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BTF5965 Taxation Law Revision Questions/solutions

Question 1 – Income/Employment receipts

Mary Johnson, aged 30, is a civil engineer who works with Adco Ltd which specialises in mining infrastructure. In November 2016 she was offered a new job with Mine Australia Ltd to establish a new mining operation in Port Headland. As part of an incentive to encourage her to take up the offer and leave her existing job she was offered and accepted a sign-on incentive of $25,000 and an annual salary of $175,000. She also received a relocation and settling in allowance of $25,000.

On 30 June 2017 all employees were awarded a productivity bonus of $10,000. However, this was not paid until 5 July 2017. Mary asked that the amount of the bonus be directed to a housing loan offset account held by herself and her partner.

Required:

Advise Mary of the tax consequences arising from these arrangements.

Solution

The salary of $175,000 would be assessable as income under ITAA97 s 6-5. However, a question arises as to whether the $25,000 sign-on incentive is an amount paid to Mary to join Mining Australia Ltd or a payment to leave her previous employer. If it was a payment to join the new employer it would be assessable under s 15-3 as a return to work payment. However, if it was a payment to leave her previous employer it would be an employment termination payment (ETP). Under s 82-130 an ETP is a payment made in consequence of the termination of the person’s employment which is received no later than 12 months after the termination of the employment. As Mary is below preservation age the taxable component which is within the ETP cap of $175,000 is taxed at no more than 30% plus Medicare.

The settling in allowance would not be a fringe benefit but rather income under s 6-5 or s 15-2.

The productivity bonus would be assessable income under s 6-5. However, as it was not paid until July 2017 it would not be derived until the following year (see Carden’s case (C of T (SA) v Executor, Trustee & Agency Co of South Australia Ltd (1938) 63 CLR 108).

Even though Mary asked that the bonus amount be redirected to an offset loan account with her partner this would not change the assessable nature of the amount due to s 6-5(4). Section 6-5(4) states that where you redirect income you are taken to have derived it as soon as it is applied with or dealt with on your behalf. This would occur in July

Question 2 –General Deductions

Ted Vogue works nightshift cleaning jet airliners at Tullamarine Airport in Melbourne. Ted’s real passion however, is photography, a hobby at which he is highly skilled. In February 2016, Ted decided he would attempt to establish a photography business of his own with the aim of eventually quitting his job at Tullamarine airport.

Ted borrowed $40,000 from the Eastpac bank on 1 May 2016 using his family home as security for the loan. The loan required Ted to pay interest at the rate of 10% per annum on the first day of each month commencing with the month of June and to pay the principal in full by 1 May 2017. Ted also paid a $500 loan establishment fee and $124 of stamp duty on 1 May 2016.

§ Ted used the borrowed funds accordingly;

§  $20,000 to purchase a second –hand photograph developing and printing machine. The machine was two years old and has a useful life of 5 years

§ $10,000 to construct a shed in the backyard of his family home from which the photographic business was to be conducted.

§ Installation of special lights costing $5,000 and curtains costing $2,650 in the shed which were needed to develop the photo’s  

§ Ted also purchased some textbooks on developing photo’s costing $350

§  In May 2016, Ted also spent a further $2,000 on ads in the local press and printing and delivering “flyers” to local households.

§ After purchasing the photograph machine, Ted had it sent back to the manufacturers for repairs in order to get it in working order. The repairs cost Ted $3,000 and took longer than expected. The machine was finally delivered to Ted’s shed on 2 July 2016, when Ted started to earn some revenue from his new business.

§  One of Ted’s neighbour’s did not appreciate the prospect of a backyard business next door and subsequently complained to the local council. Ted engaged a solicitor in June 2016 and the claim was successfully defended that month. Ted received a bill from the solicitor on 19 June 2016 for $2,500 which required payment by 10 July 2016. Ted paid the amount on the due date.

§ The business takings up to 30 June 2016 were nil and Ted expects that throughout 2016-17 receipts will be well below expenses. However, Ted estimates that by 2017-18 the business will become profitable by which time he plans to stop cleaning jet airliners.

§ Required:

§  Advise Ted Vogue of what deductions he may be able to claim under the ITAA 97 or ITAA36 and the income years in which those deductions can be claimed.

§  You must cite relevant legislation and case law to support your answer.                                (25 marks)

Solution

Issue 1

A discussion of the implications of business v hobby would be required as Ted has a view to profit by 2017-18 however business takings in 2015-16 were nil and expected to be low in 2016-17. Given that his intention was to start the business and what point in time did it commence?

• Possibly 1/5/16 when the loan was taken from the Bank-

•  business name registered?

