Principles of Income Tax Law - Assignment Example

Running Head: Principles of Income Tax Law Principles of Income Tax Law Name Tutor Institution Course Date Principles of Income Tax Law Q.1a) The term “income” is not given a definition in the Income Tax Act simply because it encompasses so many different concepts (Stephen and Rob, 2009). We can say that the term income is an ambiguous word. Generally, income is characterized by a recurrent payment like the salaries and wages, the ability to be convertible into cash and as result of an activity undertaken by the taxpayer. An activity may be a business while amount convertible into cash may include share dividends. In the Income Tax Act, assessable income is defined as the income on which tax is levied. Allowable deductions are subtracted from the assessable income in order to come up with the taxable income. Allowable deductions compose of all the money spends in order to come up with the income. Taxable income as noted is as a result of subtracting the allowable deductions from the assessable income (Stephen and Rob, 2009). Taxable income varies from person to person because of the differences in the amount of the assessable income and the allowable deductions. Taxable income should only relate to the year in which the assessable and allowable deduction accrued and not any other period. That period in which taxable income is calculated is referred to as the year of income. In our case, Patrice the financial advisor of Shamus Donegal has received a gift of a piece of land, apart from the entitled annual salary of $54,500. In this case we are to assume that there are no capital gains because land itself in most tax cases is considered as a tax gain. The amount given to Patrice as an annual salary is referred to as a basic salary when it comes to tax. Basic salary is usually a gross amount. According to the income tax Act, such gifts are assessable incomes for tax purposes (Williams, 2005). Therefore the amount of land will be added back to the amount of Patrice’s annual salary when determining the taxable income salary. The income tax Act specifies that the only exempt gifts are the ones which fall under wills. Note that if we were not instructed to assume that no capital gains, then that amount relating to the piece of land given to Patrice by Shamus as a gift would not be an assessable income. Patrice is said to be given a lump sum of $30,000 on top of her annual salary by her employer as a compensation of the off days she has been taking all year long. The lump sum amount was given on condition that Patrice’s off days were no longer to continue. This is a matter of conditionality and not because the employer wanted to compensate her off days (N. E. Renton, 2005). According to the income tax Act, the amount given to Patrice by her employer as a lump sum is an assessable income if it’s a set annual scheme. In her case, the off days seem to be part of the employment scheme therefore forming part of an assessable income in that year of income. If the off days were not as a result of an agreed employment scheme, then we would treat it as a mere compensation. In the Income Tax Act, such compensations are totally exempt for tax purposes. Therefore, in the subsequent period, if Patrice takes of days she will not be assessed on any amount received. Q1b) Capital gains tax is a tax levied on capital gains which result of selling an asset at a price higher than the price in which the asset was purchased (Stephen and Rob, 2009). Not all countries charge capital gains tax. Some countries have them at a zero rate. Therefore we can say that the capital gain tax varies from one government to another. In our case, let’s base our capital gains tax treatment in Australia. In Australia, the capital gains tax is part of the income tax system (Williams, 2005). CGT is payable for all realized capital gains apart from that relating to zero-coupon bonds. For capital gains on assets which relate to an active business and have been held for a period of more than 12months, there is a 50% discount. The capital gain is given by the sales proceeds less the cost base. The cost base includes the original cost of an asset plus any other cost increases. For people with personal residential property, their capital gains are completely exempt from tax except for any gains realized in any period in which the property was not being used for personal residence (N. E. Renton, 2005). For example, if the property was being leased to tenants or the property was being used for business purposes. In Australia, capital gains tax (CGT), applies for all properties that have acquired after the year 1985 (Post CGT). Craig is a businessman and his property was acquired in the year 2002 and sold in the year 2009. Therefore the capital gains realized are after the year 1985 making them subject to the capital gains tax. Another aspect that makes Craig’s capital gains realized qualify for capital gains tax(CGT) is the fact that its an investment no intent for personal use. How do we determine the capital gains of Craig’s property? The table below shows the steps of coming up with capital gains.           $ Sales proceeds         700,000 Add: initial lease       2,000   terminal lease value       3,000  Total proceeds         705,000             less:           original cost     (200,000)     stamp duty     (10,000)   (210,000) CAPITAL GAIN         495,000             Capital gains tax will be based on the value of capital gain above, which totals to 495,000. Craig’s capital gains have been increased by the amount of lump sum on lease and the terminal value on the lease which form part of the proceeds. Therefore I would advice Craig to avoid such amounts. If such amounts were excluded the capital gains would have been less by 5,000 to give us 490,000. Craig purchased 100% shares in Lofty Pty in the year 2002, a pillow making company for $2m and sold the shares in the year 2010 for $4m. In this case, we do not have any cost increases to add to the initial cost. The figure of the sales proceeds includes the goodwill and the cost of pillow manufacturing plant and factory. Goodwill is usually given by the difference between the purchase price and the sum of the fair value of the net assets (N. E. Renton, 2005). It classified as an intangible asset in the financial statements. Sources from the published guide to capital gains tax concessions for small business indicate that a small business has two elements (Stephen and Rob, 2009). One key element is that the total net assets should not exceed $5m. Two, it should be controlled by an individual owning 50% or more than 50% of shares. If the shareholders are two then they should share the votes equally. More than three individuals do not have any controlling position. In our case, Craig is the majority shareholder owning 100% of all the shares and the total asset of the company fall below the set limit of $5m. Therefore we can say that Lofty Pty limited