though gains or losses have accrued over a number of years, the capital gain or loss of a current year refers to the loss or gains realized in the specific year.

There are three ways of calculating capital gains but only one way of calculating losses.16 The first way of calculating capital gains is the indexation method. Use of this method is conditioned upon:

  1. A CGT moment occurring to an asset before 21st of September, 1999 at 11.45 (by ACT legal time); and

  2. The asset was owned for twelve months or more.

In this method, every amount envisaged in a particular element of the cost base is increased by a factor. The factor is known as an indexation factor and is normally calculated using the Consumer Price Index (CPI).

The second method of calculating capital gains is known as the discount method. The amount by which a capital gain is reduced is what is known as the discount percentage. A capital gain can only be reduced after applying all capital losses for a particular income year and the net capital losses that are unapplied and have accrued from previous years. As discussed earlier, this discount percentage is 5o percent for individual owners. A good example would be a person buying a parcel of land, holding it for 18 months and then selling it making a profit of $12,000. If that person had no capital losses and used the discount method, the capital gain that he would declare would be $6.000.

Thirdly, and last in what is commonly referred to as the “other” method. This method is the simplest one in calculating capital gains. In order for this method to apply, the asset must have been bought and sold within 12 months. Also, this method is applied for CGT moments that involve non-assets. In such cases, the two methods mentioned above do not apply. Calculating CGT using this method involves subtracting the cost base (what the asset cost the individual) from the capital proceeds (what the individual sold the asset for). The proceeds that remain are what constitute an individual’s capital gain.

Mostly, individuals make capital losses if they sell assets for less than what it cost them. Capital losses can be carried forward into future income years in order for them to be subtracted from the capital gains earned in the future. It is noteworthy that capital losses cannot be deducted from an individual’s income. In addition to the above, there is a limitless time as to how long a capital loss may be carried forward.

Mary’s CGT for the year ending 30th June 2016 for the first block of land = $649,000 – ($3,800 + $800 accrued capital losses) – ($23,000 council rates) – ($39,000 divide by two, subdivision charges) = $601,900 — $205,000 (construction charges) = $396,900 — $99,000 (buying price) = $297,900

Mary’s CGT for the year ending 30th June 2016 for the second block of land = $320,000 – ($39,000 divide by 2, subdivision charge) — $99,000 (buying price) = $201,500

Mary’s Total CGT = $201,500 + $297, 900 = $499,400

In answering Justine’s question, the block of land purchased in Toowoomba will not accrue CGT for the purchase since it was bought before 1985, when the CGT law came into effect in Australia as noted above.

Justine’s CGT for the year ended 30th June 2016 = $195,000 — $45,000= $150000

$390,000 — $150,000= 240,000


Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Act

Income Tax Assessment Act, 1997 Laws of Australia.

Income Tax Rates Act, 1986 Laws of Australia.

Minas, J., 2011. Taxing personal capital gains in Australia–is the discount ready for reform. Journal of the Australasian Tax Teachers Association, 6(1), pp.59-67.

Parsons, R.W., 1985. Income taxation in Australia. Principles of Income. Deductibility and Tax Accounting. Sydney. Law Book Co, 65.

Raftland Pty Ltd as Trustee for the Raftland Trust v Federal Commissioner of Taxation (2007) 65 ATR 336.

Stretch, T., Kingwell, R. and Carter, C., 2012. Grains Profitability: A Regional Analysis (p. 57). AEGIC research report, South Perth.

Sydney Water Board Employee’s Credit Union Ltd (1973) 129 C.L.R. 446

The Constitution of Australia, Section 51 (ii). States that: “The Parliament shall, subject to this Constitution, have powers to make laws for the peace, order and good government of the Commonwealth with respect to: Taxation: but so as not to discriminate between States or parts of states.”

See Section 6 of the Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Act, Laws of Australia.

See also Section 15 (4) and (5) of the Income Tax (International Agreements) Act, Laws of Australia.

Supra note 2.

(1973) 129 C.L.R. 446.

(1981) 147 C.L.R. 441. “It will, in the year of income, be established for the purpose of carrying on a business if that purpose is dominant among the purposes of its total activities, which may include investment activities.”

(1956) 30 A.L.J. 402.

The Section allows for expenditure to be deducted “in obtaining or seeking to obtain, for the purpose of producing assessable income,

(a) the grant, or the extension of the term, of a patent for an invention;

(b) the registration, or the extension of the period of registration, of a design; or

(c) the registration of a copyright.”

Stretch, T., Kingwell, R. and Carter, C., 2012. Grains Profitability: A Regional Analysis (p. 57). AEGIC research report, South Perth.

Taxation Ruling TR 97/23 at par. 14.

Ibid, at 17.

(1980) 80 A.T.C. 4542.

Parsons, R.W., 1985. Income taxation in Australia. Principles of Income. Deductibility and Tax Accounting. Sydney. Law Book Co, 65.

Supra note 12.

Minas, J., 2011. Taxing personal capital gains in Australia–is the discount ready for reform. Journal of the Australasian Tax Teachers Association, 6(1), pp.59-67.