Part A Discussions and Calculations.
Question 1 (10 marks)
Discuss if the following items are deductible or not (explain why or why not). Refer to the statutory laws and case laws if applicable.
Mal purchases various law books for $800 in the income year. He is employed as a lawyer and uses the books as a resource in his current position.
Glenn purchases $840 of paints and supplies. He uses these to paint portraits. He painted 6 portraits during the year for friends and relatives but gave them as gifts rather than selling them.
Ryan has purchased $2,700 of lottery and keno tickets during the 2019/2020 income year. On 20 June 2020, he won $50,000 from one of the lotteries that he had purchased tickets in.
Frank paid $200 to a registered tax agent to lodge his tax return for the income year of 2018/1019.
Jacqueline purchased a Ford Ranger for $49,000 in order to use it to travel to her investment properties for maintenance purposes.
Solution:
- It is evident that the law books are necessary for Mai so that he could discharge his professional duties as a lawyer. Hence, there is sufficient nexus between the outgoing of $800 on law books and the assessable income derived as lawyer. Hence, the expense would be deductible as per s. 8-1 ITAA 1997 since such expense would be frequently required considering constant update in law.
- As per s. 8-1(2) ITAA 1997, one of the negative limbs states that any expense for exempt income or non-assessable income would not be deductible. It is evident that the paints and supplies are expenses which are not aimed to derive any assessable income. Hence, the amount would not be deductible.
- Since the lottery winnings does not involve any particular skill and is essentially chance based, hence the lottery winnings would be exempt from tax as per IT167A. As per the negative limb associated with s. 8-1 (2) ITAA 1997, the expense on exempt income is non-deductible. Hence, no deduction would be available on the $2,700 spent on lottery purchases.
- As per s. 25-5 ITAA 1997, tax related expenses are deductible which also includes fees given to a registered tax agent for filing tax return. Hence, Frank would be able to claim deduction of $200 for 2018/2019.
- The car is a capital asset and thereby a capital expense. No deduction for a capital expenditure is available under s. 8-1 ITAA 1997. However, since the car is being used for income generation purposes, hence the depreciation on the car (computed as per s. 40-75 ITAA 1997) would be deductible annually to the extent the vehicle is used for income generating purposes.
Question 2 (10 marks)
Determine the taxable income and the tax payable /refundable of the following two individual resident taxpayers.
During the income year ending 2019, RafaHazeez has a gross salary of $78,000 (PAYG tax withheld is $17,700), a fully franked dividend of $2,000 and an unfranked dividend of $1,000. He had incurred work related travelling expense of $ 500. He bought a laptop for $1,500 at 01/07/2018, and used it mainly for work purposes. He estimates that he used the laptop 90% for work. For tax purposes, he could use the laptop for 5 years and he decides to use prime cost method to calculate decline in value. He has no other deductions except for those mentioned above.
Laurie Howe, sold an investment property located in Sydney on 15 January 202. The property was leased for the entire time that it was owned by Laurie.Details relating to the acquisition and the sale are as follows:
Purchase on 10 April 2010
Purchase price: $ 350,000
Stamp duty: $ 18,200
Legal costs: $ 17,700
Sales on 15 January 2020 for $ 640,000
Solution: (a) Gross salary is assessable since it is ordinary income and hence as per s.6-5 ITAA 1997 it contributes to assessable income. Dividends are assessable as per s. 6-10 ITAA 1997 since they contribute to statutory income.
Total assessable income = $78,000 + $2,000/(1-0.3) (Including franking credit) + $1,000 = $81,857
Work related travelling expenses would be deductible as per s. 8-1 ITAA 1997. With regards to laptop, the purchase price is capital expenditure and thereby cannot be deducted under s. 8-1 ITAA 1997. Hence, the decline in value would be computed as per s. 40-75 ITAA 1997 and deduction would be available for business use.
