The Income Tax Assessment Act 1997 - Case Study Example

Taxation Law As Barrister, what Roger Raymond needs to be told with regard to offsetting the losses is the provisions of different Acts. To begin with, the advice should be pegged on provisions as contained in Division 35 of the Income Tax Assessment Act 1997 (herein refers to as ITAA 1997). Basing on this provision, Roger Raymond is restricted from offsetting losses that emanate from activities that are not commercial and such are against other income 1(as a barrister). Working with Division 35 as the basis of determining Roger Raymond’s situation, it gives a framework that helps in determination of whether losses incurred from a business activity can be offset against other sources of income. S 35-5(1) outlines that Division 35 prevents Roger Raymond from losses coming from non-commercial activities undertaken on as business by him and being offset by other assessable income. While it is not clear whether Roger Raymond had other assessable income, the Division is, therefore, on the surface very simple---alleviating or preventing losses from non-commercial related activities that are offset against other sources of income. It has to be made to Roger Raymond that Division 35 has some underlying complexities. For instance, in the process of undertaking horse racing he should be aware of; Operation of the deferral rule Identification as well as separation of a particular business activity The grouping principle and The four principle tests that clearly (prima facie) determine the applicability of the loss deferral rule Coming back to the aspect of business or ascertaining whether the ‘horse racing’ as Roger Raymond terms it amounts to business or business activity, the law pertaining to its definition still fails in a number of ways.2 Additionally, Division 35 brings another layer of complexity to existing jurisprudence concerning the notion of ‘horse racing.’ At this juncture, Roger Raymond should be told that it is preferable for the legislature to bring a statutory definition of income focusing on the common indicia of his ‘horse racing’ or still, hobby style activity. Another complexity is whether the horse racing as loved by Roger Raymond is unlikely to ever make a profit and at the same time do not have a meaningful commercial significance or character. Concluding on whether the activity is a business, the statutory underpinning of a business activity that should satisfy (i) a reasonable ability to make profits and (ii) intent of profit making is clearly met by his explanation such as “He would much prefer to return a profit on his horse racing activities…” Loss Deferral Rule This aspect is introduced by Division 35 and such has been effected by s 35-10(2) which had been in operation from the income year 2000-20013. Essentially, s 35-10(2) seeks to establish; Who is Roger Raymond (the person carrying on a business4) Whether Roger Raymond can be prevented from offsetting losses in the process of horse racing5 and Against his assessable income from or “a successful Barrister” for that income year. Therefore Roger Raymond should be informed that any loss emanating from non-commercial business related activities has always been treated as though it was not incurred or accrued by him in the income year but he has a chance of this being carried forward as a loss according to s. 35-10(2). Therefore, it remains that losses that he will make from horse racing and such have been deferred in accordance with 35-10(2) are considered as prima facie quarantined and therefore meaning they can only be offset against any accrued profit(s) of the related business engagements in the subsequent or future income years in accordance with s 35-10(2)(b). Another critical information that Roger Raymond should be made aware of is that the carry forward loss that has been accrued may in some instance be offset against his other income carrying on the related business activity in an income year in which his purported business activity can meet at least one of the four set threshold tests in accordance with s 35-10(1)(a) (the threshold will be discussed briefly later). In as much, the said prima facie simple loss deferral may be complicated for Roger Raymond. The complexity here is that what about a case where the income he is likely to earn from horse racing that now, for instance, meets one of the four set thresholds test is not enough to absorb the carry forward loss? From this point, he should be informed that provided that one of triggers for permitting the loss offset has been fulfilled, any possible deferred loss emanating from an earlier income year will again not be deferred when Division 35 is considered. Accordingly, in case the horse racing realizes what he terms as “cost often outweighs the return” as well as the deferred losses theattributable to his business activity will be offset against possible assessable income from his barrister related activities. This is to mean any deferred losses will no longer be quarantined. Assuming that Roger Raymond explains or it is apparent that his barrister related income will not be enough to absorb all of the losses relating to his horse racing, then in such case any remaining Division 35 losses will be considered as normal carry forward tax related losses. In fact, under Division 36, these losses will have the same treatment as any other carry forward loss. In reality, provided that exceptions or threshold tests are applicable, the deferred losses are no longer quarantined to the horse racing as a business activity. There is also a likely scenario with horse racing as a business activity. The scenario is, in case the activity does not meet the above discussed criteria for loss offsetting but in the process, makes a profit in a subsequent year of income. In an income year that Roger Raymond will be able to make a profit but again fails to pass any of the four threshold tests as set, there will be losses deferred from years before being offset to the extent of profit made in the income year where profit was made. It translates that the loss that Roger Raymond’s business will have deferred will be reduced to the extent of the profit that has been made in that income year. His