falls under the category of small businesses. According to the published Australian journal on capital gain tax on small businesses, there were capital gains tax concessions put in place in the year 1999. One of the concessions which relate to this case says that, capital gains are to be reduced by 50% for assets actively used in business including the intangibles. The normal 50% discount rule on assets held for at least one year also applies. This means that 50% is deducted first, then another 50% on the remainder to give an overall 75%. Based on the above concession for the small business, Craig’s capital gains tax will be on the amount of capital gains 75% of capital gains. This is an advantage to Craig and would advise him to use that criterion of CGT on small businesses in calculating the capital gains tax. In the year 2010, Craig purchased BBF Pty Ltd for 350,000 at the age of 53 years. Still we can classify this as a small business since it meets all the characteristics of a small business. In the journal relating to the capital gains tax for small businesses, there is another concession relating to exemptions in relation to small business retirement. It states that, a person not over 55 years who is selling a business will not have capital gain tax charged on the net capital gains on amounts paid into a superannuation fund. The limit of the amount to be charged is only $500,000. Below is a table showing the capital gains of Craig:           $ sales proceeds on lofty pty ltd         4,000,000 Add: superannuation funds- limit       500,000   investments in Perth       700,000   car (50%50000)       25,000             cost base:           initial cost in lofty         (2,000,000)             capital gains         3,225,000             Therefore, total capital gains 75% 3,225,000         2,418,450             As a result of the CGT concessions on small businesses the amount of capital gains is less. In our calculations, we did not include capital gains of the spouse because they are taxed separately if the spouse does not operate the business with the other spouse (N. E. Renton, 2005). For the, we took the amount which relates to the business because any amount relating to the private use of a car is exempt. The property in Melbourne is for personal residence and such properties are exempt from capital gains. On the other hand, the investments in Perth relate to the business therefore qualify for CGT. Q2 (i) Case: Federal commissioner of Taxation vs. Anstis Facts: Ms Symone Anstis was a university student who used to fund her education using the educational youth funds. Upon completion she got a job. When her income tax was submitted to the federal commissioner of taxes, it was discovered that there are no expenses related to the educational youth fund deducted for tax purposes (Williams, 2005). The full federal court decision was that the funds were applied for the intended purpose, that is education and the view set out in the tax ruling TR 98/9 continues to apply. Therefore the commissioner of taxes made an appeal to the high court on 1st April 2009 claiming that such amounts are deductible for tax purposes. Sources from the weekly Tax bulleting indicate the reason why the commissioner appealed to the federal’s court decision is because in TR 98/9 the commonwealth schemes on which deductions are not made on are the AUSTUDY, ABSTUDY, and Assistance for isolated children scheme (AIC) and the veterans children education scheme (VCES). The other schemes like in the case of Ms Anstis who used the youth allowance fund qualify for deductions. Held: According to the article by Thomson Reuters “Weekly Tax Bulletin( 27th August 2010), the high court heard the commissioner’s appeal on the 29th July 2010, against the full federal court in Federal commissioner of taxation against Anstis (2009) 73 ATR 483. It decision is still pending and will be decided not on a later date than year 2011. The only verdict established by the high court is “until the matter is resolved the ruling that will continue to apply is the one set out in Taxation ruling TR 98/9.” That is educational expenses are not deductible against various commonwealth educational assistance schemes. The high courts decision seems to be based on the fact that it does not matter where the funds come from as long as they are used for the intended purpose which is education. Q2 (ii) According to the income tax Act of Australia the higher education contribution scheme sets out that the students who pay their fees in advance receive a discount, those who defer payment pay through the tax system (Williams, 2005). Therefore the high courts verdict is not reasonable. On the other hand, the court is fair to the defendant, Ms Anstis. The money she borrowed from the youth fund was used for educational purpose and not any other purpose. On the commissioner’s side, his appeals are based on a stated law TR 98/9 on that any other schemes that are not indicted to be classified as commonwealth schemes should have the educational funds considered for income tax purposes (N. E. Renton, 2005). I believe that’s the reason why the case still awaits to give a final verdict because the case is not fair at all when it comes to both parties. There is nothing that can be done about the high courts decisions for now since it’s the highest and the most powerful court. Whatever verdict is given by the high court is considered to be final. Therefore the case will still wait for the final verdict in the next court hearing. Taxes are the main sources of government revenue. If the courts rules out the amounts are not deductible in such cases, then it will not be protecting the government revenue (Stephen and Rob, 2009). If the revenue collected from tax is low then the economic development of the country will slow down. Most of the money collected by the government is usually used to develop infrastructure in the various sectors of the economy. On the other hand, the courts current ruling does not promote economic efficiency (N. E. Renton, 2005). This is because, for economic efficiency to exist borrowing should be paid. If the loan taken by Ms Antif is not taxed then how is a county’s economy expected to grow? References 1. Alan Reynolds, Capital Gains Tax: Analysis of Reform Options (1999). Australian stock exchange. 2. CCH Australia (2009). Australian master tax guide. CCH Australian Limited. 3. Deloitte Tax Country Guides 4. Guide to Capital gains tax, Australian Taxation Office, Publication (2005) 5. Guide to the capital gains tax concessions for small businesses, Australian Taxation office publication (2005). 6. Intangible Asset Definition at Wikinvest 7. N. E. Renton, (2005). Income tax and investment. The Federation Press. 8. R. C. Williams (2005). Capital gains tax: a practitioner's manual. Juta. 9. Rob W. and Stephen B. (2009). Australian taxation law 2009. CCH Australian Limited. 10. Thomson Reuters weekly article “Weekly Bulletin” (27TH August 2010). Read More