Taxation Law - Tax Advice for VFA

The key objective in the given case is to extend tax advice with regards to the taxpayer (VFA) in relation to the year ending June 30, 2018. The critical issues that need to addressed are as following...

TAXATION LAW
STUDENT ID:
[Pick the date]

Date: October 8, 2018
Dear Ross & Dale
I have reviewed the information that has been provided pertaining to the company. I have
referred to the relevant case laws, legislation and tax rulings in order to provide
recommendation with regards to the various items. The same has been carried out in manner
where the issues are firstly identified, followed by the discussion of the applicable law which
leads to application of the same for generation of advice. These can be found in the
attachment commencing from next page.
Feel free to address any further or follow-up queries that you may have regarding the
recommendations.
Yours Faithfully
STUDENT NAME

Issue
The key objective in the given case is to extend tax advice with regards to the taxpayer
(VFA) in relation to the year ending June 30, 2018. The critical issues that need to addressed
are as following.
1) The revenues obtained from TCA airways as part of pilot training contract would be
recognised on accrual basis or cash basis.
2) With regards to the proceeds from the sale of land, it needs to be highlighted whether the
same would be capital receipts or revenue receipts.
3) The possible tax deduction of the solicitor and court fees incurred by VFA in relation to
build a large training facility with reference to s. 8-1 ITAA 1997.
4) The tax implications of the sale of land which was intended to expand the operations to
training of commercial pilots and had to be closed later.
5) To ascertain whether the cash incentives for entering the lease can be treated as assessable
income under s. 6-5 or s 6-10. The same needs to also be performed for the rent free use of
the new facility by Chandler Airport Corporation for a period of one year.
6) The tax deductibility of the annual lease payments made with regards to the special flight
simulator procured from Flight Services Ltd in the light of s. 8-1 ITAA 1997 or any other
clause.
7) The tax deductibility of the payment for restrictive covenant to the tune of $ 350,000 for a
period of four years.
8) The assessability of the compensation payment to the tune of $ 750,000 that has been
provided by FlyHigh on account of cancellation of the service agreement which would have
brought in assessable income for VFA over the next four years.
9) The appropriate taxation treatment of the following expenses need to be considered with
reference to Income Tax Assessment Act 1997 (ITAA 1997) and also Fringe Benefit Tax
Assessment Act 1986 (FBTAA 1986).
 Bank Charges
 Car Expenses

 Education Expenses
 Entertainment
 Furniture
 Marketing Costs
 Telephone
 Travel Expenses
The deductibility of the above expenses and potential liability for the company ought to be
highlighted.
Rule
Ordinary income
The income derived from ordinary income sources are termed as ordinary income and
contributes to assessable income as per s.6-5 ITAA 1997. As per tax ruling TR 92/7,
assessable income would include various income such as employment income, business
income, investment income and income from personal exertion (Reuters, 2017).
Basis for Income Recognition
In accordance with tax ruling TR 98/1, a taxpayer has a choice with regards to choosing an
appropriate means for income recognition in the form of accrual (earnings) basis or cash
(receipts) basis. The taxpayer has the choice but the same should be exhibited in a manner
that presents the most accurate representation of the income. TR 98/1 highlights that the
receipts or cash method is preferable in instances where the income is derived on providing
services or where income is the result of skill possessed by the underlying income. On the
other hand, trading income or income from manufacturing operations is preferred to be
recorded on the earnings method (Barkoczy, 2017).
However, as indicated in Carden v FCT (1938) 63 CLR 108, the decision with regards to
appropriate basis for income recognition should not be based on rigid rule and must be driven
by the underlying circumstances of the business. In this regards, the size of the business plays
a crucial role and typically when the size of a business expands and there is use of other
employees for revenue generation, then the appropriate basis to be deployed is accrual basis
as indicated in the verdict of the Henderson v. Federal Commissioner of Taxation (1970) 119
CLR case (Sadiq et. al., 2015).