• Deductions can be allowed with a view to generating

• income in a future year See Steel case(1990) Sufficient nexus?

• Consider whether preliminary expenditure or recommencement?

• See Softwood pulp and paper and Griffin Coal Mining cases     

• Consider s 8-1 Positive limb – necessarily incurred in carrying on a business – passed ?

• Negative limb not of a capital nature?

•  Ted’s current source of income is from cleaning Jetliners although expenses are for photography

• Cases – Fergurson, Ronpinbon Tin, Charles More case - the character of the expenditure?

•  Consider the non-commercial loss rules in Div 35 – are the conditions satisfied to offset the losses against salary income?

•  Income from the business was generated in the 2016-17 year so stronger nexus

§ Issue 2  

§ Assuming the business commenced on 1/5/16 based on Steel consider the deductibility of the interest s 8-1 see Steel, Brown and Placer Pacific  – deduction for June 2016?

§  Annual deduction $40,000 x 10% = $4,000 x 1/12 = $ 333

§ Issue 3

§ The Borrowing costs - loan establishment fees $500 + stamp duty $124 = $624  

§ S 25-25(1)  1 year (totally repaid)  $624/ 365 days = $1.71 p/day

§  1/7/16 to 30/4/17 304 days x $1.71 p/day = $519.84 ($104.31 from 1/5/16 to 30/6/16)  

§ Issue 4

§ Second hand Photography /Printing Machine  

§ Consider Div 40 diminishing value method – assume purchased Post May 2006   

§ $7,200 (adjusted value in year 3) x 61/365 x 200%/5 = $481 ded for 2016-17 year

§   If using Prime cost $22,000 (asset cost) x 61/365 x 100%/5 x 10/11 = $668 ded for 2016-17 year * Or <$20,000 write off for a SME in 2016-17

§  Issue 5

§  Shed – Structural improvement Div 43 assume because income producing in 2016-17

§  S 43-210 = $10,000 x 10/11 x 2.5% = $227

§ Issue 6

§  special lights Div 40  assume 5 years effective life

§  Prime cost $5,000 x 10/11 x 100%/5 = $909

§  Curtains   Prime cost $2650 x 10/11 x 100%/5 = $482  

§ * Or <$20,000 write off for a SME in 2016-17

§  Issue 7

§  Text books  - could be part of his professional library or a low cost asset  allocated  to a pool and depreciated s 40-440 more likely to be a small business entity and therefore an immediate deduction as < $1,000 s 328-180

§   Issue 8 Advertising $2,000 s 8-1 deduction in full in the in 2016-17 year  see Ronpinbon Tin and Fletchers case  

§ Issue 9

§  Repairs s 25-10 not an initial repair as the machine was two years old – see Law Shipping  and Thomas case $3,000 fully deductible 2016-17

§  Issue 10

§  Legal expenses S 8-1 $2,500 deductible in the 2016-17 year when paid if Ted is operating on a cash basis   See Cardens case

§ Payment of damages and legal costs:  students should consider whether this would be a normal business risk (Herald and Weekly Times case).  

Question 3 –Specific Deductions

On the 1 August 2016, Stephen Smith purchased a laser printer for $900 for use in his photography business. He estimated that the laser printer will be used 80% of the time for a taxable purpose. The closing balance of Stephen’s low-value pool was $30,000 on 30 June 2016.

On the basis that Stephen is a small business entity, calculate:

(i) the total decline in value of Stephen Smith’s low-value pool for the 2016/2017 tax year, and

(ii) the closing balance of Stephen Smith’s low-value pool for the 2016/2017 tax year.

Solution

Low-value depreciating asset pools

(i) The decline in value deduction of Stephen Smith’s low-value pool for the 2016/17 tax year

The deduction for depreciating assets under the Pooled asset provisions is determined by multiplying the opening pool balance by 15%. Where assets are added to the pool during the year.

Therefore $900 x 80% x 15%                                                                                                          $108

+ 30% of the closing pool balance for the 2015-16 tax year ($30,000 x 30%)                              $9,000

Total decline in value deduction for the 2016-17 tax year                                                             $9,108

· Note if SME immediate ded <$20000 may apply

 (ii) The closing balance of Stephen Smith’s low-value pool for the 2016/17 tax year is calculated as follows:

(*See POTL p 490).

Question 4 – Tax Admin

In determining its taxable income for 2016/2017 of $2,500,000 and subsequently making its final tax payment, Echo Ltd incorrectly claimed a deduction for expenditure of $220,000 on renovating a machine. No outright deduction was allowable because the expenditure was capital in nature, but a claim of $20,000 by way of decline in value of the depreciating asset in relation to the capital improvement, could be made.

