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HI6028 Taxation Theory - Practice And Law, Holmes Institute, Australia

Capital Gain Taxation In Australia

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Introduction: It is the report which is relied upon the individual assessment of taxation theory, laws and practice. This comprises three main questions which came from the capital gain impact of Helen capital gain transactions. Apart from this, Barbara's income generated from personal exertion is going to elaborate in this report. Moreover, the procedure of Patrick assessable income will be elaborated in this report.

Question 1: Definition of CGT Asset as per Section 108.5 of Income Tax Assessment Act includes

a) Any kind of property;

b) A legal right or equitable right other than provided in a).

Answer: Furthermore, the clarification as per section 108.5 of ITAA 1997 supports a CGT asset comprising goodwill, partnership's interest, and interest in partnership' assets. Further, more explanation in the form of some of examples of CGT assets are land and buildings, share, options, contractual obligation right enforcement, units of a unit trust, foreign currencies, and debts (Section 108.5 of ITAA 1997).

Section 110.25 (2) of ITAA 1997 states that the first element of cost base is money payment and/ or exchanged item's market value for payment to acquire the CGT Asset. The second element includes all the incidental costs for acquiring the CGT Asset. Section 110.25 (4) of ITAA 1997 states that the cost base comprising interest on borrowings, land tax, costs of maintaining, repairing or insuring, and rates (Section 110.25 of ITAA 1997).

Excessive capital proceeds over the cost base results in the assessable gross capital gain and Excessive cost base over the capital proceeds results in the deductible capital loss. However, the capital gain tax is levied on disposal of capital gain tax asset is dependent applied method from the three methods for determining the CGT liability. All the three methods are described hereby:

Discount Method: 50% deduction of assessable capital gain is allowed under this method. This is most of the time beneficial for lowering tax burden on capital gain as compared to other two methods. However, this method has some conditions which should be fulfilled for its applicability. Most of the conditions are connected with the residential status and the holding period of CGT Asset. First condition, a person must be resident in Australia and Second condition, the acquired CGT asset must be held for 12 months or more before the taxable disposed off CGT event. The method provides 50% deduction out of total assessable capital gain in the hands of the tax payer.

Indexation Method: A cost base is indexed by considering the concerned index for calculating the indexed cost-base of CGT asset. In general, it is apparent that the indexed cost always decreases assessable capital gain and improves the capital loss deduction on the taxable CGT event. The method needs fulfillment of some conditions its applicability. First condition, the tax payer must be resident in Australia. Second condition, the holding period of the CGT asset must be started before September 21st 1999 and holding the CGT asset for 12 month or more than 12 months before the CGT event (Section 104.5 of ITAA 1997).

Other Method: When aforesaid both the methods are not applicable due to non-fulfillment of conditions as prescribed by both methods. This method has highest assessable capital gain which results in the highest capital gain tax liability outflow in the hands of the taxpayer. This method is applicable when the CGT Asset is held for less than 12 months (Working out your capital gain, 2019).

Question 2: Your client Helen wants to fund her business as a fashion designer, therefore she has sold some of the assets as follows.

Answer: Calculation of net capital gain or loss of Helen for the assessment year

According to the Australian Taxation System, the capital gains tax is applied to the capital gains which arise on sells of capital nature assets. The capital gains or loss is calculated by using the below formulae:

Sales consideration or fair value of assets xxx

Less: Cost of acquisition of assets xxx

Capital Gains or losses xxx

It is the duty of assesse to report capital losses and gains in his/her income tax return and pays tax accordingly to the income tax authority (Minas, Lim and Evans, 2018). When assesseincur a loss in selling the capital assets, he cannot set off this loss with any other income but he can carry forward this loss and set off with the next previous year capital gain income (Martin, 2019).

Conditions regarding capital assets

If any capital assets were acquired before 20th September 1985, then the assessedoes not come under this head.

If any capital assets are acquired after 20th September 1985, then the assesse is liable to pay tax under this head, except below two points are excluded:

• The capital gain tax doesn't apply to depreciable assets which are specifically used for taxable purposes, such as fittings in a rental property or business equipment (Faccio and Xu, 2015).

• Personal assets like car, home, furniture, etc. are exempt from capital gain tax (Pellegrinoa, Perbolib and Squillerod, 2019).