Decline in value = ($1,500/5) = $300
Since 90% is business use, hence available deduction = $300*90% = $270
Total deductions = $500 + $270 = $770
Taxable income = $81,857 – $770 = $81,087
Basic income tax = $3,572 + 32.5%*($81,087-$37,000) = $17,900
Income tax levy = 2%*(81,087) = $1,622
Total tax payable = ($17,900 +$1,622) – PAYG (i.e. $17.700) – Franking credit ($857) = $965
b) The cost base of the property would be determined based on the s. 110-25 ITAA 1997.
Cost base of the property = $350,000 + $18,200 + $17,700 = $385,900
The sale of property would trigger a A1 CGT event as per s. 104-5 ITAA 1997. The formula for computation of capital gains is outlined in s. 104-10 ITAA 1997. This is indicated below.
Capital gains/(losses) = Sales proceeds – Cost base
The current property has been leased since purchase and hence main residence exemption would not apply here.
Capital gains from sale of property = $640,000 – $385,900 = $254,100
Since the taxpayer is an individual resident taxpayer and the capital gains are long term, hence as per discount method (s. 115-25 ITAA 1997), 50% concession may be availed by taxpayer.
Hence, taxable capital gains = (1/2)*$254,100 = $127,050
Assuming a marginal tax rate of 30%, tax levied = 0.3*$127,050 = $38,115
Part B Case study (30 marks)
Question 3 (10 marks)
The Armstrong Pty. Ltd is a family business with two resident shareholders, Nick and Gavin. During this income year of 2018-2019, the activities of the company gave rise to the following:
| $ | |
| Loss from rental property | (10,000) |
| Interest income from term deposits | 56,000 |
| Cash received from no frank dividends | 7,000 |
| A capital gain from the sale of Telstra’s shares that had been held for three years | 2,000 |
Nick also has the following income:
• Net Salary of $90,000 (PAYG withholding tax instalments of $35,000 have been deducted).
• Work-related expenses of $21,000
Nick has private hospital cover.
Required:
Calculate the taxable income and tax payable or refundable for Nick for the income year. Please show all your workings.
Solution: Gross salary = $90,000 + $35,000 = $125,000. This amount would be assessable since this is ordinary income and therefore assessable as per s. 6-5 ITAA 1997.
Deduction for the work related expenses to the extent of $21,000 as per s. 8-1 ITAA 1997.
It is noteworthy that the company is a separate legal entity and hence the transactions of the company would not be taxable at the level of shareholders. The taxable income of the company would be levied corporate tax. Also, it is noteworthy that the shareholders can have tax implications only if they receive any dividends or salary from the company. The profits of the company does not automatically does not flow to the shareholders since company is a separate legal entity.
Hence taxable income for Nick = $125,000 – $21,000 = $104,000
Basic income tax for 2018-2019 = $20,797 + 0.37*(104,000-90,000) = $25,977
Medicare levy = (2/100)*$104,000 = $2,080
No MLS (Medicare Levy Surcharge) would be applicable since Nick has private insurance and also taxable income does not cross the threshold level.
Tax payable/(refundable) = $25,977 + $2,080 – $35,000 = -$6,943
Hence, Nick would obtain a tax refund of $6,943.
Question 4 (10 marks)
Ali and Sumara started a retailing shop on a partnership. Each of them contributed $40,000 fund to the business. The partnership agreement provides:
- Both Ali and Sumara are to receive interest at the rate of 10% pa on their capital contribution.
- Ali will receive a salary of $25,000 for the management of the shop, as well as superannuation contributions of $6,000.
- The remainder in profit and loss will be shared equally between Ali and Sumara .
The accounts for this income year show the following:
| Income ($) | |
| Sales | 240,000 |
| Expenses ($) | |
| Cost of goods sold | 130,000 |
| Interest on capital paid to Ali and Sumara in total | 8,000 |
| Salary to Ali | 25,000 |
| Concessional Superannuation to Ali | 6,000 |
| Rent expense | 7,000 |
| Other deductible operating expenses | 14,000 |
Required:
Calculate the net income of the partnership. Show the allocation of net income to each of the partners.
