Australian Taxation Law Issues - Case Study Example

1 The ruling in Kennedy Holdings and Property Management Pty Ltd v. Federal Commissioner of Taxation (1992) 39 FCR 495; (1992) 92 ATC 4918; (1992) 24 ATR 321 gives explanation on the circumstances in which it is considered that: a lease surrender a receipt received in order to surrender a lease is computable income according to section 6-5 of the Income Tax Assessment Act of 1997 and also a payment to surrender a lease is deductible under section 8-1 of the Income Tax Assessment Act of 1997. The ruling also covers the application of ITAA provisions concerning capital losses and gains. Thomas obtains a lump sum payment of $ 5000 from Gino and Anna in order to surrender his interest in the lease. The surrender of the lease under ITAA is a disposal of a CGT asset. The lease is usually considered as a capital gains tax asset. The ruling does not talk of waivers or variations in the terms of a lease though it has to be noted that similar commercial outcomes may be attained by surrender and a waiver or variation of a term of lease. This verdict is applicable just to the surrender of leases of buildings and land and does not pertain to the surrender of leases that come within the function of Division 4 of Part III of the ITAA 1936. Under these rules, Thomas is therefore liable to pay tax as his disposal of his interest in the lease is considered a capital gain1. Under section 6-5 0f the ITAA Act of 1997, a receipt from a lease surrender would be of a capital nature if it was part of the profit making structure of a business. In the case of Thomas’s lump sum, the lease was part of the profit making structure of his business as it was his premises. Thomas could therefore claim that he is not entitled to pay any tax on the amount based on this assertion. Under the ruling, a receipt from a surrender of a lease would be classified under assessable income if it was received in the ordinary course of doing business of buying and selling in leases. For instance if Thomas would have been a businessman involved in the buying of leases and selling them for profit, the lump sum would have been chargeable2. The actuality that a taxpayer's trade involves leasing property from which to run a business is not sufficient to make receipt of a lease surrender income under common concepts. Whether a surrender of lease receipt is in the normal course of commerce is an issue of degree and fact to be established in the state of affairs of every one case. It is also chargeable if it is a normal incident of business. This is even when the happening was extraordinary or unusual when compared to the normal activities of the business. The lump sum would also be chargeable if the receipt makes the lessee to gain or profit from an isolated commercial transaction or business operation which has the purpose or intention of making the pertinent gain or profit3. The receipt was a profit cut off from the capital invested in the business of the firm that had come in to the recipient for his separate use, benefit and disposal. The firm had employed its capital in carrying out its business to acquire the incentive receipt. The Court noted that the matter was not equivalent to a taxpayer agreeing to surrender, or adjust, a component of its profit-earning makeup, and so the standard of the case will not be valid where the lease is a component of the capital structure of the business and the taxpayer receives the payment for surrendering the lease. The lease is part of the capital structure of the business in Thomas’s case and hence it will not apply. It has to be mentioned that this transaction has to be outside of the ordinary transactions of the business. As Thompson did not initially have the intention of profiting or gaining from the business transaction his lump sum receipt is capital in nature. Under Capital Gains Tax regulations subsection 110-25(1) a receipt of payment for lease surrender should not be included in the reduced cost base or cost base of the disposed lease as it is not part of the cost of acquiring the lease. Under section110-135 the Act asserts that it is not an incidental cost related to the Capital Gains Tax event4. The lessee usually receives no real capital income from the disposing the lease. In several unique circumstances, the market value substitution rule might determine the capital earnings for the sale of the lease, though it is highly unlikely that the market value would be more than negligible. Thomas therefore would not ask for waivers on his tax obligations ion respect to the lease acquisition as the lump sum is excluded from the amount used to acquire the lease. According to section 8-1, If a lessor makes a lease surrender payment and allows the surrender of the lease during the acquisition or production of calculable income, or in engaging in business for the reason of acquiring or producing such revenue, the imbursement would be an permissible deduction as long as it is not of a capital character. Dixon J in Sun Newspapers Limited and Associated Newspapers Limited v. FCT delineated three matters to be taken into consideration in determining if a payment is on revenue or capital account, as well as the nature of the benefit sought after by the imbursement. Hill J took into consideration the relevance of these matters in the circumstance of a lease surrender imbursement made by a lessor in Kennedy's case. The judge ruled that: By the imbursement, the applicant obtained a lasting advantage that is the surrender of the lease with its existing options. It couldn’t be said that that benefit was temporary simply for the reason that straight away after that its co-owner and the applicant were able to enter into a new lease, albeit for a more advantageous rent The second and third of the matters referred to by Dixon J in Sun Newspapers similarly support the view that the expenditure was of a capital nature. The payment was a once and for all payment, it was not paid by way of a periodical reward or outlay to cover use and occupation for some period commensurate with the payment, nor could it appropriately be said to have been recurrent in the sense in which that expression is used in the cases. The present is not a case of a company whose business consisted of granting leases and obtaining surrenders of them as part of the normal ebb and flow of the business, in which event a different view of the matter might be taken. Accordingly, it is more relevant to take the view that when a lessor who is not involved in the business of surrendering and granting leases makes a once and for all imbursement to acquire a lasting advantage, the surrender of the lease, the imbursement is of a capital character and not deductible under section 8-15. 