Income from Personal Exertion - Assignment Example

Question 1 Income from personal exertion refers to income one earns in payment for one’s efforts and skills (Australian Taxation Office 1991). Therefore the $10,000 Hilary received from the Daily Terror newspaper when the newspaper published her story is not income from personal exertion. It should be noted that Hilary has never written before. In fact, she is not a professional writer; hence she may be lacking writing skills. The $5,000 she received when she sold the manuscript to the Mitchell Library, as well, is not income from personal exertion. However, the $2,000, the proceeds from the sale of her mountaineering photographs is income from personal exertion. This is income from her professional sport, mountain climbing, where she employs her skills to gain. The answer would be the same if she wrote the story for personal satisfaction and then later sold it. The proceeds from the story would not be income from personal exertion since she did not write with an intention of selling it. Of course she shall have earned income, but it is not a personal service income. Question 2 The Australian Taxation Office (2016) defines assessable income as the income which is subject to taxation. It is any income earned above one’s “tax-free threshold.” Since there was no neither a formal agreement nor security involved in the transaction between the client and her son, the $40,000 the client loaned her son was a kind of a gift to the son. However, the son repaid the money after two years with interest equal to 5 percent per annum. This 5 percent interest which translates to $4,000 is a gain to the client. This gain is an income subject to tax hence forms part of the client’s assessable income: it has an increasing effect on her assessable income. Question 3 Introduction Business people and corporations acquire capital assets for investment purposes – so as to earn income from them. A capital asset is any depreciable property which results in capital gain or loss when sold (Investopedia 2016). Examples of capital assets are landed estate, machinery, structures and all forms of mutual funds (Canada Revenue Agency 2013). Even though no businesses anticipate losses, an asset may decline in value, resulting in a capital loss. How to treat capital gains is a touchy issue in taxation. This is because taxation decreases the level of one’s income, hence, affects financing and investment decisions. The capital gains made ought to be considered together with the taxable assets since they accrue from appreciating property. Capital gains will, however, be subject to taxation only when the property is sold (Burman 2009: 2). In Australia, like in several countries, capital gains and losses are considered for taxation upon sale. The tax rate for capital gains depends largely on the holding period. Financial Dictionary (2016) defines the holding period for a capital asset as the duration from the time a capital asset was purchased up to that moment when it was sold. The capital gain is classified into two when defined in terms of the holding period: it is short-term when the asset was sold within one year after its acquisition, and long-term if the asset was sold after one year. While a short-term capital gain is subject to the usual income tax rate, a half of the long-term capital gain is exempt from taxation (Piper 2014). This implies that holding on to a capital asset for more than a year before selling it is preferable to selling it within a year of its acquisition. Burman (2009: 2) confirms that “since the top tax rate on ordinary income is 46.5 percent, this makes the top capital gains tax rate 23.25 percent.” This confirms further that holding a capital asset for a longer period is a worthwhile consideration. The need for concessional taxation has been a topic of argument. High rates of tax, it has been explained, may be detrimental to economic growth. Since most capital gains are realized from assets prone to risks, it follows that high taxes are likely to discourage business people from considering (Burman 2009:3). It has also been observed that capital gains are eroded by inflation. Furthermore, there are chances of double taxation if the gains on corporate shares and unit trusts are taxed. These capital gains, observes (Burman 2009), are incomes that form part of the corporation tax. This boils down to one observation: if capital gains are taxed highly, savings will be discouraged to some extent. To avoid high taxations on capital assets that appreciate, property owners would prefer holding on to their assets, a case referred to as the “lock-in effect” (Abeysekera & Rosenbloom 2002:1623). The lock-in effect should be minimized since the capital gains tax makes investors to “postpone reallocation until the return differential is sufficient to offset the capital gains taxes imposed on the disposal of assets.” (Abeysekera & Rosenbloom 2002: 1623). This causes distortion in financial markets. (a) Determining Scott’s net capital gain or loss Before determining the net capital gain, capital gain is determined first. Capital gain is realized when upon the sale of a capital property, the proceeds are more than the price at which the property was purchased (Asset Preservation Inc 2016). The net capital gain is realized when net long-term capital gain is more than the net short-term capital loss (Global Property Guide 2015). Hence net capital gain is: “total capital gains for the year (including those distributed by a managed fund or trust) minus total capital losses (including any net capital losses from previous years) minus any CGT discount and small business CGT concessions” one is entitled (Australian Taxation Office 