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Trimester 1 2021 Examination

MLC301

Principles of Income Tax Law

QUESTION 1: Topics 2 and 3 23 marks

Abbie’s Employment

Abbie works as a tax manager in the head office of a major supermarket retail chain, called Moolies Ltd. Her work contract entitles her, on top of her salary, to an annual bonus of up to $20,000, depending on her performance rating. Abbie has worked for Moolies for 7 years and has consistently received annual bonuses of $15,000 - $20,000. Abbie’s contract also entitles her to a paid day off every month.

Moolies offers Abbie (and other employees with similar contracts) a lump sum of $80 000 in exchange for Abbie modifying her contract, so that she no longer has the right to the bonus, and also no longer has a right to a paid day off every month. Abbie agrees to this.

Sale of Premises

As well as working as an employee, Abbie also owns a private business (as a sole trader) that offers tax consulting services for clients. She had a friend called Peter who ran a clothing store (as a sole trader). Peter’s business owned the retail store premises, as well as the land it was located on. Two years ago, Peter’s store was struggling to make money. As a result, Abbie’s business lent Peter’s business $200,000 at 5% annual interest.

However, a year after the loan was made, it became clear that the business could not repay the loan. As a result, Abbie and Peter came to an agreement: in exchange for Abbie’s business forgiving the debt, Abbie’s business would take a 40% interest in the land that the premises were located on.  This agreement also made it clear that the land would be sold in the near future. Consequently, the shop was demolished. Also, council plans were obtained to build an 8-storey apartment. This involved Abbie’s and Peter’s businesses paying a collective total of $40,000 for architect, lawyer and local council fees. The land was then sold to a developer for $1 million through a real estate agent.

Abbie’s Investment Property

Abbie purchased an apartment on 1 March 2005, for $300,000, and paid stamp duty of $15,000. She moved into it immediately. On 1 March 2015, Abbie bought herself a house. She immediately moved into it and, thereafter, treated it as her main residence. From this time (1 March 2015), Abbie rented out her original apartment to a tenant. Its market value at the time was $500,000. In March 2018, with regards the apartment, Abbie paid $2,000 for repairing recently broken windows and $30,000 for renovating the kitchen. Abbie sold the apartment on 1 March 2021 for $650,000.

Abbie had paid $15,000 in council rates for the period 1 March 2005 up till 1 March 2015, and $6,000 for the period 1 March 2015 to 1 March 2021.

Abbie’s Car and Jewellery

In March 2021, Abbie’s antique car, which she had bought 2 years ago for $50,000, was burnt out by an arsonist. The fire also destroyed her jewellery, which had been located in the glove box of the car. The jewellery had cost her $11,000 3 years ago. Insurance gave Abbie $60,000 for the car, but unfortunately they gave her nothing for the jewellery, as the insurance company said she should not have stored it in the car.

Required: For Abbie, consider the effect on her assessable income for all five (5) receipts as follows:

1) Discuss whether Abbie’s receipt of $80,000 is assessable as ordinary income (5 marks).

2) Discuss whether Abbie’s receipt of her share of the proceeds from the sale of the land constituted ordinary income (5 marks).

3) Discuss the CGT consequences of the sale of Abbie’s apartment (6 marks).

4) Assume for Abbie’s apartment that the facts are different: she rented out the apartment from purchase (1 March 2005) till 1 March 2015, and then lived in it from 1 March 2015 until the time she sold it on 1 March 2021 (from the time she lived in it she treated it as her sole main residence for tax purposes). What difference would this make to the CGT consequences regarding Abbie’s apartment (4 marks)?

5) Discuss the CGT consequences regarding Abbie’s antique car and her jewellery (3 marks).

Support your answers with case and legislative authority. You can consider each of the 5 issues mentioned in isolation from each other.

 

QUESTION 2: Topics 4 and 5 18 marks

Tanya is a pharmacist. The following events, relating to herself and her son, occurred in the current tax year.
Tanya’s Rottweiler

Tanya owns a pharmacy retail store as a sole proprietor. Lately, there have been some thefts of restricted medications from the store. As a result, Tanya pays a professional dog trainer $5,000 to train her four-year-old Rottweiler to be a guard dog for the store. After the dog is trained, she regularly leaves it overnight in the store to guard it. Tanya is unsure whether this expense is capital or not (note: assume that the dog does not constitute ‘livestock’ for tax purposes).

Nathan

Tanya’s son, Nathan, is a junior pharmacist who works for Tanya as an employee. Nathan wanted to increase his income, so he sold illegally small amounts of restricted prescription medications. As a result, he had to appear in front of a government tribunal. As this was his first offence, he was allowed to keep his pharmacy license. However, he had to pay a $5,000 fine. Further, to maintain his license, he had to undertake 120 hours of community services (unpaid) at a regional drug rehabilitation centre. Nathan undertook this unpaid service work on Tuesday evenings. He would travel directly from his mother’s pharmacy (where he worked Tuesdays) to the regional rehabilitation centre using rail travel. He would get a lift home from the centre from a friend for free.  Total train fares from his mother’s pharmacy to the rehabilitation centre for the tax year amounted to $1,000.  