General Deduction
General deduction is available for business expenses under s. 8-1 ITAA 1997. As per ss. 8(1)
ITAA 1997, the necessary positive limb for claiming tax deduction for outgoings or losses is
that the underlying outgoing or expenditure must have been incurred with regards to
producing assessable income and there should be sufficient nexus between the outgoing and
the assessable income production (Woellner, 2015). Further, there are three negative limbs in
relation to ss. 8-1(2) that are outlined as follows (Krever, 2017).
 The expenditure cannot be capital in nature and has to be revenue. In case of capital
expenditure no deduction can be availed.
 The expenditure should be business expenditure and must not domestic expenditure
since no deduction is available for private expenditure.
 The expenditure should be done for assessable income and any expenditure incurred
for producing tax exempt income or non-assessable income would not be able to
claim deduction under this section.
Capital or Revenue Nature of Expenses/Outgoings
A key concern with regards to expenditure or outgoing is to determine the underlying nature
of the same which is of special information to s. 8-1 deduction and also other sections which
provide deduction only belonging to revenue nature. A suitable case law for indicating the
difference between the two is Sun Newspapers Ltd and Associated Newspapers Ltd v.
Federal Commissioner of Taxation (1938) 61 CLR 33 case. In this particular case, Dixon J
highlighted a test to differentiate between the two which focused on the advantage produced
from the underlying outgoing (Deutsch et. al., 2015). If the advantage that is procured from
the outgoing has an enduring effect, then the underlying expenditure would be capital in
nature. However, if the advantage would be realised in the current tax year and would not be
long term, then the expenditure would be revenue. A similar stance has also been assumed in
the Carden v FCT (1938) 63 CLR 108 case (Coleman, 2015). For instance, any payment
related to restrictive covenant would be capital expenditure and not revenue expenditure as
the underlying positive effect in terms of lower competition is not limited to the current tax
period but tends to extend in the future and hence the nature of the advantage would be
termed as enduring (Gilders et. al., 2016).
Deduction for capital expenses

With regards to capital expenses, deduction can be availed in accordance with s. 40-880
ITAA 1997 where any business related capital expense can be deducted completely over a
five year period with equal deductions applicable every year (Krever, 2017).
Capital Gains Tax
It is noteworthy that when there is a sale of assets, then the underlying proceeds are capital in
nature and exempted from tax. However, any capital gains that are obtained in the process
would be taxed in accordance with Capital Gains Tax (CGT). The CGT needs to be charged
on the capital gains which are required to be computed once a CGT event takes place as per s.
104-5 ITAA 1997. A prominent CGT event is A1 event which is triggered whenever there is
a disposal of any asset. In accordance with this the capital gains can be computed by
subtracted the asset cost base from the proceeds realised on asset case (Reuters, 2016).
The cost base of the asset is determined in accordance with s. 110-25 ITAA 1997. As per ss.
110-25(1) ITAA 1997, there are five elements which tend to contribute to the asset cost base
as highlighted below (Barkoczy, 2017).
ss. 110-25(2) – The price for which the asset has been purchased.
ss. 110-25(3) – The incidental costs which are related to either the asset purchase or sale and
are necessary.
ss. 110-25(3) – The ownership costs for the asset including the payment of certain taxes along
with the payment of interest on any loan assumed for the asset purchase.
ss. 110-25(4) – The capital costs in regards to the preservation or enhancement of asset value.
ss. 110-25(5) – The capital costs incurred by the taxpayer in relation to the title preservation
of the asset.
The capital gains thus determined considering the cost base and sales proceeds can further be
reduced through the application of discount method or indexation method. The discount
method is outlined in s. 115-25 ITAA 1997 and offers 50% discount on the capital gains
provided these are long term. For long term capital gains, it is imperative that the underlying
asset has been held for a period of more than one year. However, this discount cannot be
availed by companies and restricted only to individuals and small businesses. Hence, the only
alternative remains in the form of indexation method which is applicable only for assets

purchased prior to September 1999. Finally, the capital gains remaining after this would be
levied CGT at the rate of 30% (Sadiq et. al., 2015).
Fringe Benefit Tax
Fringe benefits are those benefits that are extended to the employees by the employers and
are provided not in form of cash besides being personal in nature. The legislation for the tax
treatment of these benefits is Fringe Benefit Tax Assessment Act 1986 (FBTAA 1986). The
discussion on the key aspects is indicated below (Gilders et. al., 2016).
 One of the most common fringe benefits is car fringe benefits which as per s. 7
FBTAA 1986 arise when the employer owned car is provided to employee for
personal usage. The extent of fringe benefit can be determined as per s. 9 statutory
formula which is indicated below (Coleman, 2015).
Further, the taxable value of the benefit is obtained by multiplying the above value with the
gross factor which depends on the underlying year and whether the underlying item would
have GST applicable or not. Also, the FBT burden on the employer is computed by
multiplying the taxable value with the FBT rate which may vary annually (Woellner, 2015).
 As per s. 58X, FBTAA 1986, if the employer provides any electronic portable item
(such as mobile, laptop) for office work, then the same is exempted from purview of
FBT. However, if the bill of these devices is paid by the employer and part of the
usage is private, then FBT may be levied on employer (Deutsch et. al., 2016).
 With regards to entertainment fringe benefits, FBT would be levied on the employer.
However, deduction under s. 8-1 ITAA 1997 is available for employer for any
expenses in relation to client and their associates but the expenses related to client are
non-deductible. Further, for Christmas party, FBT would be levied on the employer if
the minor benefit exemption does not apply (Coleman, 2015).