Methods of calculating the capital gain

There are two methods which can be used by the assesse while calculating the capital gains which are listed below:

1. Discount Method: The assets held by the assesse for 12 months or more than capital gain reduced by the assesse by 50% for resident individuals and 33.33% for fulfilling super funds &qualified life insurance companies (Smith, 2015).

2. Indexation Method: The assets acquired by the assesse before 11.45am on 21st September1999 and detained for 12 months or more than the indexation factor used by the assesse to calculate the cost of acquisition of assets which was purchased by the assesse in the previous year (Evans, Minas and Lim, 2015).

The indexation factor is calculated by using the CPI (Consumer Price Index). If CGT incurred before 21st September 1999, then the indexation factor is calculated by using the below formula:

Indexation Factor: CPI for qtr. when capital gain tax event happened/CPI for qtr. in which expenditure was incurred.

If CGT incurred after 21st September 1999, then the indexation factor is calculated by using the below formula:

Indexation Factor: CPI for the quarter ending September 1999/CPI for the quarter in which expenditure was incurred.

Part 1: An antique impressionism painting Helen's father bought in February 1985 for $4,000. Helen sold the painting on 1 December 2018 for $12,000.

Solution 1: Helen has an intention of starting a new business of fashion designer and for which she wants to collect the money so she has sold antique impressionism painting. She has acquired antique impressionism painting in 1985 February by expending cost of $4,000 and sold the same for $12,000 in 2018 December.

Section 108.10 of ITAA 1997 defines CGST Asset is a collectible and collectables are consisting of artwork, coin or medallion, antique, jewellery, manuscript, rare folio, postage stamp, and book (Section 108.10 of ITAA 1997). Therefore, the antique impressionism painting is collectable as per the the definitin of 108.10 of ITAA 1997 which means the same is CGT asset and sale thereof attract CGT Event.

The sale of the antique impressionism painting by Helen is CGT A1 Event because of vary in ownership by transferring ownership in the CGT asset from one person to unrelated other person in accordance to Section 108.5 of ITAA 1997. The excessive capital proceeds over the cost base provide capital gain in this case (Section 104.10 of ITAA 1997).

Now, it is the time of evaluating the conditions of all three methods for estimating taxable capital gain from this transaction in hands of Helen.

First condition of both the methods are fulfilled as Helen is resident in Australia and now second condition of holding CGT asset, Helen acquired the antique impressionism painting in 1985 February so acquired the CGT asset before September 21st 1999 and holding the same continuously so the holding period is more than 12 months. In this case, both Discount method and Indexed method are applicable. Helen should select best one for reducing her capital gain tax liability from the sale of the CGT asset. The given below tables present the all the steps of calculation of the assessable capital gain under both Discount and Indexation methods:

Discount Method

Cost Base, Acquired in Feb, 1985

$4,000

Capital Proceed, Sold in Dec., 2018

$12,000

Capital Gain, Capital Receipt - Cost base

$8,000

50% Deduction, $8,000×50%

$4,000

Taxable Capital Gain

$4,000

Indexation Method

Index figure, Acquired before 20 Sept., 1985

120%

Cost Base, Acquired in Feb., 1985

$4,000

Indexed Cost Base, $4,800×120%

$4,800

Capital Proceeds, Sold in Dec. 2018

$12,000

Taxable Capital Gain

$7,200

Taxable capital gain in Discount method is $4,000 whereas the taxable capital gain in Indexation method is $7,200, Helen should select the method which provides the least taxable capital gain. And in this case, Discount method has the least taxable capital gain which is $4000 Therefore, Helen must choose Discount method for estimation of the capital gain tax liability.

Solution 2: The antique impressionism painting was purchased by her on February 1985 that was before the applicability of the Income-tax law in Australia. Hence, this amount is exempt from tax because this asset was purchased by her before 20th September 1985.

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Part 2: Helen sold her historical sculpture on 1 January 2018 for $6,000. She has purchased the piece on December 1993 for $5,500.

