Income Tax Law

Income Tax Law 5

Income Tax Law

Income Tax Law

  1. Whether or not the three payments are income from personal exertion:

The three payments include the $10,000 payment Daily Terror Newspaper offers Hilary for her to write her life story about her mountain climbing, the amount of $5,000 she receives from selling the manuscripts to the Mitchell Library and the $2,000 she receives after selling the photographs.

These three payments should be considered income from personal exertion given that she wrote the book without any external help and she has been paid the amount of $10,000 so that she can write the life story. S 6-5 of the Income Tax Assessment Act 1997 (ITAA) defines income from personal exertion to include income from personal services regardless of whether it is received as an employee or as a consultant and includes the present rewards to the individual for the personal toil and effort. Income from personal exertion thus includes salary, wages, and payment for overtime work, tips, allowances and commissions (Flynn, 2016). Income from personal exertion would also include awards of retrospection, lump sum compensation with bonuses and back pay. In Brent v FCT, Brent was approached by newspapers for publication of her life story and an agreement was reached with daily telegraph giving the newspaper exclusive rights to the story’s publication after interview with the newspaper staff. She claimed that the pay was not income from personal exertion but that she was paid for giving up capital rights. The issue was whether this was ordinary income. It was observed that the payment was income from personal exertion as she was paid for offering her services and not an asset or capital.

In the present scenario, the payments are mainly gratuity from Dairy Terror as well as other areas implying that the payments are ordinary income for the services offered. This is because the income is produced by her personal skills and efforts. The story, the photos and manuscript in this case arise from her profession of mountain climbing. For this reason, such income should be classified income from personal exertion and in this case personal income rules will fail to apply as was observed in Brent v FCT. This is a personal business where the three different customers give her different tips that are assessable under ITAA 1997 S15-2 since they are employment payment for the different services offered to the three customers. In this case, there has been an upfront payment made by the contracting party to Hillary (Commonwealth Consolidated Acts, 2016). It is assumed that the upfront payment is aimed at covering related expenses as agreed by the parties. This includes travelling allowance which enables her capture the photos which she then sells for income that is assessable.

The scenario would not change if she wrote the story for her own satisfaction and only decided to sell it later. This would still be considered income from personal exertion as she does not sell capital. Her profession is not writing and hence the payment she would have received would be compensation for selling the story, the manuscript and the photos which would be considered income and hence assessable.

2. The effect on the assessable income of the parent

In the first scenario, there is an agreement that the son will repay the $40,000 short term housing loan at the end of five years and that a total of $50,000 will be repaid. In this case therefore, it is clear that the son will pay a $10,000 interest on the money loaned as a lump sum when repaying the loan after the five years period agreed upon. The second scenario is however different from the first one. In this case, the loan is made to the son without any formal agreement and without any security being provided for the sum lent. In addition, it is clear that the loan will not attract any interest as the lender (the mother) has told the son that he need not pay interest. However, when the son is repaying the loan in full after two years, he includes an additional amount that is equal to 5% pa on the amount borrowed. A single cheques is presents for the total amount. The effect on the assessable income of the parent will depend on whether the extra amount of 10,000 or the extra amount equivalent to 5% is treated as interest and hence assessable income or not. The issue therefore is whether the extra amount in both cases is interest and hence income for tax purposes and hence assessable or if the amount is treated as a gift and hence not assessable.

In the first scenario, it would be right to consider the extra $10,000 as interest payment to the mother and hence assessable income. The income tax law describes interest as a payment that would be charged or paid owing to the fact that the lender did not have his money during the period it had been loaned (sawarddawson.com.au, 2016). This was held in Riches v Westminster Bank Limited (1947) AC 390 at 400. In the present case, it is clear that the $10,000 paid on top of the $40,000 during the repayment is a compensation to the parent for the time that the mother had no access to the $40,000 loaned for five years. In this case, it would be right to treat it as interest and hence income as per ITAA 1997 S6-7 and thus it will be part of the parent’s assessable income. It is worth noting that interest may be paid as lump sum as is the case in the present scenario or as regular instalments and hence the $10,000 will still be treated as interest income although it was paid at the end of five years.

In the changed facts, the mother did make it clear to the son that he does not need to pay interest despite the fact that the son when repaying the loan decides to make an additional payment equivalent to 5% pa together with the $40,000 loan repayment in a single cheques. The extra amount could still be treated as interest and hence assessable income thus adding to the parent’s assessable income. However, it should be noted that there is no interest expectation from the terms of the loan. Thus, I would not treat the extra 5%pa as ordinary income under ITAA S 6-5. Rather, it should be treated as a gift to the mother which is not related to the loan and hence not assessable. The parent can argue that the extra money was a gift by the son in appreciation of the act of lending him the money. This is similar to the judgement in Scott v FCT where it was held that the payment was not income but a non-taxable gift as there was ample evidence of the taxpayer’s desire to express appreciation of the taxpayer’s personal qualities (Fidelity, 2016). The principles of the case are such that an unsolicited gift does not become income merely because it can be traced to gratitude engendered by some services rendered. In distinguishing a gift from income, it should be established whether the gift was in a relevant since a product of the recipient’s personal services or an exceptional payment due to the recipient’s qualities. In this case, the parent did not ask for interest and hence the extra payment should be treated as an appreciation for the act of lending the money. In addition, this is a family agreement between mother and son and since the mother did not solicit for interest, it is only good to treat the extra payment as a gift from a son to a mother. In this case therefore, the extra money will not be part of the parent’s assessable income.

