Analysis of Tax Implications in Various Scenarios

Question 1

Issue

Whether Granitex can make capital gains and deduct the expenses from the net gains?

For capital gains, division 102 of ITAA 1997 provides for the rules to determine whether there has been capital gain or loss. The amount of loss made can be deducted from the total sale amount and also the necessary expenses can also be deducted. In the given situation, Granitex is set to make capital gains from the sale of the ptoperty. In this regard, Granitex had to bear an expense of (3000+5000+20000+8000= 36000) to improve the resale value of the property. Granitex made gain amounting to $3,000,000 - ($1,000,000+$36000)= $1,964,000.

Issue

Whether the advertising expense is necessary to retain the market share of the company and claim deduction for the expenses incurred?

When it comes to deduction, expenses that are necessary to produce assessable income can be deducted from the net sale price to get thr actual amount on which tax has to be paid. The positive limb of section 8-1 of ITAA 1997 states that expenses that are necessary for producing assessable income or necessary for carrying on a business which will produce assessable income is deductible. The case of C of T (NSW) v Ash (1938) 61 CLR 263 held that it is not necessary to show a connection between an expense and particular instance of income, rather it must only be shown that the expense was a step toward producing assessable income. Also, FC of T v Smith 81 ATC 4114 decided that for an expense to be deductible in a particular year, it is not necessary to produce income from that expense in the same year. In addition to that, section 32.45 of ITAA 1997, a taxpayer is entitled to claim deduction for the expenses incurred for advertising to the public. Based on the situation of Granitex, such an expenses was necessary to enable the company to make profits in the next income year. Since it was necessary to produce assessable income, it can be deducted from the income earned.

Issue

Whether the legal expense incurred in defending the directors can be deducted?

Under the positive limbs of section 8-1 of ITAA 1997, deduction can be claimed for expenses that are necessary for a business to produce assessable income. Now what is necessary to carry on a business for producing assessable income depends on the situation. For example, the case of Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542 showed that legal expenses incurred by a company for defending its directors against claims are deductible. In this case the court stated that it is not necessary to show a direct connection between the expense and the income earned. Rather, the interest of the tax payer and the interest of the directors is relevant here since the directors are reasonable capable of making a company earn profits, such expenses can be deductible. Similarly, for Granitex, the legal fees of $30,000 is deductible.

Issue

Whether the expenses incurred by Steve for travel expense are deductible?

The landmark case of Lunney and Hayley v FC of T (1958) 100 CLR 478 decided that there is a difference between travelling on work and travelling to work. Expenses incurred for travelling from home to workplace is not generally deductible since it has no connection with the income producing process. Based on this principle, the travelling expenses incurred by Steven are not deductible.

Issue

Whether the prizes won by Charles in the polo sports competition is assessable income?

In the past, income for athletes has been dealt with in the case of Kelly v FC of T 85 ATC 4283, where the court held that there must be some connection between profession of the concerned tax payer and the income earned. This position was further clarified in FC of T v Stone 2005 ATC 4234 where the court stated that an award or prize which has no connection with the main profession of the tax payer is not assessable under ordinary income. There must be regular activity in order to quality that income as assessable. For Charles, the income from the polo sport competition has nothing to do with his profession and rather he only plays for fun in his spare time. Therefore, the income made from the prizes and awards are not assessable or part of ordinary income.

Issue

Whether the franked dividend is assessable for Granitex that is received from Australian resident company TechCo Ltd?

Franked dividend usually represents portion of the money on which the company has already paid the required amount of tax. It means that taxes are deducted before franking dividend is distributed. However, section 44(1) requires that tax payer shows that franking dividend and tax in their statement even though it is paid by the company. Similarly, for Granitex a corporate tax of 30% has been paid and the dividends are franked. There is not taxation implication in this regard, but it has to be shown on tax statement.

Question 2

Is there any income tax implications arising from the circumstances of Hugh, Deb and Fallon.

The expenses incurred for acquiring a property is not deductible. However, expenses incurred for making it capable to produce income is deductible under the positive limbs of section 8-1. There are also provisions to make specific deductions that can be dealt with separately. Therefore, Hugh and Deb cannot get deduction for the total of $50,000 incurred for legal fees, transfer duty and other related cost of acquiring the investment property. However, the expense incurred by them to restore the wall of the house is deductible because it is necessary to rent the property to earn assessable income. Therefore, Hugh and Deb can claim deduction for $20,000 paid to the builder. Further, the lossess allocated to Hugh and profits allocated to Deb has no implication in this regard since the salary income of Hugh is ordinary income whereas the profits made from investment property is not ordinary income under the meaning of section 6. In relation to the rental income of Hugh and Deb, the entire rent of $80,000 is not taxable. This is because they have incurred some additional expense to earn the rental income. In other words, without incurring those expenses, they would not have earned the rental income which falls under the meaning of section 8. The personal property bought by Hugh and expenses incurred can be deductible depending on the amount of capital gain or loss from the contract of sale. In this regard, it can be seen that Hugh made capital loss, which means there is no taxation implication in this regard and rather Hugh can claim capital loss deduction.

Taxable income for Hugh

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