The same land invested by Jane involved in two transaction in this case. Issue 1.1: Is land a CGT asset?
Land is a Capital Gains Tax (CGT) asset as defined in s 108-5(1) of ITAA 1997 (the Income Tax Assessment Act 1997 (Cth), and referred to in all sections cited hereafter, unless it is otherwise cited): any kind of property. Besides, the land was purchased for trading and making a profit, not for main residence. Thus, a CGT gain or loss resulting from a CGT event happening to the land will not be ignored (Subdiv 118-100).
Issue 1.2: Is there a CGT event?
A CGT event A1 (disposal of CGT asset) was triggered when Jane transferred the land to her husband without consideration because the ownership had been transferred to her husband (s 104-10(3)). The land was purchased by Jane in 1982 (before 20 September 1985). Therefore, the land is generally except from capital gains tax (Div 109).
Issue 1.3: What is the amount of GCT gain?
Considering that: 1) Jane did not receive any consideration from the CGT event; 2) the special connection between parties (wife and husband), Jane should be taken to have received the market value of the land which is the subject of the event (s 116-30). The market value of the land should be $2m—the price that a willing purchaser (the developer) would like to pay at that date: Spencer v Commonwealth (1907). Therefore, Jane realized a capital gain of $1,980,000 ($2,000,000-$20,000) by transferring the land to her husband.
The CGT event A1 will happen when Jane’s husband sells the land to the developer for $2m because the ownership of the land will be transferred to the purchaser: s 104-10(3).
Jane’s husband became the owner of the land in 2015 (after 11.45 am on 21 September 1999) and if the land has been held by Jane’s husband for more than 12 months before being sold to the developer, a 50% general discount can be applied to the capital gains from selling the land to the developer (Div 115). However, if the land has not been held more than 12 months, no exemption rule applies. According to the market value substitute rule (s 116-30), the first element of the cost base (the money paid or required to be paid by the taxpayer: s 110-25(2)) will be replaced by the market value if no consideration given to acquire the asset: s 112-20 (1). As a result, since the cost base of the land is $2m and the capital proceeds from selling the land will also be $2m, Jane’s husband will make zero capital gains when he sells the land to the developer.
In conclusion, neither Jane nor her husband needs to pay the capital gains tax in the income year. Substance of this case: Jane successfully avoided to be taxed on the 1,980,000 profits made by selling this land to the developer through her husband. Since this land was purchased in 1982 (prior to 20 September 1985) with the speculative purpose of reselling and making quick bucks, Jane would realize an assessable profit of $1,980,000 if she sold the land to the developer directly (s 25A of ITAA 1936) because the profit is from selling an asset that was purchased with a profit-making intent through resale.
Issue 2.1: Is there nexus between the loan and the business being carried on?
The expense is deductible if the expense incurred in the process of carrying on a business for the purpose of gaining or producing assessable income (s 8-1(1)(b)). In this case, the loan is borrowed for running the business, which meets the requirement under s 8-1. Meantime, none of the negative limbs under s 8-1 could be satisfied.
Issue 2.2: Whether the nexus between the expense and the ceased income producing activities still exist?
John stopped running the business by selling it after years of losses, while interest of loan which is taken to run the business continued incurring. In ACG (Advanced) Ltd V FCT (1975), the High Court of Australia allowed the taxpayer a deduction where the expense is related to past business activities, and applies the approach in ACG case afterwards to grant tax deduction for expense related to ceased business. In FCT v Brown (1999), the court granted the deduction despite the interest expense continued incurring after the business is sold.
In John’s case, it is clear that the only reason to incur the interest is financing the business activities which could bring assessable income (TR 2004/4: Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities). So, the occasion here could easily be identified.
In conclusion, the interest on the loan should be fully deductible.
Issue 3.1: Has a CGT event happened to Shaun?
A CGT event A1-disposal happened because an ownership of a painting was transferred from Shaun to his brother during the income year (s 104-10(1)).
Issue 3.2: Is the painting a CGT asset?
The painting is a property and thus falls within the scope of a ‘CGT asset’ (s 108-5(1)). Specifically, since the painting, as one type of artwork, was hung in Shaun’s home office study, it can be considered to be kept for personal enjoyment. Also, no evidence suggests the painting be purchased for investment purpose. Therefore, it is regarded as ‘collectables’ (s 108-10(2)). Issue 3.3: Does an exception rule or a roll-over apply to this case?
The painting was acquired in 2000 which is after 20 September 1985, and thus it is not generally exempt from capital gain tax. Also, the capital gain made in this case cannot be disregarded because the first element of its cost base is more than $500 (s 118-10(1)). In this situation, no roll-overs allow Shaun to defer or disregard a capital gain or loss from a CGT event as there is neither replacement asset nor same asset roll-overs in relation to this event (p331, Principle of Taxation Law 2014).
Issue 3.4: What is the amount of capital gain?
