Principles of Income Tax Law
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MLC 703: Principles of Income Tax Law
Please note that the following will not form part of the word count:
• References, including statute and cases;
• Diagrams;
• Tables;
• Calculations.
You must complete all parts of the assignment – three (3) questions. Please complete the various parts of the assignment separately ie start each new question a new page. You should allocate the appropriate amount of words to the various questions in accordance with the recommendations in the box provided at the commencement of each new question. There is a strict word limit of 3,000 words for this assignment.
For the three (3) questions in the assignment you will be required to go beyond the study materials for this unit and you will be expected to conduct your own research of cases and other academic material upon which you should base your answer.
You are encouraged to use headings for purposes of clarity and presentation of your assignment. It is however, essential that your assignment is written in full sentences and not ‘dot/bullet point’ format. If you use any equations in solving the problem question please make sure that you cite the correct sections of the relevant legislation and that you outline your entire working.
You must begin each question separately. It is however essential that you place your name and student number and the question number on each question which you complete.
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http://www.law.unimelb.edu.au/files/dmfile/FinalOnlinePDF-2012Reprint.pdf
Please note that this AGLC style is intended for Law students and although it is preferred that you follow it, marks will not be deducted for not citing cases etc exactly as described. In other words, whilst you must reference, you can choose to use other referencing styles (ie not necessarily the AGLC style) if you wish.
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Assignment Style:
Font: Times New Roman or Arial;
Font size: 11 or 12 point;
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Format: Assignments are to be presented/submitted in MS Word format only.
Please note in the interests of equity to all students, academic staff will not be able to provide any assistance with the questions in this case study.
DUE DATE: 11:59pm Monday 15 September 2014
QUESTION 1:
THIS QUESTION IS WORTH 5% OF YOUR OVERALL MARK FOR THIS UNIT. ALLOCATE APPROXIMATELY 500 WORDS (MAXIMUM) IN ANSWERING IT
On 1 July 2010, Suzette sold the farm she had purchased 25 years earlier and moved to the north coast of New South Wales where she rented a house, intending to retire. She also purchased a hectare of land on the waterfront. She soon became bored with nothing much to do in retirement. In order to more fully provide funds for her retirement and by way of investment, Suzette had much consultation with, and subsequently commissioned a builder in October 2012 to design and build eight townhouses on the land she owned on the waterfront. Suzette also consulted her accountant at this time and asked him to provide details of the expected rental return from the lease of seven of the units, as she intended to live in one of them.
The units were completed in May 2013. Suzette was successful in leasing five of the units on a short-term basis. In October 2013 she successfully applied to have each of the units changed to ‘strata titles’ and by the end of December 2013, four of the units had been sold. With the proceeds Suzette purchased an adjoining block of land, with the intention of building more units.
Required:
Advise Suzette of the income tax implications of the above transactions (ignore any Capital Gains Tax implications).
QUESTION 2:
PROBLEM QUESTION
THIS QUESTION IS WORTH 15% OF YOUR OVERALL MARK FOR THIS UNIT SO YOU SHOULD ALLOCATE APPROXIMATELY 1,000 WORDS (MAXIMUM) IN ANSWERING IT
Thang purchased an investment property in Perth during February 2006 for $200,000. He paid stamp duty of $10,000 at that time. He had no trouble finding tenants for the property. In August 2013 Thang required a new tenant for the property. Because of strong demand for rental housing, Thang was able to get a new tenant to pay him a lump sum ‘up front’ amount of $2,000 (in addition to the annual rental) for entering into a 12 month lease. However, in January 2014 the tenant wanted to be released early from this lease. The tenant and Thang agreed that the lease would be terminated early in exchange for the tenant giving Thang $3,000. On May 3, 2014 Thang entered into a contract to sell this property for $700,000; this sale was settled in June 2014.
Thang also enjoyed being a businessman. As a result, during September 2006, Thang purchased 100% of the shares in a company called Hong Pty Ltd for $2 million. Hong Pty Ltd owned and operates a pillow-manufacturing factory.
In February 2014 Thang sold his shares in Hong Pty Ltd for $4 million. At this time Hong Pty Ltd’s assets were as follows:
• Pillow manufacturing plant and factory $2,500,000
• Goodwill $1,500,000
Annual turnover for the company has been consistently around $2.5m per year for a number of years.
