Questions
Case Study
Married couple, Rob and Jane White acquired a 120 hectare farm property in Central Queensland twelve years ago. Their partnership agreement shows that they agree to share their profits and losses in the ratio of Rob 60% and Jane 40% respectively.
Rob and Jane presented their financial details to you, as their tax accountant for the year ended 30 June 2017.
Receipts for the tax year:
- Livestock trading (from livestock trading account) to be calculated
- Proceeds from the sale of 200 cattle $ 163 000
- Agistment fees received $ 7 800
Livestock Details:
- On 1 July 2016, there were 312 cattle at a cost of $80 600
- During the year, Rob and Jane bought a further 70 head of cattle at $275 per head
- There was a natural increase of 95 head and 41 cattle deaths
- 5 cattle were slaughtered for rations (from opening stock)
Expenses for the year:
- Hay bought to feed cattle $ 5 600
- Repairs and servicing of farm equipment $ 1 300
- Construction of new fencing $ 8 000
- Salary to Rob $ 20 000
- Salary to Jane $ 20 000
Other information:
- The opening balance of Rob and Jane’s small business depreciation pool is $51 000
- Their small business pool comprises of farm equipment that Rob and Jane bought in the year ended 30 June 2017
- The farm equipment is 100% used for the cattle business
- Their partnership elects to value livestock at cost for the year of income
Rob and Jane want to sell their business in the coming financial year, ending 30 June 2018. They have been approached by a number of interested buyers. Their business broker has advised them that they have a good chance of selling the cattle business together with their farm equipment and trading stock for $5 million. It is envisaged that the profits arising from the sale of the cattle business arises mainly from the goodwill of the business and the 120 hectares of land. It is anticipated that trading stock will be disposed of at market value at the time of sale which will be higher than the cost price of the cattle. It is estimated that the farm equipment could be sold for $40 000. The cattle business obtained a bank loan five years ago which was secured over the 120 hectares of land. The outstanding amount on this business loan is estimated to be $600 000 at the time of sale.
Rob and Jane look forward to retirement as they are both over 55 years old. With the proceeds of the farm, they intend to downsize and buy two houses, one which they will use as an investment property, and the other which they will use as their primary residence. With the remainder of the money, they intend to set up a trust for their two sons – Jacob (22 years old) and Nicholas (14 years old), with Rob acting as trustee.
Required
1. On the basis of the information provided, determine the net partnership income or loss for the year ended 30 June 2017. You must show all calculations and explanations supported from the ITAA (1997). You may either use the reconciliation or tax approach to come up with your net partnership/losses.
2. Advise Rob and Jane of the capital gains implications of the intended disposal of the farm in the coming year. Also advise them as to the potential capital gains implications of acquiring the two properties. You are notrequired to do any calculations for this question. (Hint: consider the difference in the intended uses of the two properties they wish to purchase. Also consider whether this business may be considered to be a small business enterprise and the tax benefits arising from this.)
3. Advise Rob and Jane on the tax implications, if any of the trust that is intended to be set up for their two sons. Clearly explain and support your arguments with reference to legislation.
4. Primary producers may opt to use income averaging when managing their tax affairs. Give a brief explanation of what this is and why it was introduced.
Answers
1. Livestock Trading Account
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Livestock Trading Account
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In the Books of Rob and Jane
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For the year ended 30th June 2017
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Particulars
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Amount ($)
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Amount ($)
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Income Reconciliation
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Receipts
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Livestock trading (A)
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$ 99,850.00
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Proceeds from sale of Cattle (B)
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$ 1,63,000.00
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Agreement Fees received ( c )
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$ 7,800.00
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Net Income from Business (D)
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$ 2,70,650.00
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Income Reconciliation Adjustment
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Opening balance of livestock pool ( E )
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$ 51,000.00
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Sub Total (F) ( D+E )
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$ 3,21,650.00
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Expenses Reconciliation Adjustment
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Hay bought to feed cattle
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$ 5,600.00
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Repairs ans Service of farm equipment
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$ 1,300.00
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Salary to Rob
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$ 20,000.00
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Salary to Jane
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$ 20,000.00
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Sub Total (G)
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$ 46,900.00
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Expense subtractions:
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Construction of new fencing (H)
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$ 8,000.00
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Total Assessable Income (I)
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$ 2,66,750.00
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Tax on Taxable Income
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$ 73,356.25
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Medicare Levy
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$ 5,335.00
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Net Tax Payable
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$ 78,691.25
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2. Part III A of the Income Tax Assessment Act 1936 lays down the provision of capital gains and losses arising from the partnerships (Pinto, 2011). In particular the taxation rulings of TR IT 2540 lays down the provision relating to the disposal of the partnerships assets and dealings by the partners concerning the interest that is held by them in the partnership (Barkoczy, 2016). As evident from the following case of Rob and Jane who wants to dispose the interest in partnership business in the upcoming year 2018. According to the viewpoint of their business broker the partners Rob and Jane has better chances of disposing their interest in partnership business together with their assets and trading stock for approximately $5 million.