balance will therefore become the Division 35 loss for the same year thus deferred in accordance with s 35–10(2). Looking at s 35-15(1) loss deferral rule can be modified for an income year if Roger Raymond (in this particular paragraph considered as a taxpayer) derived exempt income as per s 35-15(1). If this is the case, a loss that would otherwise be carried to a future income year in accordance with s 35-10(2)(b) will first have to be reduced by amount of any net exempt income of Roger Raymond that is not applied for his particular income year in accordance with ss 36-10 and 36-15. Roger Raymond will have this reduction made before he applies the s 35–10(2)(b) money or income against assessable income horse racing s 35–15(2).6 The discussions above note that the deferral rule can apply if the allowable deductions of the business Roger Raymond engages in exceeds the assessable income of the very same business activity for the income year in question. While this discussion notes that the deductible amounts given to his business activity should include all amounts that can be subjected to deductions under ITAA 1997 and Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’), and not just s 8-1 ITAA 19977. This exemption means that pursuant to Taxation Ruling TR 2001/14, the provisions do not necessarily apply to amounts and figures that are uncured horse racing has ceased. However, this comment when it comes to ruling concerns long tail liabilities that can continue to be deductible as per s 8-1 ITAA 1997 in as much as there a case where they have crystallised and turned to be incurred after the stoppage of a business within the reasoning in Placer Pacific Management Pty Ltd v FCT.8 The rule governing deferrals functions differently where there is cessation of non-commercial business activity. As already presented above, in most cases, in accordance with the loss deferral rule the loss can be attributable to the next income year. In as much, if the race horsing ceases, while there was carrying forward of the loss, it only becomes deductible in his income year if, and only when, horse racing is conducted. If horse racing is not reestablished, its cessation as business insinuates that any unused deferred losses are consequently forfeited.9 Threshold Tests Threshold tests have been included in this section so as to allow Roger Raymond connect with loss deferral rule as discussed above. The legislative decision underpinning the framework of Division 35 for deciding what activities would be subject to the loss deferral rule was the inception of the following tests: Real property test Assessable income test Profit test and Other assets test While the above tests have focused entirely on the profitability as well as the size of the race horsing as business activity, indications from the hobby v business dichotomy10, there are a number of criticism that Roger Raymond should be informed about.11 Assessable Income Test This is a critical issue that horse racing as a business activity should be made aware of. The deferral rule will not be applied to race horsing if in the subject income12 year the assessable income from race horsing is at least $20,000 pursuant to s 35-30(a). Again, what is Roger Raymond’s assessable income is complex under Division 35 and cannot be assumed to be only the engagement as barrister. Again, according to Explanatory Memorandum an estimate rather than a pro-rating will be necessary where seasonal variations should be taken into consideration when making determination of the assessable income for his income year.13 Profit Test The fundamental basis of this test with regard to the case of Roger Raymond is that loss deferral rule may not apply to horse racing for a given income year, if, for each of at least three of his past five income years, (and such has included the current year in which the loss may have arisen), the horse racing has managed taxable income pursuant to s 35-35(1). The issue that the client should be told is how the test will be dealt with now that horse racing has not been in operation for more than five years. However, the starting point is Taxation Ruling TR 2001/14 [62] that states that it is not needed that race horsing be done for five years. It suits especially, when horse racing makes a profit in three out of four years of its operation.14 Pursuance to ATO Interpretative Decision ID 2003/407, where is continuity in horse racing, then the above statement becomes futile since the profits Roger Raymond would have made will be taken into considerations for the same purpose. Real Property Test In accordance with s 35-40(1), under the third threshold test, the loss deferral rule will not be able to apply to a racing horse for Roger Raymond’s income year in case his total values of real property used in carrying on the race horsing in that year is estimated to be at least $500,000. The complexity in this test is that the legislation allows Roger Raymond to make a choice on whether to use the value of his real property or opt for the value of the interest in the real property.15 On the same note, this report finds it necessary to furnish Mr. Roger Raymond with information concerning the determination of the value of the real property. According to legislation, there is use of the market value or in some instances, the reduced cost base.16 Again in accordance with s 35-40(2) Roger Raymond has the obligation to use the interest or the market value of the real property where the market values are able to exceed the reduced cost base. S 35-40(4)(a) excludes certain assets though this information is not relevant for Roger Raymond. Other Assets Test The other assets test holds that the loss deferral rule may not apply to a horse racing for an income year in case the total value of his assets (with an exception of real property assets) that has been used in the business activity in the trading or income year, is at least $100,000 as per s 35-45(1). To this extent, Roger Raymond should be taken through table as contained in s 35-45(2) where there is a set of a number of rules that are needed to accommodate a number of assets that might be included in the other assets test and thereafter how to estimate their value. Read More