In June 2014, Thang (who was aged 53 at the time) purchased Julian Pty Ltd, for $350,000. The assets of Julian Pty Ltd were as follows:
• a Bed and Breakfast accommodation $290,000
• a 10 % share in Investment property $60,000
At the time of the sale of Hong Pty Ltd, Thang and his spouse held the following assets (other than the shares in Hong Pty Ltd):
Thang
Car (used 50% for his business) $50,000
Property in Melbourne (Thang lives in this property) $850,000
Investment Property in Perth $700,000
Superannuation $1,450,000
Thang’s spouse
Investment Property in Sydney $600,000
Required:
For all transactions in this question discuss only the Capital Gains Tax implications.
Refer to all of the relevant sections of legislation, cases and any other scholarly material when providing advice to Thang. Advise Thang on:
• Any Capital Gains Tax liabilities for him in relation to his activities;
• Specifically, make sure that your discussion includes advice on whether Thang can take advantage of the small business concessions to reduce the amount of tax payable on the sale of Hong Pty Ltd.
QUESTION 3:
POLICY BASED ESSAY QUESTION
POLICY BASED ESSAY QUESTION: THIS IS WORTH 20% OF YOUR OVERALL MARK FOR THE UNIT SO YOU SHOULD ALLOCATE APPROXIMATELY 1,500 WORDS (MAXIMUM) IN ANSWERING IT
The Australian government recently enacted laws in its 2014 Budget to reform the Family Payment system that is currently in place. Reforms have also been applied to eligible income support recipients in relation to the Education Entry Payment.
Required:
Discuss both of the following:
i) Explain what the law was regarding the Family Payment system and Education Entry Payment prior to the changes put forward, and the nature of the above mentioned changes. Your explanation should indicate when these new measures will begin and cease (if applicable).
ii) From a policy perspective, consider whether it is desirable to implement these changes. Please consider this in the context of fairness, efficiency, equality, protection of government revenue and any other relevant considerations.
SAMPLE ANSWER
Question One: Suzette’s Income Tax Implications
Suzette should not pay taxes on the gains she made from selling her farm. This is because Australian laws allow individuals not to include proceeds from selling a home in his/her taxable income. Australian Taxation Office (2014) cites that when a person sells his/main residence any profit gained is exempt from taxations. This is referred to as ‘main residence exemption. The relief applies if Suzette used the farm as his main home and nothing else. However, he must pay for taxes on rental income he has been receiving since he built the eight town houses. Suzette should also claim incidental costs he spends in improving or constructing the rental units. Such expenses include advertisement to tenants, bank charges, insurance, cleaning, gardening and lawn mowing, property agent fees and commissions among others (Australian Taxation Office, 2014).
Nevertheless, this only applies to part of property used for rental purposes and from the time the units were rented or available for renting. Therefore, Suzette should apportion the claim based on floor-area basis. That is, she should not include expenditure on the unit she lives in. According to Australian Taxation Office (2014) if the unit represents 10% of the property’s total floor area then she would qualify for the 90% of the total deductions. In addition, she should claim for the costs incurred from May 2013 up to October 2013 when he converted the houses to strata tittles. This is because under strata title she does not own the whole property but only the four units that she did not sell. Barnett and Harder (2014) cite that that according to the new strata title laws each proprietor pays taxes on his/her gains from the property owned. This means that Suzette would pay taxes on the four units that she still owns. In other words, she must pay taxes on all the income she received since she sold the units. The new buyers would pay for their proportions.
In addition, Suzette should also use the strata agreement to claim for incidental costs such as lease costs, licenses fees, and agents’ commissions she incurred while converting the property to strata title. Barnett and Harder (2014) advices that she should deduct other expenses she incurred in deriving the taxable income such as maintenance costs. Moreover, since Suzette used the sales proceeds to purchase an adjoining block of land, she could defer the taxes on gains from the sales up to December 2014. This is because the capital gain tax event exemption laws allow property owners to post pone taxes on capital gains derived from disposing off a property by one year, if the proceeds are either used to acquire a new asset or improve an existing one (Australian Taxation Office, 2014).
