Income Tax Law
Case Study – Accessibility of Income and deductibility of Expenses Harry Fernandez is employed as an Architect and is married to Elizabeth with 2 school aged children. He is employed by a leading construction company in Sydney. He is also the secretary of the local swimming club for the past 10 years. This is an honorary role and he does not get paid any wages for this. Harry has converted his garage into a study area at his home exclusively allocated as a home office with no other use. During the Christmas season Harry’s office did have a compulsory closure from 20 December 2019 to 5 January 2020. As there was nothing else to do during this period Harry took his family on a holiday to Cairns for 2 weeks. Following are his Receipts and Payments which Harry believes could be relevant for his tax return for FY2019/20 (All amounts are in AUD). Receipts: Net Wages (from employment) 107,000 PAYG on wages withheld by the employer 43,000 Bank Interest (joint account with Elizabeth) 2,200 Franked Dividends from Woolworths Ltd (Co Tax rate 30%) 3,500 Dividends from AMP - Unfranked 400 - Franked 1,225 Harry Received a one-off consulting payment from an overseas client 4,500 Advising a friend in Darwin relating to a construction matter 500 (Paid by the friend as cash in hand during one of their meetings) Honorarium paid to Harry in recognition of his contribution to the club 500 During the year Harry sold 200 shares he held in Woolworths Ltd for $ 40 each. In 2014 he purchased 400 shares in Woolworths Ltd for $32 each. The brokerage on purchase and sale were $20.00 each time. Payments: Holiday travel to Cairns (though the entire family travelled)
the cost of Harry’s ticket was 450 Accommodation and incidentals for the entire family 2,900 Travel between home and office for week-end work (not reimbursed by employer) 800km (has records) Travel to worksites using his own car (not reimbursed by employer) 1700km (has records) Harry recons that he would have used petrol to the value of $400 for both travel and wants to claim it as a deduction Heavy Jacket to be worn for outdoor work, during winter (no logo) 900 Dry cleaning of Heavy Jacket – At the end of Winter 149 Home Laundry of his employer’s Logo shirt mixed with other clothes 3 Loads per week 50 weeks Hi-Viz clothing (with no logo) 250 Laptop bought (100% work related) on 1/10/2019 3,500 Repairs to Laptop (dropped Accidentally on 1/02/2020) 375 Increase Laptop memory 10/01/2020 750 Australian Institute of Architects 1,300 Professional Indemnity Insurance 1,450 Book “Construction Design Management” 170 Book “Stock Market investments for professionals” 195 Construction Project Management Course for Architects 990 Tax Return preparation course with H & R Block 549 New book shelf for home office 125 During the financial year, Harry worked in his home office for 8 hours a week for 50 weeks Paid to fix his garage window at home 150 Bank charges (on his savings account where wages are credited) 120 Bank charges on Home Loan (Investment Property) 96 Spouse Information Elizabeth is a High School teacher and has a taxable income of $85,000 in the financial year. She does not have any Reportable Fringe Benefits (RFB) or Reportable Employer Super Contribution (RESC). Investment Property During the year Harry purchased an investment property (freestanding House) in Scofield’s by himself (not joint with his spouse). The contract for the investment property was signed on 3 September 2019 and the settlement occurred on 15 October 2019.
Harry incurred the following expenses in buying. Stamp duty of $29,250, Solicitors fee of $1,500 and loan processing fee of $750. These amounts were all paid with cash monies Harry had previously saved in his bank account. Harry obtained an interest only loan of $800,000 to purchase the Scofield’s property. Harry secured this loan by mortgaging the residence which he owns joint with his spouse. The loan was for a period of 20 years and the interest rate was fixed at 4.0% for the next 3 years. Harry borrowed this amount as he was bidding for the property at an auction and was able to secure the property for $752,000. As a result, he decided to do some renovations to his residence using the rest of the borrowed funds. Harry wants to claim the entire interest on the loan as a tax deduction as the primary purpose of borrowing was for the rental property and the property could fetch around $800,000 in a booming property market. Whilst preparing the property to place it with a real estate agent, it was discovered that air-conditioner in the lounge was not working and Harry replaced it with a new 9.5kw split system for $ 2,800 and added a new 2.5 kw split system to the master bed room, at a cost of $ 800 so that he could command a better rent from prospective tenant. Further Harry replaced carpets throughout the house for $ 9,000 added a new (Polyethylene) rainwater tank for $2,400 and had some repairs done for $ 2,000. All repairs and additions were completed and the property was ready to be occupied on 1/11/2019 and was listed with the local real estate agent on the same day. Due to the quiet real estate market, a tenant for the property was not obtained immediately, in fact the tenant did not move in until 1 December 2019. Harry engaged a quantity surveyor who provided a depreciation report with the following costs. Building construction cost of $300,000 and date of completion of the building was 30 June 2012. The property also includes previously owned and used asset, hot water system valued at $ 875. Rental Income from the property was $700 per week and it was rented for 30 weeks during this financial year. His real estate agent charged a commission of 7% (including GST) for the services provided. Other expenses Harry incurred relating to the rental property are: Council Rates 1,487 Water Rates 698 Repairs due to tenant damage (Jan 2020) 1,695 Last year Harry’s Grandmother passed away in Spain and according to her will Harry received an inheritance in October 2019 of Cash 100,000 Euros. This money is invested in a term deposit Maturing in October 2020. Harry is pretty confident that he does not need to declare either the inheritance or the interest earned in his any of his tax returns as the money is held overseas.
