BULAW5916 Income Tax Consequences Assignment Sample

Taxation Law And Practice 

Table of Contents

Question 1

Part 1 – Income tax consequences

Part 2 – Income tax consequences if agreement was entered into on August 1 1993

Question 2

References

Question 1

Part 1 – Income Tax Consequences

The scenario depicts that ABC Ltd is an Australian Company that engages in a diversified nature of merchandising and financial business. It further comprises of an agency agreement with an Indian shopping company, which the parties signed on August 1st, 1985. The duration of the contract was established as 30 years. However, the contract was terminated due to restructuring within the Indian shipping company after 24 years of being in operation. Based on a calculation of the estimated profits for the subsequent six years, a sum of $4 million was arrived at, which the Indian shipping company paid without any questions. In terms of the profit ratio, the business with the Indian shipping company amounted to roughly 60% of the profits of ABC Ltd. Upon cancellation, the minor activities of ABC Ltd. related to shipping were terminated.

Considering the specifications of the scenario, it would be important to discuss the nature of the income that was generated by ABC Ltd. considering it was an Australian company. Section 6(1) of the Income Tax Assessment Act 1936 defines the term resident in the context of a taxpayer (Federal Register of Legislation, 2020). Three elements are predominantly highlighted within the definition including the incorporation of the company within Australian territories, the company carries on business within Australia and its voting power and management are comprised of Australian residents.

Considering the specifications of the scenario as mentioned above, ABC Ltd. would be considered as a resident company, and therefore would be subject to the taxation system within Australia in accordance with the ITAA36, ITAA97 and the Taxation Rulings of the Australian Taxation Office. The judgment passed in the matter of “Bywater Investments Limited & Ors v Commissioner of Taxation” is relevant in this regard as it led to the establishment of the Central Management and Control Test (High Court of Australia, 2020). TR2017/D2 is also relevant in this regard, which further solidified the aspect of a resident company within Australia by stating that the place of central management would be located where the critical decisions of the company are made (BDO Australia, 2018).

Establishing the fact that ABC Ltd would be considered as a resident company, the next important step would be to determine whether the income generated by the company in terms of the consideration would be classified as assessable income. Assessable income within Australia is primarily classified into statutory income and ordinary income. While income derived from ordinary concepts does not find any specific definition within ITAA36 and ITAA97, the general rule of law typically includes three categories of incomes as derived from ordinary concepts. The most prominent among them include the profits from personal exertion or salaries, profits from running a business and profits from the property such as rents or dividends.

The judgment passed in the matter of “Commissioner of Taxation v La Rosa [2003] FCAFC 125” is relevant in this regard, as it established how the income from any business activity, whether lawful or unlawful, would not interfere with the aspect of its taxability (Parliament of Australia, 2020). While the key fundamentals within the case law related to the prohibition of deductions where the taxpayers engages in an indictable offense, an underlying essence of the judgment were certainly aligned with considering income from business activity as ordinary income provided that the taxpayer was a resident Australian. Naturally, the $4 million generated by ABC Ltd as part of the lump-sum payment due to the early termination of the agency agreement would be considered as part of their ordinary income as it was directly linked to their business activities.

Considering how ABC Ltd has been established as a resident company and the income has been classified as an ordinary income, it would be important to determine the accounting methods chosen by the organisation. While it has been mentioned that the $4 million was paid as a consideration for the future profits of the company for the reaming six years of the contract, the entirety of the amount would be taxable since it was paid in a lump sum. However, the amount that is taxed would depend on the chosen accounting method utilized by the company over the years.

Section 8 of TR98/1 allows for resident taxpayers to calculate their taxes based on the Receipts method, which is often referred to as the cash received basis or the cash basis (Australian Taxation Office, 2020). The derivation of the income is dependent on the receipt either in actuality or in construct. Provided that ABC Ltd relied on the receipts method, the $4 million received in consideration for 6 years of the remaining contract period would be broken down into 6 parts and taxed on a yearly basis or as directed by the taxpayer.