2016). Since the cost of land on 1 October 1980 is not provided, we shall use the deemed cost. The deemed cost is arrived at using a discount rate based on the present value tables. The discount rate for 1986 was 8%. A discount rate of 8%, for 6 years (1980 to 1986) corresponds to 0.5963 in the present value table. Hence the deemed value of land was: = 0.5963 x $90, 000 (value of land in 1986) = $53, 667. To arrive at the value of the house in the current tax year (1996), we shall use the deemed value. (NB: We shall assume that the current tax year is 1996) A discount rate of 9%, for 10 years (1986 to 1996) corresponds to 2.3674 in the future value table. Hence the deemed value of the house is: = 2.3674 x $60, 000 (value of house in 1986) = $142,044. (i) Scott’s net capital gain from the land Hence, the deemed value of land (1996) is the total proceeds from the property less the value of the house. Thus: = $800, 000 – $142,044 = $657,956 Therefore, Scott’s capital gain = capital proceeds – cost of land. = $657,956 - $53,667 = $604,289. However, the land is not subject to capital gains tax since it was acquired in 1980 before the introduction of capital gains tax in Australia, in September 1985 (Burman 2009: 3; The Treasury 2006). This follows that Scott’s net capital gain for land is $604,289 since it is not affected by taxation. (ii) Scott’s net capital gains for the house The capital gain for the house is deemed value (in 1996) less cost of purchase (in 1986). Since the house was constructed after the introduction of the capital gains tax (CGT), it is subject to a CGT rate of 23.25 percent, which is 50 percent of the normal tax rate of 46.5 percent (Burman 2009: 3). Hence capital gains tax is: 23.25% of $82,044 = $19,075.23 Therefore: net capital gains = $82,044 - $19,075.23 = $62,968.77 Scott’s net capital gain for the property is the sum of net capital gains for land and that for the house. Thus: net capital gain for the property = $604,289 + $62,968.77 = $667,257.77 (b) Net capital gain or net capital loss if he sold the property to his daughter for $200,000. If Scott sold the property to his daughter for $200,000, the transaction would be considered as a gift, which is not subject to taxation since there is no gift tax in Australia. However, the tax office may interpret the exchange as a way of evading tax (Whittaker 2015). In such a case, the tax office has powers to tax the property. It is important to note that if the tax office taxes the property, the market value will be used. Consequently, what will be subject to tax is $800,000 which is the property’s market value. So the $800,000 would be the capital proceeds even if the property were to be sold for $200,000, amount much less than the market value. So the house would be subject to the same tax rate as in (a) above. Likewise, the land would be exempted from the capital gains tax for the same reason as in (a) above. The net capital will be the same as in (a) above. (c) If the owner of the property were a company instead of an individual In that case, the net capital gain for the land would be as in (a) above ($604,289) since it was not subjected to capital gains tax. The house, however, would be subjected to corporate income tax of 30 percent (Global Property Guide 2016) Hence capital gain = $142,044 –$60,000 = $82,044 So corporate income tax = 30 percent of $82,044 = $24,613.2 Therefore the net capital gain from the house is capital gains less capital gains tax. = $82,044 - $24,613.2 =$57,430.8 There are some loose ends which make it impossible to establish the amount of rent income the property yielded. For one, the duration the construction took is not given. Likewise, we do not know the duration under which the property was tenanted. In addition, ascertaining the rent charged is impossible as the figures are not provided. References Abeysekera, S. & Rosenbloom, E. (2002)The Capital Gains Lock-In Effect: Deciding Whether to Hold or Switch [online] available at https://www.ctf.ca/.../2002ctj5_abeysekera.pdf [16 August 2016] Asset Preservation Inc. (2016) Capital Gain Tax Calculator [online] available at https://apiexchange.com/capital-gain-tax-calculator/ [18 August 2016) Australian Taxation Office (1991) “Income Tax: Personal Services Income” [online] available at https://www.law.ato.gov.au/atolaw/view.htm?docid=ITR/IT2639/NAT/ATO [20 August 2016] Australian Taxation Office (2016) “Working out Your Capital Gain or Loss”, [online] available at [18 August 2016] Burman, L. (2009) “Taxing Capital Gains in Australia: Assessment and Recommendations” [online]www.urban.org/.../411857-Taxing-Capital-Gains-in-Australia-Assessmen... Canada Revenue Agency (2013) “Capital Gains – 2015” [online] available at [17 august 2016] Global Property Guide (2015) “Taxes Are High in Australia” [online] available at https://www.law.cornell.edu/uscode/text/.../12... [16 August 2016] Financial Dictionary (2016) “Holding Period”, [online] available at financial-dictionary.thefreedictionary.com/holding + period [online] Internal Revenue Service (2016) “Tax Topics - Topic 409 Capital Gains and Losses” [online] available at https://www.irs.gov/taxtopics/tc409.html [17 August 2016] Investopedia (2016) “Capital Gain” [online] available at http//www.investopedia.com [18 August 2016] Piper, M. (2014) “Capital Gains and Losses: Short-Term and Long-Term”, Oblivious Investor [online] available at www.obliviousinvestor.com [16 August 2016] The Treasury (2006) “A Brief History of Australia’s Tax System", Economic Roundup Winter2006 [online] available at [18 August 2016] Whittaker, N. (2015) “Gift Tax”, The Sunday Herald [online] available at www.smh.com.au/money/ask_an_expert/gift_tax_20150317_1m1djc.html [17 August 2016] Read More