HI6028: Taxation, Theory, Practice & Law - Capital Gains Tax - Fringe Benefits Tax -Case Study Assessment Answer

Taxation Case Study Assignment

Case Scenario 1

Fred is a resident who signed a contract to sell his holiday home in the Blue Mountains in August last year. The sale was settled in February this year when Fred received $800,000 from the purchaser. Fred incurred legal fees of $1100 (Inclusive of GST) and real estate agent’s commission of $9,900 (Inclusive of GST) in relation to the sale. Fred purchased the holiday home in March 1987 for $100,000 and paid $2,000in stamp duty on the transfer and $1000 in legal fees. In January 1990, Fred engaged a builder to build a garage on the property for $20,000,

Case Scenario 2

Periwinkle Pty Ltd (Periwinkle) is a bathtub manufacturer which sells bathtubs directly to the public. On 1 May 2015, Periwinkle provided one of its employees, Emma, with a car as Emma does a lot of travelling for work purposes. However, Emma's usage of the car is not restricted to work only. Periwinkle purchased the car on that date for $33,000 (including GST).

For the period 1 May 2015 to 31 March 2016, Emma travelled 10,000 kilometres in the car and incurred expenses of $550 (including GST) on minor repairs that have been reimbursed by Periwinkle. The car was not used for 10 days when Emma was interstate and the car was parked at the airport and for another five days when the car was scheduled for annual repairs.

On 1 September 2015, Periwinkle provided Emma with a loan of $500,000 at an interest rate of 4.45%. Emma used $450,000 of the loan to purchase a holiday home and lent the remaining $50,000 to her husband (interest free) to purchase shares in Telstra. Interest on a loan to purchase private assets is not deductible while interest on a loan to purchase income-producing assets is deductible.

During the year, Emma purchased a bathtub manufactured by Periwinkle for $1,300. The bathtub only cost Periwinkle $700 to manufacture and is sold to the general public for $2,600.

Assignment Task1

(a) Advise Periwinkle of its FBT consequences arising out of the above information, including calculation of any FBT liability, for the year ending 31 March 2016. You may assume that Periwinkle would be entitled to input tax credits in relation to any GST- inclusive acquisitions.

(b) How would your answer to (a) differ if Emma used the $50,000 to purchase the shares herself, instead of lending it to her husband?

Assignment Task2

Calculate Fred’s net capital gain for the current year. Assume he also has a net capital loss from last year of $10,000 arising from the sale of shares. Would your answer be different if the loss arose from the sale of an antique vase?

Introduction

Case Study 1: Capital Gains Tax

Calculating CGT gain or loss

Disposal of a Capital Gains Tax (CGT) asset

• Under s. 104-10 CGT event A1:
• Capital gain is recognised when the capital proceeds from the sale or disposal of an asset are over the asset’s cost base (Akhtar, 2014).
• A capital loss is obtained when the capital proceeds from the sale of an asset are less than the cost base.
• Under s. 104-10(2) the disposal of the asset happens when there is a change of ownership of the asset (Australian Tax Office, 2016).
• Under s. 104-109(3) the time for the sale of the asset is when the when contract of sale was ventured into; or, if there is no contract, when the change of contract of ownership happened.

Calculating CGT gain or loss

Under s. 110(25) the cost base of calculation of CGT is divided into five elements, which are;

1. First element: The acquisition cost s. 110(25).
2. Second element: Incidental cost s. 110(35).
3. Third element: costs of owning the property or asset. Not included are the deductions that are claimed or claimable s. 110-45(B), s. 110-40(2); is not applicable to personal use or collectable assets s. 110 -25(4); different when computing for the CGT loss.
4. Fourth element: Capital expenditure (s. 110-25)
5. Fifth element: Title cost.

Methods of calculating CGT gain on sale or disposal of an asset

• Indexation approach
• Not accessible for: assets initial bought after on 21^stSept 1999, 11:45 am.

Expenditure acquired after 11:45; 21^stSept 1999, on the property that was initially bought on or before September 21^st, 1999 (Hewson, 2014).

Assets or property not held for at least a year, or 12 months.

Indexation cost base:

All the elements of the cost base, other than the third element are indexed.

Capital Gain = Capital proceeds – indexed cost base.