Required:

Advise Echo Ltd as to what action it should take in respect of the incorrect claim

Solution

Revised estimates; penalties

Where the final return had been lodged by Echo, with the incorrect claim of $200,000 ($220,000 less $20,000 depreciation), the company would be subject to penalties based on the shortfall amount. The shortfall amount is the amount by which the relevant liability, or the payment or credit, is less or more than it would otherwise have been (TAA Sch 1 s 284-80).

Where reasonable care was taken in determining the taxable income, no penalty applies (see Miscellaneous Taxation Ruling MT 2008/1). However, if no reasonable care was taken, a penalty of 25% of the shortfall amount applies (s 284-90(1)). Reasonable care requires a taxpayer to exercise the care that a reasonable person might use. This requires a degree of compliance which reflects the taxpayer’s knowledge, education, experience and skill. It also requires that the taxpayer has taken reasonable care in keeping appropriate records and systems to ensure compliance with their obligations under the Act.

Where the shortfall amount exceeds $10,000 or 1% of the return tax, and is caused by a question of law, a second test is applied (under s 284-90(1)) as to whether the taxpayer’s position is “reasonably arguable”. A taxpayer’s position is reasonably arguable if the taxpayer’s treatment of the item giving rise to the shortfall amount is about as likely “to be correct as incorrect, or is more likely to be correct than incorrect” (TAA s 284-15), having regard to the relevant authorities.

Section 298-20 provides the Commissioner of Taxation with power to remit the whole or part of the penalty tax imposed for a false or misleading statement. In particular, a remission of penalties may be made where an isolated book keeping error was made, the mistake was unintended and the taxpayer had a good compliance history.

In addition to the above penalty, the Commissioner may impose a “Shortfall Interest Charge” penalty under TAA Sch 1 Subdiv 280-B and an interest penalty under TAA Sch 1 s 298-25 based on the general interest charge (TAA s 8AAA to 8AAH). Also pursuant to TAA Sch 1 s 298-10, the Commissioner is required to give written notice to the taxpayer of the penalty and the reasons for it.

Based upon the fact that it had made an incorrect claim, Echo could make a voluntary disclosure of the error to the Commissioner of Taxation. TAA Sch 1 s 284-225 provides for an 80% reduction of the penalty tax applicable, where the taxpayer notifies the Commissioner of Taxation in writing of the error before being informed of a tax audit.

Question 5 –Tax Offsets

Tom Maher aged 55 paid a health insurance premium of $2,242 to a private health fund on 1 November 2016, for one year’s family hospital and ancillary cover in advance. Tom is married with two children, and his family’s adjusted taxable income for 2016/2017 was $91,000. Tom’s wife is also aged 55.

Tom’s brother Henry aged 66 had health insurance premiums of $83 deducted from his pay every month during the 2016/2017 year, which were paid to the same private health fund. The premiums were for one month’s hospital cover (no ancillary cover) from the date of payment. Henry is single and his adjusted taxable income for 2016/2017 is $97,000.

Required:

What tax offset (if any) are Tom and Henry entitled to for the year ended 30 June 2017?

Solution

Private health insurance tax offset

Tom Maher is entitled to a tax offset for private health insurance pursuant to ITAA97 s 61-205, subject to Subdiv 61-G conditions being met. These include the requirement that the premium be paid in respect of a ‘complying health insurance policy’, such as one that provides hospital cover and/or ancillary cover, and also that the premium be paid in the same income year that it is claimed as an offset.

The 26.79% private health insurance tax offset is reduced for individuals earning more than $90,000, or families earning more than $180,000. The offset cuts out completely for singles earning more than $140,000 and families earning more than $280,000. An individual’s entitlement to the offset is now tested against their income for Medicare levy surcharge purposes.

Three tiers of private health insurance tax offset entitlement apply (see tables below).

See also ATSM XXV

Income thresholds

Private health insurance tax offset available

Medicare levy surcharge

Note: These rebate rates are for premiums paid between 1 July 2016 and 31 March 2017.

From 1 July 2012, the Medicare levy surcharge has increased for singles and families who fall within tiers 2 and 3 and do not hold appropriate private health insurance cover.

Therefore Tom is entitled to a tax offset of:

     $2242 x 242/365 x 26.79% (less than 65 years of age, family income < $180,000) = $398.23  

Henry also satisfies the conditions in Subdiv 61-G and is entitled to a tax offset of:

 $83 x 12 x 22.33% (aged b/w 65 and 69 yrs and Tier 1 single with ATI b/w 90,000 and $105,000) = $222.41