Task Description:
Introduction to Taxation Law – Professional Task (40%)
Word limit: 2500 words maximum total (excluding footnotes & bibliography)
Case Study:
Armani Enterprises Pty Ltd, a company owned by the Armani family, amongst other investments, owns and operates a chain of profitable business clothing stores. Armani Enterprises Pty Ltd also has a small number of investments. Armani Enterprises Pty Ltd is an Australian resident company for tax purposes. The company’s Senior Accountant, Joe is in the process of preparing income tax returns for the income year 2022/23, for the company and staff. He approaches a prominent firm GraussShillingsWorth (GSW) which employs a highly skilled team of tax lawyers and tax accountants. GSW is renowned for providing integrated tax solutions for their clients. GSW organises a meeting between Joe and one of GSW’s tax partners. The CEO of Armani Enterprises Pty Ltd, Carlo, also attends the meeting. Shortly afterwards the parties sign an Engagement Letter which provides for Armani Enterprises Pty Ltd to engage the services of GSW. Armani Enterprises Pty Ltd seeks advice on the matters set out below:
Requirements:
Prepare GSW’s Memorandum of Advice. Advise Armani Enterprises Pty Ltd, Carlo and Joe regarding the following in relation to the 2022/23 income year:
A) the income tax implications and any potential FBT implications, arising from the facts in PART A. (25 marks)
B) any relevant income tax and/or capital gains tax implications, regarding the sale of property arising from the facts in PART B. In your answer make sure you show your calculation of any relevant amount included in LandCo’s
assessable income in relation to the sale of property. (5 marks)
C) any relevant income tax and/or capital gains tax implications in relation to the sale of the Strathfield property to Tina, arising from the facts in PART C. In your answer make sure you identify any relevant CGT Event,
identify each element of the cost base and show your calculation of any relevant capital gain/loss. (5 marks)
D) the capital gains tax (CGT) implications in relation to the sale of the beach house, arising from the facts in PART D. In your answer make sure you identify any relevant CGT Event, identify each element of the cost base and
show your calculation of any relevant capital gain/loss. (5 marks)
SOLUTION:
Introduction
Armani Enterprises Pty Ltd, an Australian corporation with a network of business clothing outlets, is receiving guidance from GraussShillingsWorth (GSW) for its 2022-2023 income tax returns. The CEO and Senior Accountant of Armani are attending the consultation with GSW’s tax partner, ensuring the company’s tax compliance and effective management of its assets.
The hypothetical scenario involves complex tax-related issues for Armani Enterprises Pty Ltd’s commercial operations, including capital gains implications, fringe benefits taxation, and business expenditure deductions, as the corporation and CEO, Carlo, engaged in various transactions and operations during the 2022-2023 fiscal year.
This advise will examine Armani Enterprises Pty Ltd’s operations, utilizing Taxation Laws, Firnge benefit laws, and case studies, with a specific focus on:
Part A: Evaluation of the company’s deductible costs, such as trading stock purchases, salaries, advertising expenditures, and benefits for the CEO.
Part B: A review of LandCo Pty Ltd’s post-acquisition operations, encompassing the rezoning procedure, building expenses, and ensuing real estate transactions.
Part C: Analysis of the renovations made to a Strathfield investment property by Armani Enterprises Pty Ltd and their potential impact on capital gains tax.
Part D: Evaluation of CEO Carlo’s real estate dealings, covering stamp duty, remodeling expenses, and capital gains tax consequences.
This research aims to provide precise advice on taxation for Armani Enterprises Pty Ltd and its CEO, using the HIRAC method for a comprehensive analysis. The study will focus on relevant issues, provide a detailed solution, and offer comprehensive guidance through a memorandum of advice. The goal is to provide a clear understanding of the subject matter and provide a comprehensive solution.
CASE STUDY- ANALYSIS AND SOLUTION
Memorandum of Advice
To: Armani Enterprises Pty Ltd and its CEO Carlo and the Senior Accountant Joe.
From: GraussShillingsWorth (GSW)
Date: —————-
Subject: Case wise detailed Income Tax and FBT Implications for the 2022/23 Income Year
Introduction:
Using the HIRAC approach and the presented data, this memorandum examines the income tax and Fringe Benefits Tax (FBT) implications for Armani Enterprises Pty Ltd, Carlo, and Joe for the 2022–2023 income year.
PART A :
Issue:
Armani Enterprises Pty Ltd faced losses in 2022/23, including stock purchases, employee wages, advertising, and rent. CEO Carlo, an Australian, receives a $200,000 salary, a laptop, and travel expenses. He also teaches art classes and won a prize.
