Foundation of Taxation Law Source of Payment

Question: Describe about the Foundation of Taxation Law for Source of Payment. Answer: 1. Issue The case pertains to a famous mountain climber named Hilary. She has never written any book before but is given offer by the local newspaper to write a book on her own life (autobiography) and in lieu of that, the newspaper promises to make a payment of $ 10,000. She accepted the offer and went on to complete the book and sold the rights for $ 10,000. Further, the manuscript was also sold by Hilary and a compensation of $ 5,000 was derived. Lastly, $ 2,000 were derived on account of sale of photographs she had from her expedition. The core issue is to determine if the income derived by Hilary would be considered as that derived on account of personal exertion. Rule In the event of a payment being received, the key question from the taxpayer is to determine the source of that payment. If the payment is obtained from any business or employment in which the taxpayer is engaged, then it is classified as ordinary income as defined in Section 6-5, ITAA 1997. It is also noteworthy in this context that the any activity undertaken by the taxpayer, which is of isolated nature but with profit intention would also contribute to ordinary income under the ambit of Section 15-15 ITAA, 1997 (Woellner, 2014). However, in the event that the payment is derived from the sale of any capital asset such as land, machine, share then the receipt would be of capital nature and would not contribute to the assessable income. However, even in such cases, capital gains made may be taxed as per Section 10-5, ITAA 1997 (Barkozcy, 2014). A pertinent case which needs analysis in the backdrop of the current situation is Brent vs Federal Commissioner of Taxation(1971) 125 CLR case. The relevant facts of this case are summarised below (Sadiq et. al, 2015). The wife of a famed robber is approached by many newspapers to provide information about their married life with special emphasis on the husbands conduct towards the wife. The wife agrees to one offer and through a series of interviews extending into several days gives all the information to journalists from that newspaper. The wife does not take any active participation in the writing process. Finally, once the book is ready, the wife is asked to put her signature on every page for authenticity purposes. The central question was with regards to classification of the receipts as capital or revenue. The court in the above case had reached the verdict that the receipts derived by the wife would not be assessable as they are essentially capital. The relevant explanation put forward by the court is given below (Coleman, 2011). The various offers that the wife was getting was on account of the information she had. Hence, the real asset which the newspapers were seeking was this information of her martial life which only she could provide. Hence, the indulgence of the wife in sharing of the information is not pivotal and does not lead to the creation of any asset or any valuable service for the newspaper. The involvement in the interview is a mere mechanism to transfer the information from herself to the journalists. Similarly, the activity of putting signatures, amounts to authentication of the fact that the information is correct and the signatures otherwise do not have any worth. Hence, essentially through the contract, there is transfer of ownership of information from the wife to the newspaper for which capital receipts would be derived. Application The court reasoning and point of view would now be made applicable on the income derived by Hilary through the following arguments. The offer by The Daily Terror was not inspired from Hilarys writing skills but by her celebrity status and the information that she could provide about her personal life through the book. This information has been in the private domain and through this book, this could be brought into public domain and enable the newspaper to earn money. Thereby, the payment made is for information which is shared through writing being the medium just like interview was the medium in the Brent v. FCT Thus, the proceeds earned by Hilary through the book is capital. Similarly, since Hilarys profession is not writing or photography, hence the income derived from manuscript and photographs does not fall under the purview of either Section 6(5) or Section 15(15), thus these would be non-assessable income as they would be capital receipts. Driven by self-satisfaction In the given case, Hilary engages in book writing and is driven by only self-satisfaction as the driving factor and does not intend to earn any income. Since, Hilary is not a writer and engages in the act of writing without any profit intention, hence this would be termed as mere hobby and therefore any income derived from the same would not be assessable and be termed as capital receipts (Gilders et. al., 2013). 2. Issue The facts of the given scenario are summarised below. An oral agreement is enacted between the mother (lender) and son (borrower) as per which a financial help of $ 40,000 is given by the borrower and the lender promises to given back a sum of $ 50,000 at the end of five years. But the mother categorically states to the son that she does not have interest earning intention from the loan. The loan is repaid back by the son at the end of the second year when he makes a payment of $ 44,000 in which $ 40,000 amounts to principal repayment and the remaining amount is interest computed at 5% pa. The impact of the above lending on the assessable income of the mother needs to be analysed. Rule In accordance with Section 6(5), one of key constituents of ordinary income is interest payments. This may be earned by engaging in business of money lending. Also, investment in a security which pays interest would also contribute to the interest income. However, in accordance with Section 15-15, any casual lending with profit making intention would also lead to the interest income being termed as ordinary income (Deutsch et. al., 2016). Further, in order to segregate casual lending with commercial lending