Similarly, Section 9 of TR98/1 allows taxpayers to calculate their taxable income through the earnings method, which is often referred to as the accruals method or the cash and credit method (Australian Taxation Office, 2020). The derivation of the income is considered to have taken place as and when it is earned. Furthermore, the point of derivation is also important, as it begins to exist as soon as a recoverable debt is created. Considering that ABC Ltd relied on the earnings method to calculate their taxes, the $4 million would be taxed on the year of receipt in entirety based on the marginal tax rate of the company.

Important case law in this regard relates to the judgment passed in the matter of “Henderson v. FCT (1970) 119 CLR 612”, which led to the establishment of a recoverable debt based on the performance of a mutually agreed-upon task (High Court Of Australia, 2020). It would be safe to assume that ABC Ltd and the Indian Shipping company had mutual agreements that related to carrying on business activities, based on which the Indian shipping company paid the $4 million as consideration for termination of the contract due to restructuring.

Part 2 – Income Tax Consequences if Agreement Was Entered Into on August 1 1993

Given the scenario, the agreement between ABC Ltd. and the Indian Shipping company came into existence on the 1st of August, 1985 and was in effect for 24 years, which marks the year of termination as August, 2009. Considering that the year of entering into the contract was August 1993, the contract would have been in effect for a period of 16 years. In terms of the income tax consequences, Section 230.5 of the Income Tax Assessment Act 1997 would be applicable that relates to the classification of profits derived from financial arrangements (Commonwealth Consolidated Acts, 2020).

The sum of $4 million received by ABC Ltd would be classified as financial arrangement, where the consideration to receive a benefit would be the key criteria had the contract been in operation for the remaining period. Additionally, GST would also be applicable for the period of operation of the contract post 2000 in accordance with the provisions contained within Section 188.24 of A New Tax system (Goods And Services Tax) Act 1999 (Commonwealth Consolidated Acts, 2020).

Additionally, the business use of the term agent would also come under the purview of the consideration received by ABC Ltd. for the termination of the contract. The case of “International Harvester Company of Australia Proprietary Limited v. Carrigan's Hazeldene Pastoral Company” would be relevant in this regard, where the restriction on the usage of the agent in a business relationship was essentially removed by the judgment passed (High Court Of Australia, 2020). The sum of $4 million would be treated as a lump sum financial arrangement received and would be taxed within the year of receipt irrespective of the chosen accounting method by ABC Ltd.

Question 2

Capital Gains Tax has long been present within the Australian taxation system and applies to every CGT event in the context of gains made from the sale of a property. Section 104.10 of the Income Tax Assessment Act 1997 covers the provisions of CGT events along with the prospects of a change in ownership of the asset and the subsequent gains or losses that are derived from the change (Commonwealth Consolidated Acts, 2020). The cost involved with the acquisition of the property along with the base value of the property is typically considered when determining the price of the property on the whole.

Similarly, the costs involved in changing the ownership of the property or in other words, disposing off the property along with its base value during the time of disposal is considered when the selling price is considered. The net capital gains or losses is essentially the difference between the price required to acquire the property and the price required to dispose of the property including all of the stipulated overheads.

It is important to state that several capital goods and commodities along with a change in their in ownership do not come under the purview of a CGT event. The assets or the transaction involving the assets are specifically exempt from the consideration in this regard. Prominent examples include personal assets such as residential homes, motor vehicles, furniture and others. Furthermore, a CGT event would also not bring into consideration depreciating assets that are used for taxable purposes like business equipments or rental property fittings (Australian Taxation Office, 2020).

It is important to state that the loss incurred within a CGT event is allowed as an offset against capital gains. However, the offset can only be made on capital gains and not any other ordinary of or statutory income that does not find relevance to a CGT event. Another important point of consideration is the point of the imposition of the liability of the capital gains tax. The entering of the contract to dispose of the property is considered as the point of incidence of the tax liability as opposed to the settling of the contract (OECD, 2020). Furthermore, the CGT liability would be applicable to assets disposed off in any part of the world provided the residency requirements are fulfilled.