Solution 1: Helen sold a historical sculpture in January, 2018 for the capital receipt of $6,000 for the same which was acquired in December 1993 for $5,500. The historical sculpture is CGT asset which means selling of the same attract CGT Event, as per section 108.10 of ITAA 1997, collectables are consisting of an antique, coin or medallion, artwork, manuscript, book, jewellery, rare folio and postage stamp (Section 108.10 of ITAA 1997).

Discount method can only be applied in this case because of fulfilling its both the conditions; one is the residential status in Australia of Helen and the second condition, the holding period of the CGT asset is for 12 month or more than 12 months:

Discount Method

Cost Base, Acquired in Dec., 1993

$5,500

Capital Proceeds, Sold in Jan., 2018

$6,000

Gross Capital Gain

$500

50% Deduct, $500×50%

$250

Taxable Capital Gain

$250

Helen should select Discount method which provides the least taxable capital gain. And in this case, Discount method has the least taxable capital gain on sale of the historical sculpture, which is $250. Therefore, Helen must choose Discount method for estimation of the capital gain tax liability.

Solution 2: Helen was sold historical sculpture on 1st January 2018 for $6000 and this asset was purchased by her before 21st September 1999. In this case,the indexation method will apply for calculating the cost of acquisition (Smithies and Uppal, 2019).

Calculation of capital gain tax

Particular

Amount $

Selling price

6000

Purchase price

10120

Capital gain /loss

(4120)

Working Note: By using the Indexation Method cost of acquisition or purchase priceof assets= 112.6/61.2= 1.838*5500=10120

Therefore, Helen incurred capital loss of $4120 while selling the historical sculpture in the current year.

Part 3: An antique jewellery piece purchased in October 1987 for $14,000. Helen sold the antique jewellery piece on 20 March 2018 for $13,000.

Solution 1: Helen sold an antique jewellery piece which is CGT asset as per section 108.10 of ITAA 1997 which defines that all the collectables consisting of an antique, book, artwork, coin or medallion, manuscript, jewellery, rare folio, and postage stamp are CGT asset and disposal thereof is CGT Event.

Helen has acquired an antique jewellery piece for cost burden of $14,000 in October 1987 and sold the same in March 2018 for entire capital receipt of $13,000 attracting all three methods. However, the capital proceeds is lower than the cost base so there is capital loss on the disposal of the CGT asset. It means Indexation method should be selected for increasing deductible capital loss to reduce the entire capital gain tax in the hands of Helen by deducting the same from other taxable capital gain.

Indexation Method

Index figure in Oct., 1987

        47.60

Index figure in Mar., 2018

112.6

Acquired in Oct., 1987

$14,000

Indexed Cost Base, 112.6/47.60×$14,000

$33,118

Capital Proceeds, Sold in Mar., 2018

$13,000

Deductible Capital Loss

($20,118)

An antique jewellery piece purchased in October 1987 for $14,000. Helen sold the antique jewellery piece on 20 March 2018 for $13,000.

Solution 2: Helen purchased antique jewellery piece on October 1987 for $14,000 and the assets were purchased before 21st September 1999, then the indexation method is used to calculate the capital gain or loss.

Calculation of capital gain tax

Particular

Amount $

Selling price

13000

Purchase price

33117

Capital gain /loss

(20117)

Working Note: By using the indexation method cost of acquisition or purchase price of assets = 112.6 /47.6*13000=$33117

Therefore, she incurred capital loss of $20,117 on selling of capital assets.

Part 4: Helen sold a picture for $5,000 on 1 July 2018. Her mother purchased the picture in March 1987 for $470.

Solution 1: According to Income Taxation Assessment Act 1997, the collectibles acquired by incurring the cost base of $500 or less, are exempted from CGT on selling the same. In this case, Helen sold a picture for $5,000 in July 2018, which was acquired March 1987 by incurring cost of $470. The cost base is lower than $500 which means the attraction of CGT Event is not possible in this case, even though the picture is CGT asset as per section 108.10 of ITAA 1997. Therefore, Helen has no capital gain tax liability on this disposal of the CGT asset in the form of the picture.

Solution 2: Helen purchased a picture on March 1987 for $470 which was purchased by her on September 1999; then again indexation method will be applicable here for calculating the capital gain or loss.