Question Two:Capital Gains Tax Implications for Thang
Investment Property
Australian tax laws require property owners to work out their capital gain or loss from every capital gain tax event (CGT) related to the asset in particular year. The capital gain refers to the difference between the capital proceeds and the CGT asset’s cost base (Hulse et al., 2011). Therefore, Thang made capital gain because his capital proceeds exceeded its cost base. The cost base includes purchase costs and other costs associated with acquiring, holding and disposing the asset such as legal fees, stamp duty, and real estate agent commission among other related expenses. In this case, Thang incurred $ 200, 000 purchase costs, and $ 10,000 stamp duty. Therefore, total purchase cost was $210,000. While gains was $ 700,000 sales proceeds, $ 2,000 lump sum and annual rental income. This means that Thang’s capital gain would be $ 490,000 (sales proceeds $ 700,000 – property costs $ 210,000).
The capital gain tax depends on Thang’s income and the duration over which he owned the asset. Since Thang owned the property for more than a year it would be subject to long term gain laws. Hulse et al., (2011) cite that individuals whose income fall in the lowest tax bracket would not pay any taxes, those paying taxes in the next 20% bracket would pay 18% taxes, while people who fall in higher tax bracket pay 28% taxes. For example, if Thang falls within 20% bracket his capital gain taxes would be $ 88,200 (18% x $ 487,000). However, he qualifies for tax deductions such as, legal costs; tenancy cost such as lease agreement and advertisements expenses; depreciation costs; structural improvements such as amount he might have spent to repair and maintain the property; and interests on loans he might have borrowed to renovate the property (Australian Taxation Office, 2014. Therefore, Thang should deduct the $ 3,000 he paid back to the client for the lease termination.
Shares in Hong Pty Ltd and Julian Pty Ltd
Like in the investment property case, Thang’s capital gains from his shares in Hong Pty Ltd Company would be the difference from sales proceeds and the purchase cost. Prince (2013) argues that Australian laws treat profits on share disposal as ordinary income and not as capital gains. This implies that gain on share sales are subject to personal income tax laws. However, the Australian CGT laws exempt business people from paying taxes on personal assets such as main residence car and home. However, the laws awards exemptions when the taxpayer uses it solely for enjoyment and cost less than $ 10,000. While his residence in Melbourne would not impact on his capital gain tax because it does not relate to any recent CGT event. This means that Thang should include his personal car and residential home in Melbourne in taxable income.
Similarly, since the goodwill cannot be separated from the business, it would be calculated together with other Thangs’ asset or interests in Hong Pty Ltd. Wallace, Hart and Evans (2013) cite that in 1998 FCT v Murry case Australian High court held that although goodwill comprise many elements that might differ from other business assets, it remains one whole item. This means that goodwill constitute a capital CGT event therefore Thang taxable income would be $ 2 million. As such, Thang tax liability = sales proceeds $ 4 million (pillow manufacturing plant factory $ 2.5 million + $1.5 million) – $ 2 million.
However, Thang qualifies for several CGT exemptions. For example, despite Thang annual turnover exceeds $ 2.5 million he qualifies for CGT concession. This is a preferential exemption provided to small business owners such as Thang. Australian Taxation Office (2014) explains that individuals who qualify for CGT concessions pay tax on 50% of the total capital gains. In addition, the laws allow Thang to pay a maximum of $ 500,000 from the sales into a superannuation fund or retirement savings account. Sinclair and Lipkin (2012) cite that this is a capital gain tax retirement exemption provided to all Australians aged 55 and below. Moreover, Thang is eligible for CGT rollover exemption. That is, the exemption allows a business owner who disposes an asset and uses the proceeds to purchase a new property or improve an existing one to defer his capital gain for one year. This means that because Thang used proceeds from Hong Pty Ltd to acquire Julian Pty Ltd he might defer part of 2014 capital gain tax to 2015. However, he should only include the $ 350, 000 shares he spent on Julian Pty Ltd deal. As such, Thang’s CGT event transactions = sales proceed – tax deductions (rollover benefits + sales disposal benefits)
= $ 2 million – $ 500,000 – $ 350,000 = $ 1,150,000
As a result, his superannuation would increase by $500,000 to $ 1,950,000; while his CGT concession relief allows him to pay taxes on 50% of the total capital gain = $ 1,000,000.