The issue here, is to determine the income tax implications for Armani Enterprises Pty Ltd, Carlo, and Joe for the 2022/23 income year.
Rule:
Relevant legislation includes:
Income Tax Assessment Act 1997 (ITAA 1997)
Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986)
Application:
| Sr No. | Expense | Application |
| 1. | Purchase of Trading Stock ($1.5 million) | Deductible under s8-1 as it is an expense incurred in gaining assessable income |
| 2. | Wages Paid to Employees ($2 million) | Deductible under s8-1 as it is a necessary expense incurred in carrying on the business |
| 3. | Advertising Expense ($40,000) | Likely deductible under s8-1 as it is incurred to promote the business and maintain market share |
| 4. | Rent for Retail Premises ($200,000) | Likely deductible under s8-1 as it is incurred for business premises |
| 5. | Bad Debts Written Off ($25,000) | Deductible under Division 25 if certain conditions are met, such as the debt being previously included in assessable income and being written off as bad at the end of the income year |
| 6. | CEO’s Salary and Benefits | Salary is assessable income under section 6-5 of the ITAA 1997. Therefore, Salary Of $ 200000/- and Laptop Value $ 3,000/- will be assessed in the hands of Carlo. |
| 7. | Membership Fees and Subscriptions | Membership dues ($700) and subscriptions ($130) are deductible expenses as allowed by ITAA 1997 section 8-1. |
| 8. | Client Entertainment | Client Entertainment expense worth $ 600 is Subject to FBT unless exempt. |
| 9. | Travel Expenses for Teaching Art Classes | Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) normally allows Carlo to deduct his $2,000 travel expenditures for giving painting classes. Since these expenses are neither capital, private, or domestic in nature, they are seen as incurred in the process of acquiring or producing assessable income. Guidelines for the deductibility of travel expenses, including those related to commuting between places of employment, incurred in the course of obtaining or producing assessable income are provided by Taxation Ruling TR 97/17. |
| 10. | Art Competition Winnings | The Cash Prize won of $ 30000 and the value of annual pass both have to be assessed under section 6-5 of the ITAA 1997. |
| 11. | Antique Tea Set | CGT may apply on the same on which gain would be calculated as $670 ($1,800 – $1,130) |
Conclusion- income tax implications and potential FBT implications:
In view of the analysis:
1. Suggestions for Pty Ltd Armani Enterprises:
The 2022-2023 income tax return must accurately record and claim all deductible expenses, including rent, advertising, salaries, and bad debts. It’s crucial to determine if client entertainment costs are FBT-liable and explore potential exemptions or concessions for selling an antique tea set.
2. Carlo’s Salary and Benefits Advice:
In the 2022-2023 fiscal year, consider your pay, laptop costs, professional subscriptions, membership costs, cash prizes, and art competition passes as taxable income. Also, include teaching income from community college art classes as taxable income, ensuring subscriptions and membership costs are properly deducted.
3. Recommendations for Joe:
Armani Enterprises Pty Ltd must ensure accurate record-keeping of deductible costs in its income tax return and assess if client entertainment expenses are subject to FBT, ensuring compliance with relevant legislation.
PART B :
Issue:
Armani Enterprises Pty Ltd acquired shares in LandCo Pty Ltd in March 2021, which had previously acquired land for holiday rentals. After rezoning the land, LandCo Pty Ltd constructed eight homes, with the estimated market value at $3 million. The homes were completed in January 2022 at a cost of $2 million, selling at a profit.
The issue is to Analyse the case to find out Relevant income tax and/or capital gains tax implications for LandCo Pty Ltd that arise from the sale of property in the 2022/23 income year
Rule:
Selling real estate incurs capital gains tax (CGT), calculated by dividing the asset’s cost base by sale price, including initial purchase price, acquisition costs, and improvement costs.
The FCT v. Whitfords Beach case provides guidelines for determining capital in character (subject to capital gains tax) or revenue in nature (subject to income tax). LandCo Pty Ltd’s sale of houses should be recognized as a capital transaction which subsequently attracts capital gains tax. The court considered the taxpayer’s intention during the acquisition process, the sale of the site with rezoning for residential development, and the transaction scale and frequency. In conclusion, the sale of the houses by LandCo Pty Ltd should be regarded as a capital transaction liable to capital gains tax.
Consequently, LandCo Pty Ltd is required to declare and pay capital gains tax on the proceeds from the sale of the dwellings during the 2022–2023 tax year.
