Taxation Law Issues - Essay Example

1. Capital event in D (receipt of 60,000) and outlaying of pool costs is more likely to be occurred since there is a contractual obligation, therefore, the cost proceeds and cost base should be identified with regards to legislation or cases. The construction of the swimming pool has had a series of costs and the question is whether the costs of the pool can be put against the proceeds to reduce the tax liability. In respect to the vacant land that BLW owns they could have a tax break against leasing it according to ATO ID 2001/338, but the question is whether the same rules apply in respect to construction of a swimming pool to the benefit of the community. Under Section 8-1 of the ITAA 1997 and expenditure will be deductible if it is incurred in gaining or producing assessable income. However, this section also puts a discretionary element into the ATO's or the Judge's determination because the expenditure has to be necessary to the actual capital gain, which brings into question the validity of the expenses that are preparatory in nature or for other purposes rather than the actual construction. The key point that this judgment made is that the determination of this and subsequent cases is in reference to all circumstances, which includes an examination of the taxpayer's purpose or intention in incurring the expenditure. If it is necessary to apportion a loss or outgoing, the appropriate apportionment will depend on the facts of each case. The method taken must be fair and reasonable as per the case of Ronipibon Tin NL v Tongkah Compound NL v FC of T [1949] (78 CLR 47). The expenditure to be deductible if it necessarily incurred for the particular income producing purpose in question, which can include limiting to an the income for just a particular year as per the case of Fletcher v Federal Commissioner of Taxation [1991] (173 CLR 1). In this case of the vacant land that was leased in the aforementioned ATO decision the owner did not purchase the land for leasing, rather private purposes so in the original sale there was no allowable deduction. Now the owner is using the land to bring in income, therefore the owner is allowed a deduction in the tax year that is expended up to the amount of the income earned but not exceeding this. In the case of the swimming pool that BLW have built on the vacant land that they own they are sure to be allowed certain expenditures on the land as allowable deductions. The first thing to identify is that the improvement and expenditure outlaid is not for private purposes, because if it were the costs would not be deductible. As the purpose of the expenditure is to build a swimming pool for the community, which will cost to enter then it is classed as a business venture and therefore valid deductions are possible from the income of $60,000 from Mulga Council. It needs to be noted that the whole profit is counted as no GST was paid because in this dealing of the monies going to BLW from the council there was a tax exemption. In relation to the $660, 000 to the builder of the pool one has to consider whether this is deductible or as this is the contractual duty that BLW owed to Mulga to get the $600,000 then it is not a deductible cost because it is the work that needs to be completed to get the $60,000. Therefore under Section 8-1 of the ITAA it is not a deductible costs; however for the other costs that are mentioned they may be deductible. Also in respect to deduction and depreciation under CGT and cost bases this property fulfills the requirement, which is that the land is improved to enhance the value of the land. Therefore any expenses incurred under the principle of the fourth cost base can be deducted for the actual improvement. This is confirmed in the ITAA 1997 subsection 110-25(5); however as the decision of ATO ID 2001/665 reflects: For expenditure to be included in the fourth element of the cost base of an asset under subsection 110-25(5) of the ITAA 1997, it must be incurred 'to' enhance the value of the asset; i.e., for the purpose of enhancing the value of an asset. It is immaterial whether or not the expenditure in fact enhances the value of the asset. This will be very important in subsequent points to determine which costs are deductible and which are not; however we do know that certain costs under CGT are covered under CB4. 2. Is the swimming pool a depreciating asset, hence, the expenditure should be deductible by using either the Diminishing value method or Prim cost method, Div 40 in 1997 act, but is it within the definition of capital work in Div 43, then the important point for which provision prevails is that whether the swimming pool is a plant or not, if it is, Div 40 would apply as expenditure is deductible under depreciating asset, otherwise, div 43 would apply In respect to CGT on the improvement of the land there may be a certain amount of deduction on the basis that the asset is depreciating. This will be discussed in the next point; however prior to going in the role of depreciation the consideration of CGT and the improved land will be discussed in general. Under CGT a property that has been improved can be depreciable if the improvement is in favor of carrying out a business and the improvements are completed and ready for use within the tax year. In this case the land is considered an active asset because it is in use for business purposes and all improvements were completed by the end of the tax year; therefore under CGT it is depreciable, as per the Taxation Board Case [1956] 6 CTBR(NS) Case 24 where finished improvements were depreciable, whilst unfinished property is not: 'Thus, under the Assessment Act prior