The capital proceeds and cost base of the painting should be firstly calculated. Capital proceeds are the amounts that the taxpayer receives or is entitled to receive (s 116-20), and are seem to be $500,000 in this case. However, a market value substitution rule is applied because the two parties involved did not deal at arm’s length (s 116-30), because Shaun accepted the lower offer in need of the cash quickly. Also, the strong connection between them may exercise influence on Shaun to accept the lower offer. Thus, the capital proceeds should be measured at market value as $600,000. The cost base is the money paid by Shaun to acquire the painting is 2000 (s 110-25(2)). Therefore, Shaun made a capital gain because the capital proceeds from the disposal ($600,000) are more than the asset’s cost base ($200,000) (s 104-10(4)), and the capital gains are $400,000.
In conclusion, the $400,000 capital gains Shaun made are taxed as statutory income under ITAA 1997.
Issue 4.1: Has a CGT event happened to Jack?
A CGT event A1-disposal happened in this case because Jack sold his 80-hectare acreage and thus its ownership was transferred during the 2015 income year (s 104-10(1)). The land in this case satisfy the definition of CGT asset (s 108-5(1)).
An issue is noticed that since the land was subdivided into 8 separate parcels, the disposal of a subdivided parcel should be treated as the disposal of an asset in its own right, and not as a disposal of part of an asset (TD97/3). Therefore, 8 CGT events A1 happened in relation to this transaction as 8 titles of separate block was transferred by Jack to another party.
Issue 4.2: Does an exemption rule apply?
Since Jack acquired the original land at 2000, and the date Jack acquired the subdivided blocks is the date he acquired the original parcel of land (Australian Taxation Office), all the 8 CGT events happened after 20 September 1985 and cannot generally exempt from this capital gains tax (Div 104).
However, the fact that Jack has lived on this property continuously after 2000 suggests the land was his main residence during the period between 2000 and 2015. Also, it is clearly stated that the land has not been used to produce assessable income, the Main residence exemption could be applied. Thus, the capital gain from these CGT events are disregarded (s118-100 of Pt 3-1).
Issue 5.1: Is the prize for services or upon luck?
Whether the prize is ordinary income depends on whether the level of personal exertion is sufficient to turn a prize into ordinary income: Kelly v FCT (1985), which is a question of the fact and degree. Based on the facts, it is more likely that the prize is not ordinary income, because May at that time was a master of commerce student and she won the prize primarily upon luck, rather than being engaged to the audit subject by the university: Case 37 (1966). However, if the prize was from Break Fast Pty Ltd with a contract that May will become an employee of the company, then the prize will be assessable as ordinary income under s 6-5. Section 51-10 specifically excludes such receipt from exemption because the prize contains a binding condition.
Therefore, the prize is ordinary income if there is a binding condition. Otherwise, it is not assessable as ordinary income.
Issue 6.1: Is the expense deductible under s. 8-1 of ITAA97?
Expenditure to decide whether to start income earning activities is not deductible under s 8-1: Softwood Pulp and Paper v FCT (1976). In this case, the feasibility studies had been no commitment to commence operations of selling domestic windmills and were incurred before this income-earning activity. Therefore, the expense on feasibility studies is not deductible under s 8-1. However, it may be deductible underclass="divcss">statutory provisions such as s 40-880.
Issue 6.2: Is the expenditure a capital or capital in nature?
The proposed business is to sell domestic windmills on EBay. It is necessary to determine whether the outgoing is a capital (capital in nature) or not, where three tests need to be considered, like those in Sun Newspaper v FCT (1938).
As three factors are met in determining capital expense, the outgoing for feasibility studies is capital in nature.
Issue 6.3: Is the expense deductible under s. 40-880 of ITAA97?
Section 40-880 and Explanatory Memorandum to Tax Laws Amendment Act (2006) state that capital expenditure relating to a proposed business to be carried on for the purpose of gaining assessable income can be deductible in equal proportion over future five income years. From the discussion above, we know that the capital expense on feasibility studies is for the proposed business selling domestic windmills. Clearly, it is made to gain or produce assessable income in accordance with s 6-5 and, therefore, the $2,000 expense can be deducted in $400 annually over the next five income years after it incurred.
- Firstly, whether the advantage sought results in a lasting benefit for the taxpayer. The feasibility studies are to determine whether the windmills business is viable in a long run, thus resulting in a lasting benefit for Mike’s proposed business.
- The second test is whether the benefit is received once and for all. Clearly, the expense on feasibility studies is made only once in determining whether to start the business, so its benefit is enduring and for all.
- Additionally, it is also important to consider the substance (rather than form) of the expense. In this case, Mike can pay for this expense in either one-off payment or recurrent payments.
- However, despite of the payment forms, this expenditure is to explore the possibility of creating monopoly (no domestic windmills are sold on EBay) or to secure the advantage of effective business planning (from market demand and potential resources). Therefore, the expense is capital based on its substance (FCT v Star City (2009); National Australia Bank v FCT (1997)).