Online Tutoring on Australian Taxation

Case Study 1:

There is a heavy dependence of the system of Australian taxation on the personal income of an individual. According to the Australian tax law an individual can receive his or her income through personal exertion by working in a specified field or through some sort of an investment (Australian Government, 2015). It is not necessary that the income that is received by an individual is always in monetary terms, it may take a form of goods received or services rendered. According to the section 6 of Income Tax Assessment Act 1936, the income through personal exertion is defined as
“the income that is generated from salaries, commissions, bonuses, wages and individual earnings” (Australian Government, 2015). Income from pensions, superannuation and retiring allowances and privileges that are received by the individual under the terms of his or her employment is also considered as an income from personal exertion. Income generated from personal exertion can also consist of the revenue from any business that is started by the taxpayer as a sole proprietor or in a partnership. It is also termed as an income that comprise of any kind of salary, fee or profit that is generated through holding a position in the office or employment (Australian Government, 2015). Profit arising from the sale of the taxpayer’s property for the sole purpose of earning profit or any scheme or undertaking that relates to the intention of making profit also comes under the banner of income rising from personal exertion. Rents, non-share dividends or any sort of dividends are not included in the income arising from personal exertion (Australian Government, 2015).

In the scenario the first payment of ten thousand dollars is offered by the Daily Terror newspaper to Hillary for writing her life story, who is a well-known mountain climber. She writes the story by herself without any help from a ghost writer. She gets paid after the story has been published in the newspaper. This payment of $10000 does not come under the branch of income from ‘personal exertion’ because she is a mountain climber and writing a story is not her skill. It is a written fact that Hillary the famous mountain climber has never written a book in his life. The assigning of her right, interest and title in the copyright to the daily terror newspaper and receiving $10000 for that does not falls under the section of ordinary income and real gain. Note that the receipt of $10000 has not been generated for the service rendered because of the fact that Hillary has been paid for selling the copyrights and not for her amateur first time writing. Moreover the income received by Hillary constitute the selling of the actual copyrights and not from the use of the copyrights. It is a one-time payment and not a regular one. The other thing that needs to be addressed that Hillary is not into the writing business, she is a mountain climber, hence the receipt cannot be said to flow from her principal business. The payment received from the daily terror newspaper cannot be regarded as an ordinary income and it is definitely not an income from ‘personal exertion’ as it fails to fulfill the all there prerequisites of the ordinary income and they are income from receipt that is generated from a business, service or a property.

The payment of $5000 which Hillary has received from selling manuscript of her life story to Mitchell library is also a one-time receipt and not a regular one. Writing is not her profession or a skill. The other thing to note is that the payment of $5000 is not a receipt that is associated by her principal business or profession which is mountain climbing. Using the fruit tree analogy, the receipt from the sale of the manuscript or a copyright in order to be an ordinary and a taxable income should be the fruit of the tree (tree being the main business) (Australian Government, 2015). In the scenario the main business of Hillary is mountain climbing and not writing. As the fruit (receipt from the manuscript) and the tree (mountain climbing) are entirely different from each other hence the payment of $5000 will not be regarded as an income generated from personal exertion. Brent v. Federal Commission of Taxation (1971), clarifies the issue much further. In this case the taxpayer that is the wife of a famous train robber Ronald Biggs, wrote her story and sold it to a newspaper for $65250. She was able to receive $10000 only in the income year of 1970 (CCH Australia Ltd, 2011). The verdict of the court signifies the importance of personal exertion. According to the decision in the Brent v. FC case, $10000 out of $65250 was the income that was assessable in that income year. Referring to the Brent v. FC (1971) case the income was titled as assessable income from personal exertion because it was paid for “the time and service” of the wife who also gave an interview which was considered as service rendered (CCH Australia Ltd, 2011).

The payment of $2000 that is received by Hillary by selling photographs that she took while mountain climbing may or may not be regarded as an income from personal exertion. Several mountain climbers are also professional photographers for the climbing magazines (Reichmann, 2011). If this is the case with Hillary then it is regarded as her skill. According to the definition of the income from personal exertion i.e. any income that is earned directly from any effort of an individual which relates to his or her skill or labor (Australian Government, 2015), the payment of $2000 will be regarded as an income from personal exertion. But in the case study provided in the question, it is not explicitly mentioned that the photography is her profession hence according to the case study Hillary is not considered as a professional photographer. As taking photographs is not her professional skill, the payment of $2000 will not be regarded as an income from personal exertion. Moreover it also cannot be regarded as a regular income as it is a one-time payment. Using the fruit-tree analogy it also is not a fruit (receipt from the sale of photographs) of a tree (climbing business). Hence it cannot be regarded as income that is related to personal exertion.

