Income Tax Law ITAA Capital Receipt

Question: Discuss about the Income Tax Law for ITAA Capital Receipt. Answer: 1. Issue In the case presented, a famous mountaineer Hilary has been approached by a local newspaper named The Daily Terror for writing her story in the form of a book and agrees to provide a consideration of $ 10,000 for copyrights of the same which is agreeable to Hilary, The book is completed by her without any external aid even though she has never written before. The copyrights of the book is provided to newspaper while the manuscript and some photographs taken during mountaineering expedition are sold are a total amount of $ 7,000 to a library. In wake of the above, it needs to be discussed if the payments derived are taxable or not. Rule Only revenue receipts are taxed in accordance with relevant provisions of ITAA 1997 while the capital receipts are exempt from taxation. However, post the enactment of the capital gains tax, capital receipts may attract some tax burden but it is limited only to the capital gains if any (Section 10(5), ITAA 1997). Hence, it is a central concern for the taxpayer to understand when a payment received does is capital or revenue in nature. Capital receipts ordinarily are derived from sale of any capital asset with or without any capital gains (Sadiq et. al., 2015). However, revenue receipts are derived from regular employment or in the form of business income (Deutsch et. al., 2015)/ A court case which demands discussion in this context is the Brent vs Federal Commissioner of Taxation(1971) 125 CLR case. In this case, the primary dispute was with regards to the payment being recognised as capital receipts or revenue receipts. The income was derived on the basis of the secret information that the appellant possessed by virtue of spending time with her husband who was involved in a much famed robbery. Offers were given to the wife so as to know about the personal life of the robber especially the relation with wife (Barkoczy, 2015). The information was given through the mode of interview conducted by journalists and these stretched over several days. Further, the wife was also approached for signatures on each page of the book which would authenticate the same. However, the court observed that income from the newspaper was not derived for narration or signature but for the secret information the appellant had which could not be sourced from public sources. Through grant of copyright of this information to the newspaper, there was effectively the transfer of the intangible asset from the wife to the newspaper and hence, the payments derived would be termed as capital receipts (CCH, 2012) Application The arguments of the Brent vs Federal Commissioner of Taxation(1971) can be extended to the given case also. While Hilary has engaged in writing the book, but the intrinsic asset for which the newspaper is making the payment is not for Hilarys literary skills since she has never engaged in any writing. The newspaper is essentially paying for the copyright on the information about her personal life which was already there and has not arisen because of the writing. The activity of activity is just a mode of expression which has communicated the information similar to interviewing in the Brent vs Federal Commissioner of Taxation(1971) case. Similarly with regards to photography, Hilary is not paid for the exemplary photography skills she possesses but the fact that photos depict Hilarys expedition. Thus, the money is being derived from the subject matter rather than the act of writing or clicking photos. Hence, all the above payments that are essentially derived and not earned and would be termed as capital receipts and would not contribute towards assessable income. But, the $ 17,000 may attract CGT based on the capital gains if any. .Conclusion The monies that have been paid to Hilary are capital receipts and therefore would not be assessable income but may qualify for application of CGT. (b) In the event that Hilary was driven by her own satisfaction while engaging in writing, then also the receipts derived from the book would be taken as capital receipts as the essential asset then also would have been the information about her personal life. The writing is just an incidental activity which is not central to the payment and hence its underlying motive would make no impact on the tax treatment extended to the payments derived by Hilary (Woellner, 2013). 