Calculation of capital gain tax

Particular

Amount $

Selling price

5000

Purchase price

1178

Capital gain /loss

3822

Working Note: By using the indexation method the cost of acquisition or purchase price = 113.5/45.3*470=1177
Therefore, Helen incurred capital gain on selling of a picture

Calculation of overall net capital gain or loss

From the above calculation, it can be said that Helen incurred a capital loss in her two transactions and one capital gain in last transactions. The capital loss can be set off with the capital gain and not from other heads income (Woellner, et al., 2014). If the assesse does not have sufficient balance to set off the capital loss then it can be carry forward in the next years.

Calculation of total capital gain

Particular

Amount $

1. Exempted Income

XX

2 Capital Loss

(4120)

3. Capital Loss

(20117)

4. Capital Gain

3822

Total capital loss

(20415)

Thus, the total capital loss of the client for the current year is $20,415 which will be carried forward in the next year for set off and it is the duty of Helen to report this loss in her tax return.

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Question 2: Discuss payments to Barbara separately and states if these are income from Barbara's personal exertion. Would your answer differ if Barbara wrote the Principles of Economics' book before signing a contract with The Eco Books Ltd in her spare time and only decided to sell it later? Support your answer by referring to relevant statutory and case law.

Solution 1: As per section 84.5 of ITAA 1997, an income is a pers nal service income (PSI) if the same is majorly rewarded because of personal skills and efforts. As per the explanation given in ATO ID 2015/9, the personal service income (PSI) is majorly rewarded for the personal skills and efforts (Section 84.5 of ITAA 1997). Therefore, the PSI is related to the personal skills and efforts for earning the income.

The determination of the personal service income needs first of all, finding of nature of the income whether the same is received due to use of the personal skills and efforts or not in order to applicable of provisions of the PSI. The determination of the PSI is based on the portion of income from the personal skills and efforts in the total income of an individual for the purpose. The percentage of income from each contract for labor, knowledge, skill, efforts or other things are needed to be calculated for finding the portion of such efforts in earnings in the total earnings for estimating the PSI. If the PSI is more than 50% out of the total income receipts due to provision of personal skill and expertise, it is a PSI for estimation of the tax liability accordingly. If the PSI is 50% or less than 50%, it cannot be treated as PSI for taxation purpose. However, there is no impact of PSI rules on the salary or the wages of an individual being an employee (Personal services income, 2019).

In the given scenario, Barbara has accepted the offer of writing a book for ‘The Eco Books Ltd' with the consideration of $13,000 which is clearly a PSI due to a contract of personal skills and efforts according section 84.5 of ITAA 1997. However, Copyright sale proceed $13,400 cannot be treated as PSI because of granting the right to use the property and not sale of personal efforts or skills for the compensation.

A contract of writing a book is treated as PSI, but the sale of the book's manuscript cannot be treated as PSI because of selling the rights and ownership and not the personal skills or efforts. Therefore, sale of book's manuscript to the library of The Eco Books Ltd for $4,350 cannot be treated as PSI. In the same manner the selling of interview manuscripts for $3,200 cannot be treated as PSI for the taxation purpose (Personal services income, 2019).

Solution 2: According to ITAA, 1997 provisions, Income from private exertion refers to revenue earned as per the section 393(10) of ITAA, 1997 (Edmonds, 2015). Given below is some of the revenue which are being treated as ordinary revenue.

• Commission or fees

• Revenue earned from profession or business

• Income from wages and salary

• Subsidy received

• Revenue from property disposed

• Ay allowances which is being earned by the assesses in capacity of workers.

1) Discuss Barbara ‘s income under the case scenario

First Payment: From the above clarification it is being cleared that revenue earned of $13400 by writing a book from personal skills will be termed as revenue earned from private exertion. This is substantiate by the case of " Brent v FCT (1971)125 CLR 418". As per this case assesse sold copyright of her book name "Husband story of life", in return of which she received money. Although such income were assessable and were not included in capital income because such income was earned by herself through her own skills and talent by writing books. Similarly by applying this case law it can be said that the revenue which were earned by Barbara through selling of her books will not be considered as capital income (Brabazon, 2019).

Second payment: Income earned by Barbara of $4,350 through selling of her books name ‘Economics of Principles will be considered as personal exertion income. Thus, this statement were made cleared in the above mentioned case in which a lady sold her life story books about her husband to newspaper agency were also considered as personal exertion not as capital gain (Arnold, 2019).