Question 3
Australian Recent Family Payment System and Education Entry Payment Law Reforms
Australian government enacted new laws to encourage families and young people to participate more actively in the workforce, pursue education and training opportunities. Most of the new laws were passed on July 1 2014 while some would come into effect from 1 January 2015. However, the new reforms regarding family payment system and education entry payment would impact differently on Australians and students especially separated families and international students.
Families Tax Benefits Part A and B
Under the proposed 2014 budget the government would freeze family tax benefits targeting separated families. Ducket (2014) cites that family tax benefits rates would remain constant over the next two years. This would protect the families from inflationary changes such as rise in the cost of basic commodities. Such tax benefits refer to government supplied payments to help separated parents meet their children up keep costs. Warren (2014) also cites that the laws are subdivided into part A and part B. Part A applies to middle and low families with children aged below 19 years while Part B targets single parents and families with one main source of income. Both families who qualify for the payment receives benefits after two weeks and end year additional allowances also known as supplement. According to Commonwealth of Australia (2014) the laws specify that the government must only award the tax benefits if the applicants meet certain residence requirement; comes from a low or middle income family; are fully immunized and the parent care for the child at least 35% of the time. For example, only families that earn below $ 150, 000 per year are eligible for tax benefit part B. The government might award the tax benefit to a parent, foster parent or grandparent.
According to the previous tax systems successful applicants aged between 0 and 12 years received $ 172.20 while those aged between 13 and 19 years received $224 per fortnight for part A; while those who qualify for part B earned a maximum payment of $ 146.44 per fortnight when the youngest child was aged below 5 years and $ 102.20 where the last born was between 5 and 18 (Commonwealth of Australia, 2014). In addition, a family that satisfies the criteria earned additional $ 3796 annually for the second and every subsequent child. The old system referred to the additional allowance as maximum rate of Family Tax Benefit Part A or Part B. In contrast, the 2014 budget reforms removed this benefit instead it introduced new allowances. That is, each child who qualifies for the maximum rate and is aged between 6 and 12 years would receive $ 750. Nevertheless, parents receiving over $ 1478.25 annually for child support or spousal maintenance would no longer qualify for the new payment.
Moreover, under the previous system, the Australian government provided additional $12.04 for the third and every subsequent child to low or middle income families with more than four children. On the other hand, the new laws state that the government would award the payment not only to the fourth but also to every subsequent child. Burkhauser (2014) cites that the new laws lowered the supplements to be awarded $ 600 per annum for every child who qualifies for family tax benefit part A and $ 300 per annum to every individual eligible for part B. This law would be effective from 1 July 2015 and would remain eligible up to 1 July 2017. The budgetary committee are confident that the new family payment systems are more cost effective therefore more sustainable than the previous system. That is, the 2014 laws identified loopholes in the previous systems, eliminated the unnecessary spending and provided more rewarding solutions to the affected individuals (Commonwealth of Australia, 2014).
The Students Payments
The recent laws states that education entry payment would not be available for income support recipients from 1 January 2015. According to the reforms students studying in major cities would no longer qualify for the relocation scholarship unless they transfer to specific regional learning institutions. Allan (2014) cites that the government would offer relocation scholarships specifically from or to new regions to pursue higher education. Unlike the old system, the reform requires regional education authorities to offer financial assistance to students who move to or from the major cities only if there is no institution from their previous region that provides relevant course. For example, a student from Melbourne would not qualify for relocation scholarship if he/she moves to Ottawa to pursue medicine because there are many institutions that offer medical related courses in Melbourne.
The new laws further provide that only overseas students studying through formal international exchange programs would be eligible for scholarships from 1 October 2014 (Commonwealth of Australia, 2014). This means that international Australian students holidaying overseas would no longer qualify for scholarship. On the other hand, under the previous system, international students received regular income support while travelling overseas for a maximum period of six weeks. Therefore, the new laws would allow the education authorities to utilize financial resources saved in offering more important learning facilities or activities.
