Income Tax Law and practice Essay Example

  • Category:
    Law
  • Document type:
    Article
  • Level:
    Undergraduate
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    3
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    1713

Income tax consequences

The issue

Allan being popular with the elderly patients in the town is regularly given homemade cakes and scones along with his fee. One day he treats a local wine maker’s dog for snake bite when the vet is unavailable and is given a dozen bottles of Lonarch Brae Shiraz in appreciation valued at $360. The issue is whether the gifts Allan is given are income and hence whether they are ordinary income for tax purposes and hence taxable. In other words, what the tax implications of the gifts are.

ITAA (1997) s6 (1) defines income from personal exertion (Commonwealth Consolidated Acts, 2016). The third proposition of ordinary income is that a mere gift is not income. However, as held in Hayes v FCT (1956), this rule does not apply when the payment is in substance a product of services (Paul, 2008). In other words, though a gift is made without legal obligation but it is so related to an employment or to services rendered to the party giving the gift in its substance and reality, it is not a mere gift but the product of an income earning activity and hence regarded as income from personal exertion and hence taxable.

Application

In this case, the gifts received from the elderly patients from the town are mere gifts. This is because Allan does not receive them in place of his fees but he receives them on top of his fees. On the other hand, the $360 worth wine is received as appreciation for treating the wine maker’s dog. In other words, Allan does not receive fees for treating the dog but he is given wine in appreciation. This is therefore not a mere gift since it is so connected to the service he renders and hence a product of an income earning activity and thus regarded as income from personal income and hence taxable.

Conclusion

Based on the above rules and arguments, the tax consequences of Para 1is that Allan will not be taxed on the mere gifts he receives from the elderly patients but he will be taxed on the wine he receives from the wine maker as he receives it in appreciation of the service he renders and is not paid any fees for treating the dog.

How a hobby is to be distinguished from a business

According to the Australia Tax Office, there are no single criteria for distinguishing a business from a hobby although several indicators exist. These indicators have been used in several case laws in determining whether one was engaging in a business or a hobby. Taxation ruling TR2005/1 sets forward some of these indicators to the effect that an activity will be deemed a business if it possesses the indicators listed below rest it will be considered a hobby (George, 2009).

  1. The activity in question should have a significant commercial purpose or character

  2. In Rabinowitz v Commissioner, TC. Memo 2005-188, it was held that the person in engaging in the activity need to have more than just an intention to engage in business (Woellner, R etal2014).

  3. The person engaging in the activity should have a purpose of profit and a prospect of profit from such an activity as well.

  4. The regularity and repetition of the activity will also be considered.

  5. In Sislik v. Commissioner of Internal Revenue, T.C. Memo 1989-495,it was held that the activity ought to be of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business for it to be considered a business(Woellner, R etal2014).

  6. The activity is planned, organized and carried out in a businesslike manner such that it is directed at making a profit. For instance, if the activity is organized such that you keep business records and books of accounts, you have a separate business bank account, you operate from a business premises, you have a license or qualifications and a registered business name, and then the activity will be considered a business.

  7. The size, the scale and the permanency of the activity will be considered

  8. Another factor to consider is whether the activity would better be described as a hobby or a form of recreation or a sporting activity.

Tax implications of Para 2 and 3

In Para 2, Allan and Betty start gardening as a hobby since they are doing it as something they enjoy but with no intention of making profit. However, they attend a course on organic farming which enables them to get surplus produce in the second year. Initially, Betty does not sell the marmalade and Relish she makes but gives to the neighbors. However, as time goes, she becomes popular and opens a stall at the Newton Growers Market that is held every second Sunday of the month. The excess is sold to a local supermarket and regular supplies sweet potatoes and pumpkin to three retailers. Though, they do not keep records as they have no profit motive; they estimate that in a good month they make gross receipts of between $500 and $600.