Application:
| Sr No. | Transaction | Appplication | Remarks |
| 1. | Purchase of LandCo Pty Ltd’s Shares by Armani Enterprises Pty Ltd | The purchase price of the shares in LandCo Pty Ltd was $1 million, which was considered to include the value of the land owned by LandCo Pty Ltd | – |
| 2. | Rezoning Application and Legal Fees | The costs associated with the rezoning application ($5,000) and legal fees ($4,000) are part of the property’s cost base | The expenses required to change land zoning from residential to commercial are deductible under section 8-1 of the ITAA 1997, which permits deductions for business expenses incurred for assessable income. These are crucial for obtaining necessary approvals. |
| 3. | Building Costs | The total building costs of $2 million are also included in the property’s cost base | They represent expenses incurred to improve the property and make it more marketable |
| 4. | Sale of Property | LandCo Pty Ltd sold each home for $2 million, resulting in total capital proceeds of $16 million ($2 million per home x 8 homes) | – |
Calculation of Capital Gain/Loss:
The capital gain or loss from the sale of the property can only be calculated once we have determined the cost base and the capital receipts.
1. Calculation of Cost Base
| Costs | Amount |
| Original cost of land | $ 1,000,000 |
| Rezoning expenses | $ 9,000 |
| Cost of Construction | $ 2,000,000 |
| TOTAL COST BASE | $ 3,009,000 |
2. Calculation of Capital Gain/(Loss)
| Particulars | Amount |
| Capital Proceeds | $ 16,000,000 |
| Less : Cost Base | $ 3,009,000 |
| Capital Gain | $ 12,991,000 |
Capital Gains Tax (CGT) Calculation:
The capital gain multiplied by the relevant CGT rate is used to compute CGT. The corporate tax rate, which is now 30%, and the CGT rate are the same for businesses. $12,991,000 * 0.30 = $3,897,300 is the CGT.
Recommendation:
In the income year 2022–2023, LandCo Pty Ltd is required to record the $12,991,000 capital gain on the sale of the residences. $3,897,300 is the capital gains tax that LandCo Pty Ltd must pay.
It’s important for LandCo Pty Ltd to ensure compliance with tax laws and regulations, including proper documentation and reporting of the capital gain for CGT purposes.
PART C
Issue :
Armani Enterprises Pty Ltd bought a rundown house inStrathfield for $800,000 in September 2021, improved its value with fences, repainting, and heating, and sold it to Tina in February 2023 for $1 million.
The question at hand is how Armani Enterprises Pty Ltd, Carlo, and Joe will be affected by the sale of the Strathfield property to Tina in the 2022–2023 income year in terms of income tax and capital gains tax.
Rule :
Under Australian tax law, capital gains tax (CGT) may be owed on the sale of a property. In general, the difference between the property’s cost base and sale price is used to calculate capital gains. The cost base is composed of many elements, including the purchase price, capital enhancements, and incidental expenditures related to the acquisition.
The disposal of a CGT asset results in CGT event A1. The difference between the asset’s cost base and capital receipts is used to compute the capital gain.
Application
| Sr No. | Transaction | Application |
| 1. | Purchase of Strathfield Property | In September 2021, Armani Enterprises Pty Ltd paid $800,000 for the property. This sum is included in the cost basis of the property. |
| 2. | Renovation Expenses | The property’s cost base additionally includes $28,000 in renovation costs (fences: $2,000, repainting: $3,000, ceiling and walls: $18,000, underfloor heating: $5,000) that were incurred to make improvements. |
| 3. | Sale of Property | Armani Enterprises Pty Ltd is set to sell a property to Tina for $1 million on February 1, 2023, with the proceeds being taxable. The property’s market value is $3 million, which could impact CGT calculations and potentially indicate a capital loss. However, there is still a capital gain due to the property’s increased value since its purchase. |
Calculation of Capital Gain/Loss:
To calculate the capital gain or loss from the sale of the property, we need to determine the cost base and the capital receipts.
1. Calculation of Cost Base
| Costs | Amount |
| Original purchase price | $ 800,000 |
| Improvement costs | $ 28,000 |
| TOTAL COST BASE | $ 828,000 |
2. Calculation of Capital Gain/(Loss)
| Particulars | Amount |
| Capital Proceeds | $ 1,000,000 |
| Less : The Cost Base( as determined above) | $ 828,000 |
| Capital Gains | $ 172,000 |
Identification of CGT Event:
When does Event A1 take place?
1. A CGT asset is sold by a taxpayer.
2. The asset is no longer under the same ownership or management.
The sale of the Strathfield property to Tina on February 1, 2023, initiates CGT Event A1.