Harry Fernandez seeks your advice as to what income needs to be declared in his Tax return and deductions (if any) he might be able to claim as per the information provided below for the year ended 30 June 2020. Note 1. Ignore that FY 2020 is a leap year and base your calculations on 365 days in a year. 2. Effective life of assets should be as per TR 2019/5 a) Provide a complete calculation of Harry’s Taxable Income, Tax liability (including Medicare Levy and Surcharge – if any) for the year and the net Refundable or Payable for FY 2020. Please add the relevant section of the law for the figures you have included in your calculation. (70 marks) b) Advise Harry how he could have improved his tax situation if he has done anything differently in relation to the borrowed funds. (10 marks) Total 100 marks for the assignment (Weighting – 25%)
Question 2
Taxation Law & Practice
Instructions
- See the Instructions and Assessment Criteria in the Course Description and make sure you follow them!
- Please answer all parts of the question
- All work presented for assessment in this course must comply with the
format outlined in the University’s Presentation of Academic Work
publication, available from the bookshop or on-line at
www.federation.edu.au/generalguide.
- All essays must be accompanied by a signed official cover sheet (‘Plagiarism Declaration Form’), available at www.federation.edu.au/ard/business/student_info_webct.shtml and lodged as appropriate for your campus.
- You MUST reference in the body of the essay every time you use information from other people. This requires you to keep a track of where you are taking information from and then writing the reference up. You should use the Harvard/APA style; and use the University’s new Presentation of Academic Work. The Library’s website also has a citation style guide site. If you plagiarize (intentionally OR unintentionally) you will be given zero: see Regulation 6.1.1 for more details.
- DUE DATE: [Week 9] Please check with the Course Description for details of where and when to submit your assignment. If you need an extension you must ask for one BEFORE the due date (unless this is impossible).
- The assignment should not exceed approximately 2000 words.
- The assignment is worth 30%.
Part 1
On 1 July 2016 Frank Lloyd commenced business as an architect. He operated as a sole proprietor from a converted garage at the rear of his residence. Much of his work consisted of preparing building designs and specifications for local council building permits but he quickly gained a reputation for quality drawings prepared within tight timeframes. By the end of 2016/17 he had a small client base of local builders and private referrals and billings (fees) of $75,000.
During the year (2016/17) Frank submitted a design as part of a national competition for
‘The Citadel’, the centerpiece of an ambitious urban redevelopment. His visionary design and revolutionary use of local materials left the judging panel speechless with admiration and, to national acclaim, he was awarded the prize and commissioned to build the structure. Immediately he borrowed $1 million, rented premises in Main Terrace, acquired state of the art equipment and employed six draughts men and two administrative staff. During 2017/18 his billings were $2.5 million.
Required 1: [Approximately 50% marks]
Should Frank return on a cash or accrual basis in 2016/17 and 2017/18?
You must refer to appropriate case law. Your answer must include (but should not be limited to) a discussion of the following:
- What factors affect the choice of a cash or accrual basis?
- Does Frank have a choice of the basis he adopts?
- Does the Commissioner of Taxation have a right to insist on a particular basis?
- Should Frank’s basis be the same in both years?
- Given the present availability of accounting software packages, in your view, is the traditional criteria for the cash/accrual distinction still relevant?
—————————————
Part 2
Ruby Engineering Pty Ltd [Ruby] was incorporated in 1990 and produced engine components used in the Australian car industry. In 2016 the business and company assets were sold to Diamond Ltd. Under the terms of the agreement, Ruby remained liable for any claims arising before 2016. The company used the funds to invest in real estate and shares.
During the year ended 30 June 2018 Ruby incurred the following expenses:
Required 2:
Advise the directors of Ruby Pty Ltd of the tax deductibility of the above amounts. You must make reference to appropriate authorities and legislation.
- Ruby has owned and rented a residential property since 2008. Rental income for the current year is $35,000. During the year the company replaced the old kitchen fittings, including cupboards that had deteriorated through water damage and wear and tear. The new cupboards were of the same type as the old ones and the kitchen layout was not altered substantially. The cost was $8,500.
- In another of the rental properties a visitor to the tenants slipped on the steps and sustained injuries requiring medical attention. She claims one of the steps was loose and commenced legal proceedings against the partnership alleging her injuries were caused by the poor condition of the building. Ruby incurred legal expenses to date of $7,000 and the action has not been settled at 30 June.
- In March 2015 the company owned sold a batch of parts that were subsequently found to be defective. The purchaser, an Australian car manufacturer lodged a claim for damages in the Federal Court. The claim was settled in November 2017 and the company paid an amount of $750,000 to the car manufacturer.
- The directors of Ruby were concerned about the claim in (c) and the effect it had on the year’s reported profit. They resolved to set aside a small amount of funds annually to meet any future claims. Accordingly, an amount of $100,000 was set aside in a provision in the accounts for the year ended 30 June.
- In August 2017 the directors of Ruby decided to investigate the possibility of re-entering the car parts manufacturing industry using a new type of alloy. An amount of $220,000 was paid to consultants investigating the proposal but, due to uncertainty in the motor vehicle industry, the directors decided not to proceed at the time.
Required 2. [Approximately 50% of marks]
Advise the partners and directors of Ruby Pty Ltd of the tax deductibility of the above amounts. You must make reference to appropriate authorities and legislation.