Tanya’s Investment Property

Tanya owns an investment property that she has rented out for the last 10 years. The carpet in the bedrooms and living areas has become old and worn, and so she arranges to have it removed and to polish the wooden floorboards underneath. This cost her $4,000.

Tanya’s Trading Stock

The following information is relevant for Tanya’s pharmacy concerning its trading stock during the current tax year:

• Purchases of facial cleanser and vitamins: $120,000.

• Sales of facial cleanser and vitamins: $300,000.

• Total closing stock value for facial cleanser and vitamins for end of year prior to the relevant tax year: $400,000 (in total).

• Trading stock values at end of current tax year:

o Facial cleanser: cost of $100,000, replacement value $90,000, market selling value $200,000.

o Vitamins: cost of $200,000, replacement value of $220,000, market selling value $300,000.

Required: Discuss the tax implications for the following transactions.

a) The deductibility for Tanya regarding the costs of training her Rottweiler (6 marks).

b) The deductibility for Nathan for the fine and travel costs as general deductions (6 marks).

c) The deductibility for Tanya for the $4,000 spent on her investment property (3 marks).

d) The trading stock implications for the facial cleaner and vitamins on the assumptions that Tanya wishes to minimise the income tax liabilities for the business (3 marks).

Support your answers with case and legislative authority.

QUESTION 3: Topics 6, 7 and 8 19 marks

Kirsty Lim is a 46-year-old solicitor that owns her own legal practice as a sole trader (KL Law). Kirsty is on the top (45%) marginal tax rate. The following events all occurred in the current tax year:

Dividends

Kirsty receives the following dividends on 1 March 2021:

• $8,000, fully franked, from DFJ Ltd.

• $3,000, 50% franked, from ZZY Ltd.

Family Trust

Kirsty is also the trustee of the Lim discretionary trust that, for the current year, earned dividend income (unfranked) of $50,000 and rental income of $20,000. It paid interest of $10,000 on the loan used to purchase its rental property and shares. During the current tax year, it made the following distributions:

• $20,000 to Mark (Kirsty’s son), a 21-year-old beneficiary.

• $25,000 to Jane (Kirsty’s daughter), a 17-year-old beneficiary.

Larry – Employee Solicitor

Kirsty’s law firm, KL Law, employs a solicitor called Larry, who is on a salary of $150,000.  Larry arranges a salary sacrifice agreement with KL Law where, in exchange for giving up part of his salary, KL Law will pay for:

• A laptop (that Larry can keep) that Larry intends to mostly, though not exclusively, use for work.

• Extra superannuation contributions to Larry’s superannuation fund.

• The interest expenses on Larry’s investment property loan.

GST Liability

KL Law is registered for GST and undertakes the following transactions for one of its GST periods Please assume that:

-Where GST applies, prices are inclusive of GST

-Where GST applies, unless told otherwise, a valid tax invoice has been supplied.

• Purchases of fresh fruit from a major supermarket for the staff room: $1,000.

• Purchase of a new laptop from a major department store: $2,000.

• Annual bank credit card fee for the business credit card: $550

• Payment of staff salaries: $300,000.

• Payment of water utilities bill: $500.

• Payment to plumber from a large plumbing company to fix leak in the office bathroom (no invoice supplied by plumber):  $2,000.

• Sales of services: $600,000.

Interest Rate Adjustments for Mortgages

Kirsty owns an investment property, as well as her own main residence. Each of the two houses were purchased with a mortgage. Both of the mortgages have an amount owing of $1m each. As the mortgages are both with the same bank, Kirsty enters into an arrangement with the bank: instead of paying 2.5% interest on each loan, she will pay 1.5% interest on her main residence loan and 3.5% interest on her investment property loan. The bank explained to her that this would be beneficial for her, because the interest on the investment loan is tax deductible, whereas the interest on the main residence loan is not.

Required: Discuss the tax implications for the following (disregarding the Medicare levy):

a) The tax payable due to Kirsty’s dividend receipts (2 marks).

b) The income tax implications relating to the Lim Family Trust (3 marks).

c) The Fringe Benefits Tax consequences for KL Law regarding the salary sacrifice arrangement with Larry. You are not required to calculate the actual precise dollar FBT liability (4 marks).

d) The GST liability of KL Law (only for the transactions discussed under the “GST Liability” heading of the above facts) (4 marks).

e) The possible application of ITAA 36, Part IVA, to the interest rate adjustments for the mortgages (6 marks).

Support your answers with case and legislative authority. Show calculations where appropriate.