As per the view stated in the FCT v. Everett (1980) 143 CLR 440, a partnership cannot be considered as the separate lawful entity, which is distinct from the individual partners that comprises of the partnership (Snape& De Souza, 2016). In spite of the partner has no kind of specific title owned to the property by the partnershiphowever, he or she has the interest in the partnership assets. The lawful title to the assets of the partnership remains to vest with the partners and the agreement amid the partners might vary the terms by which lawful ownership of the assets of the partnership is allocated between the partners.
An argument has been put forward under Part IIIA of the Income Tax Assessment Act 1936 which is applicable to the partnership in spite of the partnership cannot own the assets (Braithwaite, 2017). This is because the partnership is treated given that it was treated as distinct entity for the purpose of Income Tax. Part IIIA is applicable on the Rob and Jane since they own the equipment of business and trading stock, which they intend to sale. In accordance with the Part IIIA any kind of capital gains or losses on the disposal of assets accrues is incurred by the individual partners who owned the asset.
Section 160zo of the Income Tax Assessment Act 1936 requires the net capital gains must he taken in to the considerations under the assessable income of the taxpayer (Cao et al., 2015). In consistent with the views of Investments Pty Ltd v. FCT (1972) 128 CLR 158 disposal of business by the partner in the partnership business represents the disposal of interest. The disposal of partnership assets generally represents the disposal of the interest of the individual partnership assets. In order to determine any capital gain or capital loss to the partners in relation to the Rob and Jane interest in each of the assets namely equipment and trading stock it is obligatory to ascertain the part of the disposal proceeds that is attributable to each of the partners interest (Saad, 2014).
The considerations that is paid or received by on the disposal of business Rob and Jane will represent the disposal proceeds of the interest in the partnership assets. Such disposal by Rob and Jane will be accepted under the disposal of Part IIIA of the Income Tax Assessment Act 1936. Since the intended dealings is anticipated to take place in ordinary commercial context therefore the capital gains arising from the disposal of assets and business will be liable for Capital gains tax and must be included in the assessable income of the partners.
On the other hand, it is further found that both Rob and Jane intends to downsize and purchase two assets. They intend to use one as their investment property and the other as their place of primary residence. According to the Taxation Determination ruling of TD 1999/67 an individual can implement the main residence exemption under the subdivision of 118-B of the Income Tax Assessment Act 1997 whichever area of land on intends to choose where their house is located(Ross et al., 2017). The capital gains or capital or losses, which one makes from the land, is only disregarded under the main residence exemption if it is used for the purpose of private or domestic association.
As evident from the following case study of Rob and Jane, they can obtain the main residence exemption for the house, which they intend to purchase. The capital gains or losses made by them will be disregarded under subdivision of 118-B of the Income Tax Assessment Act 1997 (Davis et al., 2015). In addition to this, Rob and Jane can also claim a small business capital gains tax concession for the rollover relief over the sale of active assets. This will help Rob and Jane to defer all or a portion of their capital gain from the sale of equipment and trading stock for two years. Since the turnover of the business is less than $2 million the concessional rate of rollover, relief will be available at the time of disposing the active assets.
3. The taxation ruling of TR 2006/14 is concerned with the capital gains tax consequences related to the creation of life and remained of the trust interest in the property. The ruling is concerned with the consequences leading to the granting of the lifetime right to reside in the property (Bevacqua, 2015). As evident from the following scenario of Rob and Jane with the remainder of money from disposal of partnership business, they intend to set up the trust for their two sons with Rob playing the part of the trustee.
The capital gains tax consequences are generally different from the equitable life and those of legal life in the real property. It is noteworthy to denote that the lawful owner of the asset held on trust for the benefit of the life interest together with the lawful person being the representative of the deceased estate where the estate of the deceased are required to the held on trust with the objective of providing life benefit and remainder owners (Lang, 2014). If the trust is createdover, the original asset through the medium of declaration and settlement CGT event under section 104-55 takes place at the time of creating the trust.