Solution: In order to determine the net income of the partnership, the salary and superannuation paid would not be considered as indicated in s. 90 ITAA 1936 and tax ruling TR 2005/7. Also, the interest based on the initial capital would not be considered for computation of net income of the partnership since it was given for setting up business and thus does not result in direct aid of assessable income.
For the partnership firm, sales would be assessable income as per s. 6-5 ITAA 1997. Cost of goods sold, rent expense and other deductible expenses would be deducted in accordance with s. 8-1 ITAA 1997 as there is sufficient nexus of these activities with the production of assessable income in the form of sales.
Net income of partnership = $240,000 – ($130,000 + $7,000 + $14,000) = $89,000
Before the distribution of profits to the partners, deduction for salaries, interest and superannuation needs to be made.
Hence, profits available for distribution = $89,000 – ($8,000 + $25,000 + $6,000) = $50,000
Since both partners have equal stake, hence the profits distributed to each partner would be $25,000.
Total receipts from partnership for Ali = $25,000 (Profits share) + $4,000 (Interest on capital) + $25,000 (Salary) + $6,000 (Superannuation contribution) = $60,000
Total receipts from partnership for Sumara = $25,000 (Profits share) + $4,000 (Interest on capital) = $29,000
Question 5 (10 marks)
Suman gained a Degree in Business when he was a young lad and with skill and hard work, he has used that knowledge to start his own business
He operates his own business selling computers and related equipment. Over the last financial year, sales of computers and equipment were paid for at the time of sale. During the year ended 30 June 2019, Sumanreceived $3,000,000 in cash for sales of computers.
Purchases during the year ended 30 June 2019 were $1,200,000 and at the end of the year ended 30 June 2019 his stock on hand was $950,000 (valued at cost). Suman’s closing stock for the year ended 30 June 2018 was $650,000. Suman took 2 computers from his stock for his own use during the year. These computers cost him $220 each and had a market value of $330 each. Suman also gave away another 10 similar computers to his friends during the year.
He paid wages of $1,420,000 to his 20 staff members. This included an amount of $30,000 paid to his brother, who is still at school. The work of the brother could have been done by an unrelated person for $10,000. He also paid $200,000 into his staff’s complying superannuation funds as concessional employer contributions.
Explain how you would calculate the income from his business and the amount of all deductions that would be allowed for the year ending 30 June 2019.
You must give reasons for your answer. Your discussion must include an analysis of the pertinent sections of the relevant legislation, rulings and the relevant case law. If relevant, you must show your calculation. Ignore residency, Fringe Benefits Tax and Goods and Services Tax issues. You must apply the law to the facts given in this question and provide YOUR OWN analysis of the issues. Calculations must be included where relevant.
Solution: The computation of business income is indicated below.
Proceeds from the sale of computers would be classified as ordinary income and hence assessable income under s. 6-5 ITAA 1997.
The cost of goods sold need to be determined using the formula = Opening stock + Purchases – Closing stock
Hence, cost of computers for the given tax year = $650,000 + $1,200,000 – $950,000 = $900,000. Deduction for this amount would be available as per s.8-1 ITAA 1997 since this expense has been incurred to allow for the sales of the computers.
As per s. 290-60 ITAA 1997, the employer contribution to superannuation funds would be deductible for tax purpose.
The wages have a direct nexus with the computer sales and would be deductible as per s. 8-1 ITAA 1997. However, the market value of this needs to be computed so as to avoid abuse of the available deduction.
Market value of wages = $1,420,000 – $30,000 + $10,000 = $1,400,000
The amount taken from the stock would be deductible expense as per s. 8-1 ITAA 1997 as this is a kind of compensation which is made in kind. Deductible expense = $330*12 = $3,960
Hence, taxable income for business = $3,000,000 – ($900,000 + $200,000 + $1,400,000 + $3,960) = $496,040