73. If a lessor carries on a business that involves entering into and surrendering leases as a normal incident of its business, so that lease surrender payments are a part of the normal ebb and flow of the business, the payment would be on revenue rather than capital account6. When a lessor carries on a business that involves incurring recurrent outlays obtaining lease surrenders, those lease surrender payments would be revenue outgoings. Recurrent expenditure in this context refers to expenditure that is part of the constant demand of the business which has to be met out of the returns of trade or circulating capital. By recurrent expenditure it is not meant expenditure which may be incurred more than once, even if incurred on a number of occasions. Expenditure as we have already stated may still be capital, albeit that it is repeated. Recurrent expenditure is rather expenditure which is part of 'the constant demand which must be answered out of the returns of a trade or its circulating capital':7), notwithstanding that the proceeds of the insurance would themselves be capital, are examples of recurrent expenditure ordinarily on revenue account if incurred in the course of a taxpayer's business. Whether the expenditure is, in the sense used, recurrent, will depend more upon the nature of the expenditure than the number of times it is repeated8 Bank’s Perspective The relevant tax ruling is TR 95/35. This judgment applies to a individual who receives an sum as reparation. It takes into consideration the capital gains tax consequences for the receiver of the sum, and if the sum should be incorporated in the computable revenue of the beneficiary under Part IIIA of the Income Tax Assessment Act 1936. It defines punitive or exemplary damages to include any sum given by the Court or settled to by the two parties over and above the sum necessary to restitute the claimant for the injury suffered. Whether a receipt constitute capital or income depends on the circumstance of the receipt and the motivation for payment to the taxpayer9 The Federal Court is obligated to take into consideration the nature of the sum of recompense received by the injured party after a motor vehicle mishap. The Court concluded that the sum was paid as recompense for impairment or loss of the taxpayer's earning capacity, stated. In the case of the bank having lost its expected earnings in form of greater interest had the repayment period run to completion. The bank therefore was entitled to be compensated and no tax obligations would be placed on the bank. Law scholars argued that the sheer fact that reparation has been given as a lump sum and has not been broken down into its constituent rudiments is enough to treat the full receipt as capital. The circumstances and facts contiguous to the receipt may permit an allotment of the lump sum imbursement on a practical foundation into its component elements. In the bank’s circumstances, the current interest rate as at the date of the early settlement was fundamentally higher than that which applied to the rest of their preset interest rate time. As such, there was no outlay to the lender as the early settlement» put the lender in a situation to loan the money at a high level of interest than that which was to be applied to the taxpayer's borrowings. The 'early repayment advantage is not interest as it did not come out of the outlay of a capital amount, in that, the bank was not remunerated for having been dispossessed of the enjoyment and use of the principal sum10 Accordingly, the 'early repayment advantage received by the bank is not regular income and is consequently not incorporated in their computable revenue under section 6-5 of the ITAA 1997. Accordingly, the entire acquirement costs of the post-CGT asset ought to be reduced in according to subsection 160ZH (11) by the sum of the reimbursement. No capital increase or loss occurs for that asset until Gino and Anne actually dispose of the fundamental asset. In the case of a post-CGT asset, the reimbursement sum goes beyond the full amount unindexed acquirement costs (as well as a supposed cost base) of the fundamental asset, there are no CGT penalties in respect of the surplus reimbursement sum11. If an sum of reimbursement is received by the bank entirely in respect of lasting damage undergone to a post-CGT fundamental asset of the bank or for a lasting lessening in the worth of a post-CGT fundamental asset of the bank, and there is no removal of that fundamental asset at the moment of the receipt, it is considered that the sum stands for a recoupment of all or component of the whole acquirement expenses of the asset. Gino and Anna’s Perspective The relevant case law was ATO ID 2004/275. The issue is the question of whether an 'early repayment advantage, received by the mortgagees on early settlement of their fixed interest rate house loan, normal income and consequently, computable revenue under section 6-5 of the Income Tax Assessment Act of 1997. The plaintiffs took out a predetermined interest rate house loan to acquire their residence. Before the expiration of the predetermined interest rate loan, the home was put up for sale and the mortgage was paid back in full. A term of the mortgage contract was that in the happening of early, full reimbursement, the lender was able to recover an early settlement cost, in addition to an early repayment paperwork fee. A computation was performed by the lender with the intention of determining its costs occurring out of the early settlement. Such expenses happen where the current interest rate at the time of early settlement is a smaller amount than that which would have been applied to the remainder of the taxpayer's predetermined interest rate time, in that way refusing the lender the high level of interest they would have made in that time12. Borrowing expenditure are on capital account and for that purpose not deductible under section 51(1) might be eligible for deduction according to part 67. Nevertheless, penalty interest is not "costs sustained in borrowing funds" for part 67 reasons. These words, in the circumstance of part 67(1), refer to a "outlay" of borrowing; expenditure sustained in relation to the real founding of the applicable loan. The responsibility to pay penalty interest is originally incurred following the borrowing of the money, and is consequently not sustained in borrowing the funds. The sum is not made according to a contractual responsibility which was sustained at the occasion of borrowing as an occurrence of establishing the mortgage13 Section 6-5 of the ITAA 1997 affords that the computable revenue of a taxpayer comprises revenue according to usual concepts resulting indirectly or directly from all sources. The determination of whether earnings from a one-off transaction are revenue according to normal concepts depends especially on the state of affairs of the case. Where a taxpayer not doing business makes a profit, that profit is revenue if: the objective or reason of the taxpayer in engaging into the profit-making contract or process was to make a gain or profit; and the business or procedure was entered, and the income was made, in performing a trade operation or commercial contract14. In this occurrence, the receiving of the 'early settlement benefit' was secondary to the early settlement of the taxpayer's house mortgage. In addition, the mortgage contract clearly postulated that the lender had utter prudence as to whether or not it would convey to the taxpayer any profit it may gain as a result of early repayment. An objective deliberation of the Gino and Anne’s state of affairs results to a pronouncement that the main intention or reason in repaying the mortgage early was to get rid of their property. On entering the contract to repay the mortgage and by this means sell the property, Gino and Anne had no belief that they would obtain an 'early reimbursement advantage. As such, the earnings made from the business deal is not revenue as the taxpayer did not have adequate objective to profit from the deal. Read More