• The Discount nominal method

  • Apply the Capital Gains Tax (CGT) event at or after September 21^st, 1999.
  • Discount 50% for trusts and individuals, and 33% for ADF’s and super funds. It is not available for companies (Raftery, 2014).
  • Not applicable for twelve (12) Capital Gains Tax (CGT) events (D1).
  • The Capital Gains Tax (CGT) asset or property should be owned for at least 12 months.
  • If the Capital Gains Tax (CGT) event occurred after September 21^st1999, and the asset was initially bought that date, the tax payer may choose between these two events.
  • In this approach; the capital gains = (capital proceeds – cost base) × (1- discount rate) (Rydqvist, Schwartz and Spizman, 2014).

• Non-discount nominal approach.

  • Use this approach when the asset or property was purchased or sold within 12 months or the tax payer is a firm, and not a small business, unable to claim discount.
  • Capital gains = capital proceeds – cost base (without discount or indexation).

Fred’s case is related to Capital Gains Tax (CGT) event A1, the disposal of an asset. The period of disposal of the asset is when the contract was entered into, that is last August last year, as per s. 104 (3). There are two methods available to Fred, either Indexation method or Discount nominal method.

Indexation method

In this case, all the elements of the cost base, other than the third elements costs are indexed. Hence:

Purchase Costs $100,000

Stamp Duty $2,000

Legal Fees $1,000

Garage $20,000

$123,000

Indexation factor = CPI for the quarter ending March 1987

CPI for the quarter the expenditure was incurred.

As a result, the indexation factor = 68.7/45.3 = 1.5165562914

$123,000 × 1.5165562914 = 186,536

As per s. 960-270/280 ITAA97 the capital gains = capital proceeds – indexed cost base

The indexed cost base = 186,536 + 9,900 + 1,100

The indexed cost base = $197,536

The capital gains = capital proceeds – indexed cost base

= $800,000 - $197,536 = $602,464

The Discount Nominal Method

Purchase Costs $100,000

Stamp Duty $2,000

Legal Fees $1,000

Garage $20,000

Legal fees $1,100

Agents commission $9,900

$134,000

The Capital gains = [the cost base – the capital proceeds] × 50%

The capital gains = [$800,000 -134,000] × 50%

= $666,000 × 50%

= $333,000

The capital gains using the indexation approach is $602,464 while, that of Discount Nominal Approach is $333,000. Thus, as a result, Fred should select the discount nominal approach, as it offers a lower CGT.

Assuming that Fred obtains a net capital loss of $10,000 from last year, this arose from the disposal of shares.

Under ITAA 97 s. 108-5 CGT assets entail any king of property that is dealt in a particular manner, and in s. 108-20, it is mainly for personal enjoyment or usage, and does not include land (Ziaras, 2014). Furthermore, collectable are covered in s. 108-10(2) and s. 108-10(3). Under s. 108-10(1) any loss or gain bought for $500 or less on disposal is disregarded. If purchased for over $500, any Capital Gains Tax (CGT) is taxed; and any, CGT loss may only be offset against a CGT gain for the sale or disposal of another collectable. Furthermore, the $10,000 or $500 is either (i) is GST exclusive, if the taxpayer is entitled for ITC (Input Tax Credit); (ii) includes the GST is the taxpayer is not entitled for ITC (Australian Tax Office, 2016).

Fred is not entitled to receive any tax credit; hence, the Goods and Service Tax (GST) should be incorporated in the computation if the cost base. The net capital loss of $10,000 must be carried forward to offset the calculations of the present years net Capital Gains Tax (CGT). However, if the net loss of $10,000 arose from the disposal of an antique vase; as per s. 108-10 (2), the net capital losses from the sale of the vase must be considered as a collectable. As per s. 108-10 (1) if the antique vase was bought for $500 or less; the $10,000 capital loss can be ignored; in other instance, if the vase was bought for over $500, the capital loss of $10,000 can only be offset against the Capital Gains Tax (CGT) gains from the sale or disposal of another collectible.

Case Study 2: Fringe Benefit Tax

The Fringe Benefit Tax is distinct to income tax and it is ascertained on the taxable value for the benefits offered. In this case, Periwinkle offers Emma car and loan as fringe benefits (Australian Tax Office, 2016).

Car Fringe Benefit

In this case, Periwinkle offered a car for work purposes; however, it is also, available for private use. Hence, Periwinkle offers a car fringe benefit. The car is considered to be available for private usage to an employee on any given period if they:

1. Use it for private means.
2. Is permitted to use for private reason

In this regard, if a car is garaged near or at the employee’s (Emma’s) home, even if it just for security purposes, it is considered to be available for private usage; regardless, of whether the employee was or was not given the permission to use the vehicle privately (Bargain et al., 2014). Also, if the place of employees’ residence and employment are the identical, the car is considered to be available for private use.