If Hillary wrote the story for her own satisfaction and decided to sell the story later, still it will not be considered as an income generated from ‘personal exertion’. The main reason behind it is that writing is not her principal profession. She has skills of a climber rather than a writer. The proceeds from the sale of her biography years later will not be considered as an income from personal exertion. Hillary is not into the profession of writing books which means that the proceeds from the sale of her autobiography will not be considered as flowing from her principal business. Hence the sale will not be considered as an ordinary income or an income from personal exertion.

Case Study 2:

Assessable income includes the ordinary income and statutory income, however some of the statutory and ordinary incomes are exempted from assessable income. Exempt income does not fall into the criteria of assessable income (Australian Government, 2014). Some of the incomes are neither exempted nor assessable and hence are known as NANE. According to section 6-5 of ITAA 97, an ordinary income is assessable income if the person is an Australian (Australian Government, 2015). It includes all the ordinary income one gains indirectly or directly from all sources (within or outside the Australia) during the income year. While if the person is not an Australian but is only residing in Australia, his assessable income will be derived from all the sources (direct or indirect) from Australia during the income year. Statutory income is also a part of assessable income and is not considered as ordinary income (Australian Government, 2014). Similarly like ordinary income, statutory income for an Australian is income from all sources whether inside or outside of Australia while for a non-Australian residing in Australia, it includes all the statutory income earned directly or indirectly from all Australian sources (Australian Government, 2014).

Let us consider ordinary income to see whether parent’s loan extension without formal agreement and interest is part of assessable income or not. Income has some characteristics to be considered as “ordinary or assessable income” (Australian Government, 2014). These characteristics are: there are no set rules in concrete, regular periodic payments are made, cash or capable of being converted into cash, nexus with earning sources and mutuality (Australian Government, 2014). In Scott v. Federal Commissioner of Taxation, it was held that in order to be considered as an assessable income, the payment had to be in “relevant sense a product of the income producing activities” (australian taxation law Authority, 1966). In light of this, the loan extended by parent in the scenario above is missing the main characteristic of being periodical, regular or recurring payment for services provided (Australian Government, 2014).

The loan arrangements form family members are usually informal and are based purely on confidence, trust and verbal assurance. However, the main concept of being formal and legal advices the parties to involve into formal loan agreement for protecting both parties. A formal agreement or contract not only helps in ensuring that everyone else understands the business arrangement or not but also lets both of the parties to fulfil their duties.

Mother has provided $40,000 to her son as a short term housing loan with the informal and verbal agreement to repay $50,000 at the end of the five years. The true reflection of assessable income is set in Smith v. Federal Commission of Taxation (1987) in which it was set out that assessable income is gained “in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him” (Income Tax Australia, 1987).  The scenario indicates that for being considered as an assessable income, the loan lacks in following areas:

  • There is no periodic interest payment.
  • There is one lump sum payment by single cheque.
  • Initially mother asked her son to not to pay the interests in which case it has no tax implications for both the parties according to Australian Taxation Law.
  • There is no legal document binding the agreement of loan between the parties.
  • The lender has to declare the interest received as a taxable income and in the scenario, Mother has forbidden her child to pay interest.

In this light, the loan extended to son is not considered as an assessable income but is being more considered as gift. Allowance from a parent to child is not an assessable income. The assessable income of the parent will have no effect on it. If in case, the parent had agreed to receive 5% interest on the loan of $40,000 there would have been interest income of $2000 for the parent and it would’ve been considered to be assessable. Son can also deduct the interests as a legitimate business expense and parent can declare interest received as taxable/assessable income.