3. Determination of Scott’s net capital gain or net capital loss for the year ended 30th June of the current tax year;

We first calculate the CGT:

The house is sold for $800,000

Related costs include:

The value the land was acquired at ($90,000)

Construction cost ($60,000)

Total costs incurred ($150,000)

Capital gain $650,000

Exemption

It is worth noting that the CGT event of selling the property happened after 11.45 am on 21 September 1999 the house having been used for generating rental income. Furthermore the asset has been owned by Scott for more than 12 months having been acquired in 1980 (ato.gov.au, 2016). Scott is an individual and therefore bearing the above factors in mind, we could decide to use either indexation method or discount method in deciding the CGT exemption for Scott. Thus, we use the discount method in this case.

The discount

Given that David is an individual, we are going to apply 50% in determining the discount. Thus, the capital gain tax amount is given by;

CGT amount = Gain ×Discount rate

From the calculation above, the gain from the sale of the property is $650,000. Thus, the capital gain amount is given by;

CGT amount = $650,000×50% = $325,000

Thus, the net capital gain amount for Scott is $325,000.

b) How my answer to A would differ if Scott sold the property to his daughter for $200,000

In this case, I assume that the property is sold at a value that is less than the market value assuming that the $800,000 in part A above is the market value for the property. In this case, my answer to A above would not change at all. The tax law provides that if one receives nothing in exchange of his/her property, you are assumed to have received the market value of the property when the CGT event happened. In addition, one is assumed to have received the market value for tax purposes if what is actually received is more or less than the property’s market value (Wallis, 2016). You are also assumed to have received the market value if the two parties were not dealing with one another at arm’s length in connection with the event as is the case where the property has been transferred between family members. In the present case, the property has been transferred to a family member at a value that is far much less than the market value of the property. As such, the law will assume that Scott received the market value on the property and hence use the market value as the basis of calculating the capital gain. Thus, the capital gain amount on which Scott will be taxed will be calculated as follows;

The house is sold for $800,000

Related costs include:

The value the land was acquired at ($90,000)

Construction cost ($60,000)

Total costs incurred ($150,000)

Capital gain $650,000

CGT amount = $650,000×50% = $325,000

Thus, the net capital gain amount for Scott is $325,000.

In this case therefore, my answer for A would not change in any way since we have to use the market value in calculating the capital gain for the sale of property in question.

c) How my answer to A would differ if the owner of the property was a company instead of an individual

In this case, the full amount of the gain would be used in determine the capital gains tax. This is because the discount method of computing capital gains is not available for companies while the indexation method is only applicable up to September 30th 1999. ITAA 1997 S110-125 provides that for CGT assets acquired before 11.45 September 21st 1999 and disposed after 11.45 am 1999, one has a choice to use indexation up to September 30th 1999 or apply CGT discount to the capital gain instead of indexation. As such, one can only use the entire capital gain in calculating CGT for the company. Therefore, my answer in this case will be;

The value the land was acquired at ($90,000)

Construction cost ($60,000)

Total costs incurred ($150,000)

Capital gain $650,000

References:

Flynn, M2016, Distinguish between income and capital receipts: A search for principles, Retrieved on 21st August 2016, from;

http://www.austlii.edu.au/au/journals/JlATax/1999/13.html

Commonwealth Consolidated Acts, 2016, Income tax assessment act 1997-Sect 6.5, Retrieved on 21st August 2016, from;

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s6.5.html

sawarddawson.com.au, 2016, Personal services income, Retrieved on 21st August 2016,

http://www.sawarddawson.com.au/sites/default/files/uploads/pdf/FocusOn/BUSpsi.pdf

Fidelity, 2016, Interest income and taxes, Retrieved on 21st August 2016, from;

https://www.fidelity.com/taxes/tax-topics/interest-income

ato.gov.au, 2016, Working out your capital gain, Retrieved on 21st August 2016, from;

https://www.ato.gov.au/General/Capital-gains-tax/Working-out-your-capital-gain-or- loss/Working-out-your-capital-gain/

Wallis, V2016, How to calculate capital gains tax when selling a home you no longer live in, Retrieved on 21st August 2016, from;

http://www.theguardian.com/money/2014/feb/12/how-calculate-capital-gains-tax-sell- home