There are some situations whether the use of a vehicle from Fringe Benefit Tax (FBT). The car is exempt from FBT if the private use of the car is restricted to:

1. Travelling between work and home.
2. Incidental car travel to perform employment-linked travel (Hewson, 2014).
3. Non-work related use; however, minor, such as, removing domestic rubbish.

Other benefits employees obtain relating to the use of a car. The benefits offered by employers relating to the usage of a car, while not constituting a car fringe benefit can amounts to an expense payment or residual fringe benefit. Such as;

1. If the employers reimburses, or pays for, an employee’s expenditure on the tools, it is considered an expense fringe benefit.
2. If an employer permits an employee to utilize the electronic toll tag, constitutes offering a residual fringe benefit (Rydqvist, Schwartz and Spizman, 2014).
3. If the employer permits the use of a vehicle, which is not considered a car, constitutes to offering a residual fringe benefit.

Loan Fringe Benefit

If an employer offers an employee, a loan fringe benefit, and charge a low or no interest. A low interest is that one, which is recorded to be lower than the market benchmark interest rate. The market benchmark interest rate for fringe benefit tax (FBT) as at the end of March 31^st2015 is 5.95% (Knauer et al., 2014).

The Fringe Benefit Tax (FBT) consequences for Periwinkle

1. The Provisions for a car (under FBTAA s. 7.100 – 130) (Knauer et al., 2014).

• As per Fringe Benefit Tax Assessment Act (FBTAA) 1986 s. 7; the car is available for fringe benefit, as Periwinkle made it available for Emma’s private usage.
• In this case, if there is no absolute requirement to use the cost basis approach, or any further information to that effect, the statutory formula is:

The taxable value (33,000 × 0.2 ×330/365) = $5,967

• In Fringe Benefit Tax (FBT), the Base value is the cost of the car.
• The number of the period or days that the car was available as fringe benefit is 330 days, the days the vehicle was planned for repairs, and the vehicle is not accessible for private usage (Woellner et al., 2014). The period of time (days) when the car was parked at the airport, is still considered as for a private use, unless Emma offered the car keys to her employer.
• Emma was paid back for her expenses, and thus, there is no recipient’s contribution.

Bought bathtub for $1,300 (under s. FBTAA s. 7.250 – 270; 7. 370).

• Under, FBTAA Div 11. The bathtub would be considered as “in-house asset or property fringe benefit” as they are sold to consumers in the usual course of the Periwinkle’s business.
• Periwinkle manufactures the bathtub’s and is sold to consumers or the public under the day-to-day activities, or ordinary course of business. In this regard, the taxable value = 0.75 × $2,600 = $1,950.
• The taxable value for the tax payer is reduced by $1,300, and hence, $1,950 - $1,300 = $650.
• Under FBTAA s. 62 the taxable value of $650, may further be reduced to zero, as it is considered as an ‘in-house fringe benefit’. However, this is based on the assumption that Emma has no other in-house fringe benefit for that period or year) (Woellner et al., 2014).

Having ascertained the taxable value for every fringe benefit; it becomes necessary to ascertain whether the fringe benefit is considered as either a type 1 or type 2 benefit: as highlighted in s. 7.400.

• Type 1: Car; fringe benefit, the total value of the car is considered as being GST inclusive, and in this case, it is presumed that Periwinkle is permitted to input tax credits.
• Type 2: Loan; it is a fringe benefit. However, it is a financial supply, and hence, it is not GST permissible).

In this regard, under FBTAA s. 7.410 the taxable value for the fringe benefit is:

($4, 356 × 1.8868) + ($5,967 × 2.0802) = $8, 219 + $12,413

= $20,632

The Fringe benefit tax liability is 47% × (taxable value)

= (0.47 × $20,632) = $9,697

The taxable liability is $9,697 (under FBTAA s. 7.420).

In regards to the above items, Periwinkle taxable liability is $9,697.

Case Study 2: Fringe Benefit Tax (B)

FBTAA s. 19 highlights the effects of purchasing assets, such as, shares for personal use. In this regard, if Emma uses her $50,000 to buy shares for personal use; rather than, lending it to her husband, it would be considered for income generating purposes, and subsequently, any corresponding interest that has accrued from that transaction would be deductible. In this regard, the Emma’s taxable value of the fringe benefit loan would be diminished by about 10% ($50,000/$500,000) under the deductible rules, which was written in the FBTAA s. 19 (7.390) (Woellner et al., 2014).