Case Study 3:

It is necessary to consider the capital gains on the sale of the property by Scott. There is the disposal of CGT asset and CGT event happens: s104-10(1) of ITAA97 (Australian Government, 2015). It is however, necessary to consider whether the assets disposed of is a CGT asset, collectable or personal use asset. According to broader definition of CGT asset as defined in 108-5(1), it any kind of property or legal or equitable right that is not property (Fiddes, 2012). The examples of CGT assets include land and buildings, shares in a company, collectibles costing more than $500, personal use assets costing over $10,000, contractual rights and business goodwill. Land and Building are not collectibles and personal use assets as per the definitions of both under S108-10(2) and S108-20(2) (Australian Government, 2015). Under S108-55(2) lands and buildings are treated as separate CGT assets in certain circumstances. Land that is acquired before 20th September 1985 are treated as separate CGT assets and a capital improvement is a separate CGT asset to the land if the balancing adjustment is applied to the land under S108-70 (Fiddes, 2012).

A building or capital improvement on land is a separate asset if there was no contract for its construction and construction began after 20th September 1985 (Australian Government, 2015). The capital improvement to the CGT asset is treated as a separate asset and is subject to CGT if the cost base is more than the improvement threshold for the year in which the CGT event is happening or more than 5% of the amount of the money and property received from the event (Australian Government, 2015).

In order to find the capital gain we will use indexation method because the CGT event has happened to the asset acquired before 11.45am on 21st September 1999 and it was owned for more than 12 months. Scott will use the indexed factor to find the capital gain

  1. Indexation factor =          CPI for quarter ending 30.9.99 (68.7) 
    CPI for quarter in which expenditure was incurred

 

Indexation factor        =         68.7                 =          1.59
43.2

=          1.59 × $150,000 (Cost base)

=          $238,500

  1. If Scott sold the property to his daughter for $200,000 then

$200,000 – $150,000 = $50,000 would be the capital gain.

 

  1. If the owner was a company instead of an individual:

First of all the company needs to complete capital gains tax schedule for the total capital gains which are more than $10,000 (Australian Government, 2015). Companies can defer or roll over any capital gain until another CGT event happens. Income tax and capital gains are taxed at a flat corporate tax rate of 30% for corporations and companies (Australian Government, 2015). CGT discounting method is not available for the companies. Corporation income tax is levied on sale of goods, provision of services, dividends, royalties, rent, capital gains and interests (Australian Government, 2015). Income generating expenses for companies are deductible when taxable income is calculated.

 

References

Australian Government. (2014, July 15). Australian Governement: Australian Taxation Office. Retrieved August 6, 2015, from ATO: Assessable Income: https://www.ato.gov.au/General/Tax-terms/In-detail/Employment,-income—tax-returns/What-is-income-/?anchor=Assessable#Assessable

Australian Government. (2015, June 10). Australian Government: Australian Taxation office. Retrieved August 6, 2015, from ATO: Capital Gains: https://www.ato.gov.au/General/Capital-gains-tax/

Australian Government. (2015, June 10). Australian Taxation Office. Retrieved August 6, 2015, from ATO:Capital Gains Tax: https://www.ato.gov.au/General/Capital-gains-tax/Working-out-your-capital-gain-or-loss/Working-out-your-net-capital-gain-or-loss/

Australian Government. (2015, June 20). Australian Taxation Office. Retrieved August 6, 2015, from ATO: Taxation Ruling No. 2121: http://law.ato.gov.au/atolaw/view.htm?docid=ITR/IT2121/NAT/ATO/00001

Australian Government. (2015, June 4). Australian Taxation Office: Taxation Ruling. Retrieved August 6, 2015, from Income Tax: Personal Service Income: http://law.ato.gov.au/atolaw/view.htm?docid=ITR/IT2639/NAT/ATO/00001

Australian Taxation Authority. (1966). Australian Government. Retrieved August 7, 2015, from Legal Database: Income tax: Education and Training Grant payments provided by the Australian Cricketers Association (ACA): http://law.ato.gov.au/atolaw/view.htm?docid=CLR/CR201421/NAT/ATO/00001

CCH Australia Ltd. (2011). Australian Master Tax Guide.

Fiddes, R. (2012). Introduction to Capital Gains Tax.

Income Tax Australia. (1987). ccHiknow:Income Tax. Retrieved August 7, 2015, from Smith v. Federal Commissioner of Taxation., High Court of Australia, 13 October 1987: http://www.iknow.cch.com.au/#!/document/atagUio546686sl16811143/smith-v-federal-commissioner-of-taxation-high-court-of-australia-13-october-1987

Reichmann, M. (2011, April 15). The Luminous Landscape. Retrieved from On the Road Again: https://luminous-landscape.com/mountain-climbing-photography/