operations, comparison needs to be derived between the execution of the given transaction with the manner of execution of commercial transactions. It is noteworthy that interest periodicity is not essential parameter and even lump sum interest payment can make contribution to ordinary income provided the source falls within the ambit (Hodgson, Mortimer Butler, 2016). For any payment to be termed as gift, the list of condition is summarised below (Barkoczy, 2014). The ownership of the gift needs to be transferred in the favour of the recipient. The gift giver should have no favours in mind to be derived from the recipient either in present or near future. The recipient must not make any demand for a gift and the gift giver should engage in gift giving voluntarily. The gift extended to the recipient must be on account of personal feelings. Application The scenario given clearly signifies that the mother has engaged in a casual lending transaction as there is no requisite legal documentation or the demand of any collateral from the mothers side. Hence, the amount is given to the son on faith without any expectations of interest and this is also known to the son at the time of lending itself. As a result, any incremental repayment over and above the principal cannot be categorised as ordinary income either under Section 6-5 (since no money lending business) or under Section 15-15 (since no profit intention). There is no dispute with regards to the principal component repayment which would be capital, however the remainder payment of $ 4,000 in the given case is termed as gift on account of explanation tendered below. The interest payment was extended to the mother in a voluntary manner even when she expressed her desire of not wanting any interest. As the cheque was given to mother drawn in her mother, hence it amounts to ownership transfer. The son had no incentive or reciprocal expectation of benefit from the mother for the payment of $ 4,000. The payment of $ 4,000 is given as a personal gesture. Thus, it is wise to conclude based on above arguments that the given transaction will have no effect on the assessable income derived by the mother. 3. Part a) The information given is summarised below. The acquisition of land by Scott was enacted in the year 1980 and in 1986 he constructed a house on the premises. The property has been sold in the current financial year for a consideration of $ 800,000 which is the fair market value of the property. It is known that Capital Gains Tax (CGT) is applicable on the capital gains made on the capital assets that have been purchased after September 20, 1985. Thus in accordance with this rule, the land would be exempt from CGT but the house would surely attract CGT on the capital gains component (Sadiq et. al., 2015). Initial valuation and share At the time of construction of house, a capital expense of $ 60,000 was incurred to build the house. Also, market price of land at that time amounted to $ 90,000. Hence, when both the assets came into existence, then the contribution to the property price was in the ratio of 60000:90000 or 2:3 in favour of land. Current valuation and share Market value of property in the present = $ 800,000 [Given] Hence, dividing the value in the same ratio as initially, the value of land and house would be $480,000 and $ 320,000 respectively. As per the discussion above, no CGT would be put on the $ 480,000 component as land is CGT exempt but CGT would be put on $320,000 which is liable to CGT. In order to compute capital gains that would be levied CGT, the discount method and indexation method are available as Scott is an individual taxpayer (Nethercott, Richardson Devos, 2016). Indexation Method Index for inflation adjustment = (68.72/43.2) = 1.59 Thus, adjusted construction cost of the house which forms the cost base of the asset is 1.59*60000 = $ 95, 400 Hence, taxable gains eligible for CGT = 320000 95400 = $ 224,600 Discount method The cost base of the house would be only the construction cost as no information has been offered on any further capital works on the house. Hence, house related capital gains = 320000 60000 = $ 260,000 Under discount method, only 50% of the capital gains are subject to CGT, therefore the derived capital gains from the property = (260000/2) = $ 130,000 Clearly, the discount method would be preferred here since Scott can lower the tax payable on account of CGT by choosing this method. Hence, taxable capital gains from the property would amount to $ 130,000. Part b) The property now derives a sale price of $ 200,000 instead of the market value of $ 800,000 since the buyer is Scotts own daughter. The aim is to ascertain if this would alter the taxable capital gains. However, in accordance with Section 116-30(2), the taxable capital gains would still continue to be $ 130,000. This is because this section states that in capital gains computation the higher of the actual selling price and market value are used (Deutsch et. al., 2016). Part c) As per the provided information, there is ownership change from individual to company. This would impact capital gains tax as companies cannot use discount method and thus indexation method would be used which would leads to gains of $ 224, 600 (Woellner, 2014). References Barkoczy,S 2014,Foundation of Taxation Law 2014,6th eds., CCH Publications, North Ryde Coleman, C 2011, Australian Tax Analysis, 4th eds., Thomson Reuters (Professional) Australia, Sydney Deutsch, R, Freizer, M, Fullerton, I, Hanley, P, Snape, T 2016, Australian tax handbook 9th eds., Thomson Reuters, Pymont Gilders, F, Taylor, J, Walpole, M, Burton, M. Ciro, T 2013, Understanding taxation law 2013, 6th eds., LexisNexis/Butterworths Hodgson, H, Mortimer, C Butler, J 2016, Tax Questions and Answers 2016, 6th ed., Thomson Reuters, Sydney, NSW Nethercott, L, Richardson, G Devos, K 2016, Australian Taxation Study Manual 2016, 8th ed., Oxford University Press, Sydney Sadiq, K, Coleman, C, Hanegbi, R, Jogarajan, S, Krever, R, Obst, W, and Ting, A 2015 ,Principles of Taxation Law 2015, 7th eds., Thomson Reuters, Pymont Woellner, R 2014, Australian taxation law 2014, 8th eds., CCH Australia, North Ryde