Impacts of the New Laws on Australian Residents
The new laws are fair, and more efficient. This is particularly because the government would use savings to target the most vulnerable populations. However, this might negatively affect families who heavily relied on the benefits consumption behaviors. For example, since the laws reduce benefits to some families, the members would have to adjust their budget. Therefore, despite the fluctuations in the market and economic conditions, the families would receive the same tax benefits for a period of two years. This means that a family that receives $ 300 now should expect increase or decrease in the tax allowances after 1 July 2017. In addition, the past economic trends show that inflation is ever rising therefore the family would require more income next year to afford the same basic commodities they consume now.
Nevertheless, the income department allocated more resources towards providing social services. For example, it awarded $26.8 million to social services department to enable it provide key social services to the vulnerable families such as the aged, the poor and single parent families. Duckett (2014) cites that the government offered $ 1.5 million to the community development financial institutions to extend their services especially to the low and middle income families. The new budget specified that the institutions should provide small loans and financial literacy education services to Australian residents who might not be able to access affordable financial products. Therefore, such services would compensate the families for the reduction in the tax benefits.
The budget committee estimated that the government would save more than $ 4 billion within the next four years from the family payment reforms (Commonwealth of Australia, 2014). The Australian income department (2014) cites that by reducing family tax benefit part B payments the government would save 1.9 billion. At the same time, the government would record more than $ 377.7 million through lowering large family supplement to families with four or more children. This is because the large families would receive tax benefits for only the fourth and/or subsequent child. Moreover, the government would save $ 2.6 billion over the next four years from maintaining the current family tax benefit. The savings would then be spent on other key public services. In addition, the reforms would encourage the families to participate more actively on income generating activities thereby contributing to the growth in Australian gross domestic product.
Similarly, Education Entry Payment reforms would allow the education department to offer better quality services. Commonwealth of Australia (2014) argues that the new student payment laws would allow the country to achieve $ 153.1 million savings. As a result, the amount saved would be invested in developing local institutions. Therefore, the country would establish more performing learning institutions. Given that most international students either belong to high income families or have other scholarships, the laws would ensure that local institutions only send their students to overseas trip when it is necessary and not just for pleasure. Consequently, the government would not only eliminate unnecessary expenditure but also provide scholarship to the needy students. For example, it would use the resources that were previously allocated to student start up scholarship to provide contingent loans to full time higher education students.
Bibliography
Allan, J 2014, Why Australian universities are just not good enough, Quadrant, vol. 58 no.3 pp. 44.
Australian Taxation Office 2014, Personal investors guide to capital gains tax, Australian Taxation Office, Canberra.
Barnett, K & Harder, S 2014, Remedies in Australian private law, Cambridge University Press, Cambridge.
Burkhauser, R V 2014, Another look at the economics of minimum wage legislation, Australian Economic Review, vol. 47 no.3 pp. 409-415.
Common Wealth of Australia 2014, Budget 2014-15 overview, CanPrint Communications Pty Ltd, Fyshwick.
Duckett, S 2014, Priorities for a new government: keeping the Medicare promise, thinking beyond services and getting governance right, Medical Journal of Australia, vol. 200 no. 3 pp. 138-139.
Hicks, A, & Tran, A 2014, Small business concessions, Taxation in Australia, vol. 48 no. 7 pp. 367.
Hulse, K, Burke, T, Ralston, L., & Stone, W 2012, The Australian private rental sector: changes and challenges, Australian Journal of Political Science, vol. 35 no.1 pp. 99-110.
Prince, J B 2013, Tax for Australians for dummies: 2012-13 edition, Wiley Publications, Australia Pty Ltd, Milton, Qld
Sinclair, WI & Lipkin, B 2012, St. James’s Place tax guide 2012-2013, Palgrave Macmillan, Basingstoke.
Taylor, G, & Richardson, G 2014, Incentives for corporate tax planning and reporting: Empirical evidence from Australia, Journal of Contemporary Accounting & Economics, vol.10 no. 1 pp. 1-15.
Wallace, M, Hart, G, & Evans, C 2013, An evaluation of the contribution of Justice Hill to the provisions for the taxing of capital gains in Australia, In Australian Tax Forum vol. 28 no.1 pp. 123 -124.
Warren, N 2014, Towards a holistic analysis of personal income tax reliefs and their reform. In Australian Tax Forum vol. 29 no.1 pp. 1 -13
Yates, J 2011, Explaining Australia’s trends in home ownership’, Housing Finance International, vol. 16 no. 2 pp. 6-1
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