Third payment: He income $3,200 which were earned through collection of manuscripts by writing Economic books were also considered her personal exertion. This was made cleared with the help in the explanation of the case of " Brent v FCT (1971)125 CLR 418"

2) Discuss Barbara ‘s income under the alternative sceario

In case before signing the contract if Barbara wrote the book and later on sell it to Eco Books Ltd.

Same treatment which was explained above will be applied in case before signing the contract if Barbara wrote the book and later on sell it to Eco Books Ltd. This is so because the income which will be earned will still be considered as personal exertion whether the income earned is before or after signing the contract (Auerbach and Hassett, 2015). As the main consult here is the income is being earned through her own personal skill and talent.

Question 3: By referring to relevant statutory and case law, you need to discuss the effect of these arrangement on the assessable income of Patrick.

Solution 1: As per Section 6.23 of ITAA 1997, an amount of statutory income or ordinary income is non-assessable non-exempt income in case a provision of ITAA 1997 or of another Commonwealth law provides that the same is not assessable income and the same is also not exempt income. In the given scenario, Patrick gave $52,000 to his son David regarding starting a new business by David. According to section 6.5 of ITAA 1997, all the income is assessable which is earned from ordinary source (Section 6.5 of ITAA 1997). In the given case, Patrick gave money to David and asking for more repayment at once in future time. The analysis of ordinary source in this case is earning of higher amount of repayment as compared paid money by Patrick. The key factor in this case is relationship between the both parties so it seems that this transaction is personal nature and not the business transaction because of no interest involve expressly. An income could be assessable if the same is earned or produced from ordinary sources and in this case the paid money to the son cannot be treated as source of producing income (Section 6.23 of ITAA 1997).

Solution 2: It is mentioned in the Australian Taxation Authority (ATO), "If any kind of benefits is rendered by the parent for his son or daughter and such son/daughter repay that money. In that case, money will be taxable in the hand of parent .

In the cited case, value of income will be assessable in the hand of Patrick as this was repaid by the his son. The amount of $52000 that was borrowed by his son in order to start up his business and excess amount gained by the Patrick will be taxable at the end of 5 years or the time when he get the money i.e $6000 ($58000-$52000). Henceforth, loan was not treated as a gift as this was to be repaid.

The income of $52,00 of Patrick will not be considered as assessable income. But at the same side the income which is being earned will be taxable during fifth year when he will actually receives his income and such income will also be shown under taxable income heading.

A situation in which Patrick gave loan to his son has being re-examined, in which the loan were rendered to son without making any kind of contract and without demanding any kind of security. Such income of $52,00 repayment will not be considered under the heading of taxable income and neither it will attract any kind of gift tax liability.

But the interest of $2,400 (S6, 000/58*2) which will be received by Patrick at the end of two years on a loan rendered to his son will be considered under the heading of taxable income of Patrick.

Cheque will be considered as the mode of payment as it does not affect the accessibility of income liability. The aspect which matters the most is the parties' intention which were considered by the income tax department. In addition to this the gift tax liability can also affect the Patrick parent pension as it will lead in the increment of assessable income of Patrick. Son Patrick can easily avail the gift tax liability limit of $30, 000 in five years or $10,000 per year whichever is term to be less. Any kind of gift or payment made within the prescribe limit set then it would be term as assessable income of the Patrick parent in assessment year.

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The intention of Patrick is to help his son and not earning the interest on payment so this transaction cannot be construed as the income producing transaction. There are clear wordings of no interest charge on the paid money which also reflects personal nature transaction. Merely asking for higher money and paid the repayment by the son with additional 5% of paid money cannot be treated as earned income from this transaction because as per section 6.5 of ITAA 1997. Patrick is not liable for taxation on extra payment of 5% on paid money of $52,000.

Conclusion: From the above report, it is concluded that Individual assessment of taxation theory, law and practice is discussed. Report is made upon three questions which cover taxation, relevant theories of applicable laws andpractical implication in Australia. It emphasized upon capital gain tax consequences of Helen capital gain transactions'. Moreover, Barbara's income from personal exertion is discussed. In addition to this, the arrangement of assessable income of Patrick is discussed in this report.

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