A trust represents the obligations that is imposed on person for the benefit of the beneficiaries. In the present context of Rob and Jane,the creation of trust represents a CGT event under section 104-55 and the trustee will be held responsible for the management of the trust’s tax affairs along with the lodging of the trust tax returns and the payment of tax liabilities (Miller & Oats, 2016). The trustee in the present context is Rob who can make capital gains or losses arising from the CGT event occurring to the original asset following the commencement of being held under the trust for life interest and the their two sons. Any form of capital gains or losses that is made by the trustee is taken into the considerations at the time of working out the net capital gains or loss of the trustee.
The net capital gains are subjected to be included in the net income of the trust in agreement with the subsection 95 (1) of the Income Tax Assessment Act 1936 and it is held for tax in compliance with the subdivision of 115-C (Davison et al., 2015). As in respect of the present scenario of Rob who is the trustee of the trust set up by him for his two sons the net capital gains are subjected to be taken into the considerations in the net income of the trustee. In compliance with the subsection 95 (1) of the Income Tax Assessment Act 1936the net income will be held for taxation under subdivision of 115-C.
4. Primary producers can choose to make use of the income averaging when administering their tax affairs. Tax averaging provides the primary producers to even out their income and tax payable over the period of maximum of five years as this allows them for both good and poor year (Kaldor, 2014). This helps in making sure that the taxpayer does not have pay more tax over time than the taxpayers of comparable however steady income. Primary producers are also provided with deductions excluding the non-commercial loss with the provision that are excluded from the computation of the basic assessable income (Weisbach, 2016). The sum of averaging tax offset or the extra amount of income tax is computed automatically and the taxpayers notice of assessment will represent the details of the averaging.
The averaging rules takes into the considerations the rate of tax that the primary producers would have to pay during the current year based on the basic rate of tax on their average earnings. It is noteworthy to denote that the Medicare levy is not taken into the considerations at the time of implementing the basic tax rate (Feld et al., 2016). The averaging component on the other hand considers the part of the primary producers basic income which is subjected to the average adjustment. This is usually made up of the both the taxable primary production income and taxable non primary production income.
The primary producer has the assessable primary production income when the taxable primary production income of the producer goes past the deductions. It is worth mentioning that the assessable primary production income of primary producer is that part of the taxable income, which is generated from carrying on of a primary production business. The primary producers are also provided with the capital allowance for fodder storage assets, which is primarily held, or the expenditure, which the primary producer incurs on the fodder storage assets. Primary producers are provided with the opportunities of tax averaging that enables them to even out their income and tax payables over the maximum period of five years (Hegemann et al., 2017). This enables the taxpayers from paying more than the required amount. When the income of primary producers is less than the deductions, the assessable income of the primary producers is regarded as nil. Therefore, assessable income of the primary production always forms the part of averaging elements.
Reference List:
Barkoczy, S. (2016). Foundations of Taxation Law 2016. OUP Catalogue.
Bevacqua, J. (2015). ATO accountability and taxpayer fairness: An assessment of the proposal to split the Australian taxation office. UNSWLJ, 38, 995.
Braithwaite, V. (Ed.). (2017). Taxing democracy: Understanding tax avoidance and evasion. Routledge.
Cao, L., Hosking, A., Kouparitsas, M., Mullaly, D., Rimmer, X., Shi, Q., ...&Wende, S. (2015). Understanding the economy-wide efficiency and incidence of major Australian taxes. Treasury WP, 1.
Davis, A. K., Guenther, D. A., Krull, L. K., & Williams, B. M. (2015). Do socially responsible firms pay more taxes?. The Accounting Review, 91(1), 47-68.
Davison, M., Monotti, A., & Wiseman, L. (2015). Australian intellectual property law. Cambridge University Press.
Feld, L. P., Ruf, M., Schreiber, U., Todtenhaupt, M., &Voget, J. (2016). Taxing away M&A: The effect of corporate capital gains taxes on acquisition activity.
Hegemann, A., Kunoth, A., Rupp, K., &Sureth-Sloane, C. (2017). Hold or sell? How capital gains taxation affects holding decisions. Review of Managerial Science, 11(3), 571-603.
Kaldor, N. (2014). Expenditure tax. Routledge.
Lang, M. (2014). Introduction to the law of double taxation conventions. LindeVerlag GmbH.
Miller, A., & Oats, L. (2016). Principles of international taxation. Bloomsbury Publishing.
Pinto, D. (2011). State taxes. In Australian Taxation Law (pp. 1763-1762). CCH Australia Limited.
Ross, M., Walker, J., & Walker, J. (2017). Multinationals targeted down under. Taxation in Australia, 52(1), 22.
Saad, N. (2014). Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, 1069-1075.
Snape, J., & De Souza, J. (2016). Environmental taxation law: policy, contexts and practice. Routledge.
Weisbach, D. A. (2016). Capital Gains Taxation and Corporate Investment. Browser Download This Paper.
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