to 1936, ordinary depreciation was allowable on property being plant etc. owned and used for the production of income(s.23(1)(e)(i) ). Thus as a fundamental requirement for the allowance the relevant 'property' had to be functionally operative in the taxpayer's business. This idea was preserved in the 1936 Act, which, as well, extended the allowance to property being plant, etc., installed ready for use and held in reserve (vide S. 54). The choice of the word 'ready' in that section is indicative of the requirement of functional operability at relevant times...' Therefore the cost base of the property can be deducted under CGT provisions, because the property is now depreciable. Therefore it needs to be determined which format can be used to work out the deduction for the depreciating asset. It must be noted that the life of the swimming pool is only 50 years. Therefore there are two possible ways under CGT and depreciation for the owner of the improvement to work out the loss in value per year and can be used against the property for a tax break. If the swimming pool only has a life of 50 years then if it can be determined how much per year that the swimming pool development loses each year. If it is determined that it is a plant then it would use the prime cost formula in ITAA 1997 40-75(1). This can be done on a yearly basis through the following formula: Assets cost * [days held] * 100 % = years deduction 365 assets life Therefore say that the complete cost is $650,000 before GST then the swimming pool deduction is: $650,000 * [92/365 = 0.252] * 2 = $327,600 Until we can determine what the exact cost of the asset is that is allowable under this one has to wait to determine the allowable deduction, because as already mentioned there was the $600,000 that was paid by Mulga Council therefore reducing the cost of the building. Therefore if not classed as income it is a reduction of the costs under the contract with Mulga council therefore nullifying the $660,000 of the builder's costs because the $60,000 GST is not deductible therefore resulting in $600,000 in builder's cost; hence reducing the cost by the $60,000. It is more likely that this formula would be used rather than the diminishing value method because all the factors are available and as Section 40-75(1) states if all the values are available for this method then this is the formula to be used. However, the problem is whether this asset is a plant or not To be a plant it must be a primary production unit under Subdivision 40-F ITAA 1997, a swimming pool is not a primary producer for any product; however it is also not a unit that is selling a product bought from a manufacturer. It is in fact a leisure facility therefore could possibly be identified as a plant under the ITAA. If it is not a plant then it is common property and it cannot use the format of depreciation in 40-75(1) ITAA 1997 as per Subdivision 42 ITAA. However, the decision in ATO ID 2001/130 it was determined that a swimming pool that is functioning on business purposes, i.e. not a private facility. This is the case with the Mulga Council Pool as it is a community pool offering a service that costs money. The ATO ID 2001/130 determined that a pool can be a plant because: In determining whether an item is plant, it is necessary to establish whether the item may be regarded as apparatus used by the taxpayer in carrying on a business. It is also necessary to determine whether the function of the item is such that the item may be regarded as plant and not just as a convenient setting for the operation of the business as per the case of Wangaratta Woollen Mills Ltd v. FC of T (1969) 119 CLR 1. Therefore the Mulga Council pool is a plant under section 42-18 ITAA 1997 as a plant; hence the aforementioned prime cost formula would be applicable to ascertaining the allowable deduction under CGT and income tax on a depreciating asset. However, it must be noted that the pool must be the primary part of the business in question. Therefore in this case this pool is the primary factor it is not a mere setting for the business. If it is an additional service it cannot be classed as a plant unless it is integral to the business; therefore if it is more than a mere setting the costs would be depreciable under section 40 of the ITAA. This has been confirmed by the courts in Australia following the UK ruling: Cooke (Inspector of Taxes) v. Beach Station Caravans Ltd [1974] 3 All ER 159, where it was concluded that swimming pools and their attendant apparatus that are constructed for the use of customers of a caravan site are plant (ATO ID 2001/130). 3. Is the expenditure for removing the earth is under project pool in Div 40 I, as it is a preparation of project, which is not deductible under section 8-1 as general deduction and the depreciating asset The removal of the earth is questionable as an appropriate deduction, because under section 8-1 of the ITAA it is a preparatory cost and not a direct cost in the construction of the asset. If it is determined not to be a direct cost then it must be deducted from the overall cost of the pool when determining the cost of the pool in respect to the tax cost of depreciation. Also in income tax terms this cost is not deductible in the tax year in question, because it is not a general deduction. The removal, dredging and preparing of earth is not considered a general deduction under section 8-1 ITAA 1997, rather it is readying the land for construction as decided in the decision ATO ID 2001/78, which reiterated the provisions in the Taxation Laws Amendment Bill No 3 of 1993 (Act No.98 of 1992) re-affirming Division 10D of the Income Tax Assessment Act 1936, where any