2 Issue A son has obtained a housing loan of $ 40,000 from mother for a period of five year and promises to pay an interest of 5% p.a. The mother has no desire for any interest income but the son returns the money in only two years time and the total amount returned is $ 44,000. The aim is to determine how the assessable income of the parent would be impacted in the given case. Rule It is possible depending upon certain rules whether an underlying payment is termed as gift or is derivable income as defined under Section 6-5. This is critical as gift are exempted from tax unlike derivable income which would be subject to tax (Sadiq et. al., 2015). The conditions to be fulfilled for classification of any payment as gift are given below (ATO, 2013). The transferor of the gift must have no expectations from the transferee with regards to any present or future favours. The transfer should be driven by the voluntary intent and will of the transferor. During the transfer of gift, an ownership change from transferor to transferee is must. The transfer of gift should be motivated by a feeling of benefaction. The interest payments under ordinary circumstances would contribute to ordinary income when interest is earned on account of any business activity such as money lending or these are earned on some investment in some security or bank account. It is noteworthy that interest may or may not be ongoing and any cumulative payment in this regard could also contribute towards ordinary income provided they lie in the ambit of the same (Gilders et.al., 2015) Application The case facts clearly indicate that the mother through lending to son has not engaged in any commercial transaction. Following aspect need to be considered to establish the same. Mother communicated that she does not want any interest payment. There seems to be no documentation with regards to the loan that could serve as a potential proof in the future. The mother has not asked for home as the collateral which is commonly done in commercial money lending. On account of the above observations, it can be concluded that indeed the conclusion that the amount extended as interest by the son would not be ordinary income as it was not intended and the transaction was essentially casual. While the repayment of the loan is capital receipt and tax free, the remaining payment of $ 4,000 would also attract no tax liability as it is a gift from the son to her mother as a gesture of gratitude. Following reasons may be given in the support of the same. The son in return of the payment of $ 4,000 has no expectations either in present or future. The son indulged in making the payment even though the mother never wanted the same. Through the cheque, the payment was effectively transferred to the mother. The payment is derived out of personal gesture from the son. Conclusion The above lending transaction does not amount to any contribution to assessable income of the parent. 3 Part a) When the holding period of asset is in excess of 12 months,, then there are two ways of computing taxable capital gains. i.e. discount method and indexation method. The discount methods offers a flat 50% discount on the long term gains while the indexation method reduces the tax liability by making adjustment for inflation in the cost base of the asset. Due to difference in dates of acquisition and the consequent CGT application, the property needs to be bifurcated into two separate assets i.e. land and constructed house (CCH, 2012). Land asset Scott purchased this in the era when capital gains were not taxed and thus the realisation of this capital asset would not attract any CGT liability (Barkoczy, 2015) The house was subsequently constructed in 1986, when the land was valued at $ 90,000. Hence, valuation of property derived from land = (90000/150000)*100 = 60% Hence, market value of land at present = 0.6* 800000 = $ 480,000 The above value of the property is exempt from the CGT scope as explained above. Constructed House asset CGT would apply on the constructed house as it was constructed in the era when CGT had come into existence. Market price of constructed house = Property current valuation Lands current valuation = Current valuation of house = Current valuation of property Current valuation of land = 800000 480000 = $ 320,000 Discount method Net capital gains on house = Total proceeds from house Construction cost =320000 60000 = $ 240,000 Since the capital gains are long term, hence a flat 50% discount is extended, hence taxable capital gains = 0.5*240000 = $ 120,000 Indexation Method Construction cost of house needs to be increased to reflect the inflation in the manner shown below. Inflation adjusted cost base of the house = 60000*(68.72/43.2) = $ 95,400 Taxable capital gains as per this method = 320000 95400 = $ 224,600 Since the discount method leads to lowest CGT liability, hence Scott would choose that and thus capital gains that are taxable would be $ 120,000. Part b) When there is a substantial difference between the selling price and the market value of the asset, then Section 116-30(2) ITAA 1997 comes into play. Thus, the price used for calculating the capital gains would be the value higher between the actual selling price and the expected market value of the asset (AustLii, nd). For this situation also, this is apt as the property has been sold for $200,000 to the daughter but the capital gains would be computed taking the higher value which is $ 800,000 and hence the capital gains would be same as above. Part c) The nature of ownership of a capital asset is a significant parameter as discount method cannot be used by companies but only individuals (Sadiq et. al., 2015). Thus, in the given situation, since the owner is a company, hence the capital gains subject to CGT would be calculated in line with indexation method. Thus, in this case the net taxable capital gains will be $ 224,600. 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