Conclusion- Taxation
The capital gain will be subject to taxation at the applicable company tax rate for Armani Enterprises Pty Ltd.
Recommendations
1. Armani Enterprises Pty Ltd should ensure accurate record-keeping of the property acquisition, improvements, and sale for tax reporting purposes.
2. Tina, Carlo’s trusted cleaner, could affect the implications of capital gains tax (CGT) of the sale due to her relationship with Carlo. This relationship could be considered a related-party transaction, potentially affecting the property’s market value and capital gain calculation. The ATO considers transactions at arm’s length, meaning they are conducted between independent parties. If the sale price to Tina is significantly below the market value, it could be deemed not at arm’s length. Therefore, the ATO may scrutinize the transaction more closely, ensuring the sale price accurately reflects fair market value.
PART D :
Issue:
Carlo, the CEO of a company, purchased a $3 million house near the beach for his nephew Jimmy and family. He paid stamp duty, borrowed money, and paid interest. In February 2023, he paid $80,000 for bathroom renovation and $50,000 for legal fees. In June 2023, he sold the property for $4 million.
The Issue here, is to identify CGT implications for Armani Enterprises Pty Ltd, Carlo, and Joe regarding the sale of the beach house in the 2022/23 income year.
Rule:
When a capital gains tax event, like the sale of an asset, takes place, CGT is applied. The computation of the capital gain involves subtracting the sale profits from the cost basis.
Application:
CGT Event:
The relevant CGT event in this case is Event A1 – the disposal of the property.
| Sr. No. | Transaction | Application |
| 1. | Stamp Duty and Interest Costs | When Carlo bought his beach house, he had to pay $230,000 in stamp duty, which was an additional expense applied to the property’s cost basis for capital gains tax (CGT). He also paid $400,000 in interest on the loan that he obtained to acquire the home, which also included financing expenses. |
| 2. | Renovation Expenses and Legal Fees | Carlo invested $80,000 in renovating the beach house’s bathrooms, which are considered capital upgrades. He also paid $50,000 in legal fees to challenge a planned building blocking the house’s beach views, which are covered by the property’s cost base as they are related to preserving its value. |
| 3. | Selling the Beach House | Carlo signed a deal to sell the seaside mansion for $4 million, the full market value. This suggests that the property’s worth has increased since it was first purchased. |
Calculations
We must ascertain the cost base and the capital income in order to figure out the capital gain or loss from the sale of the beach the house.
1. Calculation of Cost Base
| Costs | Amount |
| Original purchase price | $ 3,000,000 |
| Stamp duty | $ 230,000 |
| Interest costs | $ 400,000 |
| Renovation expenses | $ 80,000 |
| Legal fees | $ 50,000 |
| TOTAL COST BASE | $ 3,760,000 |
2. Calculation of Capital Gain/(Loss)
| Particulars | Amount |
| Capital Proceeds | $ 4,000,000 |
| Less : Cost Base( as was calculated in point no. 1 above ) | $ 3,760,000 |
| Capital Gain | $ 240,000 |
Conclusion:
CGT will apply to Carlo’s selling of the beach house. There was a $240,000 capital gain on the transaction. On the other hand, Carlo might qualify for the 50% CGT deduction if he has owned the property for longer than a year.
References:
1. Australian Government. (1997). Income Tax Assessment Act 1997. Retrieved from https://www.legislation.gov.au/Details/C2021C00200
2. Australian Government. (1986). Fringe Benefits Tax Assessment Act 1986. Retrieved from https://www.legislation.gov.au/Details/C2021C00036
3. Australian Taxation Office. (1997). Taxation Ruling TR 97/17: Income tax: deductibility of travel expenses. Retrieved from https://www.ato.gov.au/law/view/document?docid=TXR/TR9717/NAT/ATO/00001
4. Australian Taxation Office. (2022). Guide to capital gains tax. Retrieved from https://www.ato.gov.au/General/Capital-gains-tax/
5. Australian Taxation Office. (2022). Company tax rates. Retrieved from https://www.ato.gov.au/Rates/Company-tax/
6. FCT v Whitfords Beach (1990) 26 FCR 562; 90 ATC 4663; (1990) 21 ATR 692
7. Australian Taxation Office. (2022). Capital gains tax. Retrieved from https://www.ato.gov.au/General/Capital-gains-tax/
8.Australian Taxation Office. (2022). Working out your capital gain. Retrieved from https://www.ato.gov.au/General/Capital-gains-tax/Working-out-your-capital-gain-or-loss/Working-out-your-capital-gain/