earthworks, such as removal in the Mulga Council case that affect the usefulness of land are not to be treated as integral to the construction of a structure : The filled in land, although improved, was not in itself a 'structural improvement' in the ordinary sense of the term. Also, the filled in land was not integral with the structure subsequently constructed on that land, as the improved land was merely land on which almost any type of construction could have occurred (ATO ID 2001/78).. Therefore the $200,000 needs to be deducted from the allowable costs in respect to the depreciation, as well as can not be put against the $600,000 that Mulga Council paid to BLW. 4. Does the Penalty fall within the general deduction provision or not deductible or something else The penalty clause, which is due to a breach of contract, cannot fall under section 8-1 ITAA, which to re-iterate states: 'For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing assessable income" mean in the course of gaining or producing such income. (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).' In this case the cost is nothing to do with a cost to the construction of the swimming pool, but a penalty imposed for breaching the completion date of the pool. As BLW was able to ensure that it was finished on time, i.e. there was no frustrating factor, the cost is not deductible. Along a similar vein the case ATO ID 2002/902 determined that damages in breach of contract are not deductible, which is in line with the case of Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431. Therefore as with the earthworks this cost is not deductible from any income tax this year a factor of CGT depreciable assets under Division 40. 5. Advertising expense occurred before the business and during the business Advertising costs are also a non-deductible expense under section 8-1 ITAA 1997, because they are a capital expense. The advertisement is not for the improvement of the land; rather it is to bring in capital and to promote a future business. This is even more apparent because the business is not even opened yet; therefore it is similar to the case ATO ID 2001/796 where a rental property was vacant and the owner decided to advertise to sell, rather than promotion of the property for rental. In addition the case of ATO ID 2003/564 came to decision that even advertising costs for a current business in the line with its industry is not a deductible expense under section 8-1 ITAA 1997. This case used court judgments to back up its ruling, the primary case was Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation [1938] (61 CLR 337) where it stated that the in character of capital costs: Three matters need to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. In the Sun Newspapers Case the case of British Insulated and Helsby Cable Ltd v Atherton [1926] (AC 205) was reconfirmed where a capital expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. Therefore in the case of improving the land by constructing a swimming pool will have allowable costs; however the advertisement of this is not included as it will bring in capital. Hence this will be another non-allowable cost either for general income tax deductions and incidental cost base for the depreciation under the CGT provisions, because if a cost is not allowable under section 8-1 ITAA 1997 it would not be allowable under as incidental cost base for CGT. 6. The replacement of the tiles- is this deductible under Repair sec 25-10 or deductible as a depreciating asset under second element of cost in sec 40 The replacement of the tiles is due to fault of the builder and not due to the 50 year depreciation of the pool, therefore C2 does not apply. It is more likely that it is deductible under 25-10 ITAA 1997 because it was incidental and part of a depreciating asset. This was confirmed in the decision ATO ID 2001/49, which reconfirmed the case of FC of T v Western Suburbs Cinemas Ltd [1952] (86 CLR 102) that held in lieu of effecting repairs to part of 'an entirety', that part which is replaced with something different, and is an improvement on the original part, no deduction is allowable for the amount, which it is estimated the repair of the part would have cost if the repair had, in fact, been effected (ATO ID 2001/49). As BLW repaired the unsuitable tiles in entirety and never added on then the repair would be deductible under 25-10 ITAA 1997. If the cost was directly in line with the depreciation of the building then the second cost base of 40 ITAA 1997 would apply. Therefore this cost is deductible from the current years profit but does not contribute to the cost of the pool in respect to the yearly depreciation calculation. 7. GST implications for each of the cost: Any of the costs that are deductible under section 8-1 ITAA 1997 can include the GST component. Therefore this would include the repair to the pool tiles, the installation of the pipes etc but not the advertising, excavation penalty or the builder's costs; however any costs that are GST exempt are not applicable. In respect to CGT and the depreciation costs the GST costs are included but depreciation is factored into the reducing cost of the asset. These principles are not only in 8-1 ITAA 1997 but also the A New Tax System (Goods and Services Tax) Act 1999 (GST ACT) whereby: Under section 11-5 of the GST Act, an entity makes a creditable acquisition if: * it acquires anything solely or partly for a creditable purpose; and * the supply of the thing to it is a taxable supply; and * it provides, or is liable to provide, consideration for the supply, and * it is registered or required to be registered for GST (ATO ID 2001/255). Read More