In Rabinowitz v Commissioner, TC. Memo 2005-188, it was held that the person in engaging in the activity need to have more than just an intention to engage in business (Barkoczy, S2015). Although at the beginning their gardening venture is done as a hobby, it has eventually gained the character of a business though Allan and Betty have no business intention. The factors that would make us conclude that they are conducting a business in this case include the commercial character, its regularity and repetition, the fact that this business is carried out in a similar manner to businesses carried out in the industry, the business size, scale and permanency has gradually increased. Finally, the venture they engage in would be better described as a business. They also attend a professional course to enable them better carry out their venture. In addition, though no records are kept, they are able to estimate the value of the supplies they make. Thus, it can be concluded that Allan and Betty are carrying on a business. The implication is that the supplies they make are subject to taxation in the prevailing income taxation rates. However, the expenses they incur in generating this income will be allowable for tax purposes.

In Para 3, Allan and Betty facilitate barter trade among their neighbors by establishing a Barter system. They do this by helping keep administrative records and for this, the participants have to pay an up-front, one-off fee of $50 to Allan and Betty as a charge for keeping the administrative records. The service they provide is thus a source of income to them. It is a professional service for which they charge $50 per participant. In this regard, the $50 per participant is income that should be taxed at the prevailing income taxation rates with any expenses that directly facilitate the keeping of the records being allowable.

Income tax implications of the barter trade system

The participants of the barter system should still pay taxes though no cash is used in the system. The income tax assessment act 1936 requires that all income derived by a tax payer, except for exempt income should be included in tax payer’s assessable income (Brant, 2013). Under section 25(1), the extent to which the consideration received during barter trade represents assessable income will depend on the nature of consideration in the recipient’s hands. In other words, the barter transactions are assessable and deductible to the same extent as a similar cash transaction. This means that for instance, Suzie would have to value the hair dressing service she offers and also value the goods she receives as consideration in monetary terms. The services and goods offered as consideration in the barter system would thus have to be valued as either the money value or at the arm’s length value while deductions would have to be valued in a similar manner. This would enable the participants to pay tax on the resultant income either through check or cash but not through the barter credits as was held in Taxation ruling No. IT 2668 (Davies, 2012).

Ordinary income under s6-5 or s15-15

S15-15 states that one’s assessable income does not apply to a profit arising in respect of the sale of property acquired on or after 20th September 1985. On the other hand, s6-5 terms property income to include amounts derived from property including rent, interest, dividend and royalties. However, it is clear that the $650,000 relates to capital and hence this amount ought to be assessed under CGT provisions. This is because Alex is not in a business of selling land or buildings and hence the proceeds could not be treated as profits.

The cost base of the land and building

Based on ITAA1936, the cost base would include the cost of purchasing the land, the cost of building including raw materials and labour as well as other incidental costs such as the legal fees that arise in the process of building or acquiring the land (Charlotte, 2012).

  1. Cost base for land

Cost of land $250,000

Stamp duty $6,800

Legal cost of conveyance $2,500

Valuation cost $2,000

Cost base $261,300

  1. Cost base for building

Development application fee to local council $4,200

Architectural fees $6,500

Building materials $120,000

Valuation cost $2,000

Building contractors payments $60,000

Labour $13,000

$205,700

Calculation of capital gain

Since both the land and the building were acquired after 21 September 1999, we use the discount method in calculating the capital gain at a rate of 50% in accordance to ITAA 1997 act (Commonwealth Consolidated Acts, 2016). This is calculated as follows;

Capital proceeds $650,000

Less cost base $600,000

Capital gain $50,000

Less 50% discount $25,000

Net capital gain $25,000

References:

Paul, R (2008). Taxation of business organizations and individual income. London, Rutledge.

George, M (2009). Taxation. Sydney, Prentice Hall.

Woellner, R etal (2014). Australian taxation law. CCH, Sydney.

Barkoczy, S (2015). Core tax legislation and study guide. Oxford University Press, South Melbourne.

Brant, J (2013). Estate and gift taxation. New York, Taylor& Francis.

Davies, W (2012). Principles of tax law. Sweet & Maxwell, Sydney.

Charlotte, C (2012). Corporate taxation. London, Rutledge.

Commonwealth Consolidated Acts, (2016). Income Tax Assessment Act 1936, Retrieved from;

http://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/