The purchase price of the land was $1.33 million for ABC Ltd. and the cost of the building erected amounted to $5 million. Subsequently, the building along with the site, on the whole, was sold off for 11 million due to the termination of the agency contract for which the site was acquired. The organization went on to state a profit of $4.58 million in respect of the change of ownership of the property.

Based on the above specifications, the purchase price of the site was $1,330,000 and the costs for the building were $5,000,000. Cumulatively, the price of acquisition would stand to be $63, 30,000. The sale price of the site inclusive of the building was identified as $11,000,000. The resultant capital gains from the change of ownership of the property would, therefore, stand at $4,670,000. However, the profit as stated by the company ABC Ltd. was shown to be $4,580,000. It, therefore, could be stated that ABC Ltd. understated its profits by a sum of $90,000 and would have to pay an additional amount of capital gains tax on the same.

A 50% deduction would apply since the property was held for a period of more than 12 months based on amendments that took place in 1999 (Australian Taxation Office, 2020). Naturally, the net capital gains that would be taxable for ABC Ltd. would be $4.67 million comprised of a 50% deduction. The tax rate would be equivalent to their marginal tax rate depending upon the revenue generated during the reporting period in which the change of ownership of the property was entered into, which is 2019-2020, since the contracts were made on the 14th of January, 2020 and the settlement also took place on 18th of February, 2020.

References for Taxation Law And Practice

Australian Taxation Office. (2020). Capital gains tax. Retrieved 11 May 2020, from https://www.ato.gov.au/general/capital-gains-tax/

Australian Taxation Office. (2020).Legal Database. Retrieved 11 May 2020, from https://www.ato.gov.au/law/view/document?DocID=TXR/TR981/NAT/ATO/00001&PiT=99991231235958

BDO Australia. (2018). ATO’s final view on tax residency of foreign companies. Retrieved 11 May 2020, from https://www.bdo.com.au/en-au/insights/tax/technical-updates/atos-final-view-on-tax-residency-of-foreign-companies

Commonwealth Consolidated Acts. (2020). A new tax system (goods and services tax) Act 1999 - SECT 188.24. Retrieved 11 May 2020, from http://classic.austlii.edu.au/au/legis/cth/consol_act/antsasta1999402/s188.24.html

Commonwealth Consolidated Acts. (2020). Income Tax Assessment Act 1997 - SECT 230.5. Retrieved 11 May 2020, from http://classic.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s230.5.html

Commonwealth Consolidated Acts. (2020). Income Tax Assessment Act 1997 - SECT 104.5. Retrieved 11 May 2020, from http://classic.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s230.5.html

Federal Register Of Legislation. (2020). Income Tax Assessment Act 1936. Retrieved 11 May 2020, from https://www.legislation.gov.au/Details/C2012C00134

High Court Of Australia, (2020). Bywater Investments Limited v Commissioner of Taxation. Retrieved 11 May 2020, from http://eresources.hcourt.gov.au/showCase/2016/HCA/45

High Court Of Australia, (2020). Henderson v. FCT. Retrieved 11 May 2020, from http://eresources.hcourt.gov.au/browse?col=1&facets=name&srch-term=&page=1440

High Court Of Australia, (2020). International Harvester Company of Australia Proprietary Limited v. Carrigan's Hazeldene Pastoral Company. Retrieved 11 May 2020, from http://eresources.hcourt.gov.au/getPdf/1/15567/100clr644.pdf?sequence=7&isAllowed=y

OECD. (2020). Information on residency for tax purposes. Retrieved 11 May 2020, from https://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/tax-residency/Australia-Residency.pdf

Parliament of Australia. (2020). ParlInfo - Income tax deductions to be denied for illegal activities. Retrieved 11 May 2020, from https://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=(Id:media/pressrel/gbvf6);rec=0;

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