Compensation Receipts
In accordance with tax ruling TR 95/35, the compensation receipts would be considered to
have the same nature as the underlying loss that they are replacing. Hence, if the
compensation receipts are provided for revenue receipts, then the income would be assessable
else not (Krever, 2017).
Lease Incentives
The tax implications of cash and non-cash lease incentives are highlighted as per IT 2631. In
accordance with this any cash incentive would be treated as income for the taxpayer. This is
also vindicated from the decision in the F.C. of T. v. Cooling 90 ATC 4472 case where it was
highlighted that these incentives tend to result from the normal business activity of shifting
premises and would be income in character. In relation to the non-cash incentive, if the same
is convertible into cash, then the same would also be included in the assessable income of the
taxpayer (Sadiq et. al., 2015).
Depreciation
The depreciation on various depreciable business assets can be computed using the prime
cost method as indicated in s. 40-75 ITAA 1997. To the extent that the asset is used for
generation of assessable income, deduction would be available to the taxpayer. However, no
deduction for the personal use of asset is permissible (Coleman, 2015).
Application
Ordinary Income
The taxpayer in this case is the company VFA which is providing services to various airlines
in regards to training their pilots and the money received on account of the same would be
considered as ordinary income as per s. 6-5. Thus, the proceeds from TCA Airways contract
would be considered as ordinary income. Considering the size and scale of business, the
relevant basis would be accrual basis, hence the complete cash receipts received in October
of each year would not be recognised. The revenue for each year would be recognised to the
extent that services have been provided to the TCA Airways and remaining revenues would
remain unearned. Further, the debtors to the extent that
Compensation Receipts

The settlement amount to the tune of $ 750,000 obtained during the year from FlyHigh Ltd
would be considered as ordinary income since the settlement amount has been received in
exchange of the loss on the future ordinary income that could have been earned had the
contract not been terminated.
Lease Incentives
The cash lease incentive offered by CAC in relation to shifting the base to their airport would
be considered as ordinary income for VFA considering that this payment has been derived in
the ordinary course of shifting business premises by the company. Additionally, the
assessability of the non-cash benefit would also be considered as the rent free place would
result in cash savings for the company to the extent of $ 100,000 over the given tax year.
Thus, both cash and non-cash incentives would contribute to the ordinary income.
Sale of Land
Land had been acquired by the company for the purpose of expansion but was liquidated later
when the permission for commercial flight testing was not provided. Considering that the
taxpayer is a company, hence discount method is not available. Further, indexation method
cannot be used as the land has been acquired on October 1, 2017.
Purchase cost of land = $ 6 million
Interest paid for holding period of 4 months from October 1, 2017 to January 31, 2018 =
0.9*6 million*(6.8/100)*(123/365) = $ 123,741
Hence, cost base of the land = $ 6,000,000 + $ 123,741 = $ 6,123,741
Selling price of the land = $ 6,850,000
Capital gains that are subject to CGT = (6850000 – 6123741) = $ 726,259
CGT obligation (assumed no previous CGT loss and no other transactions) = 0.3*726259 = $
217,878
However, it is noteworthy that the proceeds of $ 6.85 million from land would not be taxable
since it is capital in nature.
Expenses

The tax treatment of various expenses is indicated as follows.
 Solicitor and Court Fees ($380,000) – The given legal expense is capital in nature
since the benefit derived from the same would have brought incremental income for
the taxpayer over several years and hence the benefit would have been enduring.
100% deduction can be claimed under s. 24-440 ITAA over a five year period.
 Lease payment to Flight Services for simulator ($150,000) – Assuming that the given
expense is operating, tax deduction under s. 8-1 ITAA 1997 would be available since
the given equipment is necessary for producing assessable income.
 Payment for restrictive covenant ($350,000) – Since the benefits derived for the
business are enduring, hence the given expense would be termed as a capital expense
for the company. Thus, 100% deduction can be claimed under s. 24-440 ITAA over a
five year period.
 Bank charges – The card transaction fees would be revenue in nature and hence
deduction under s. 8-1 ITAA 1997 is available as these are required for payments.
 Car expenses – Since personal use is allowed on the car, hence FBT liability would be
computed on the company (Taxpayer) as per s. 9 FBTAA 1986. Further, for the
operating expenses, deduction to the extent of 77% can be availed under s. 8-1 ITAA
1997 since it relates to production of assessable income.
 Education Expenses – These are requisite expenses for the business since it is
imperative to train the staff and also the instructor. Hence, the nature of the business
expense is revenue owing to which deduction as per s. 8-1 ITAA 1997 is permissible.
 Employee Remuneration – These are deductible revenue business costs and thereby
deductible in accordance with s. 8-1 ITAA 1997.
 Lunches and Christmas – Depending on the availability of the minimum exemption
rebate, FBT would be levied on the employer in relation to the entertainment and
meal fringe benefits that are extended. However, the amount of spending would be
deductible under s. 8-1 ITAA 1997 as the employees produce assessable income for
taxpayer.
 Furniture – The expenditure on furniture would be capital in nature and hence non-
deductible under s. 8-1 ITAA 1997. However, over the useful life depreciation would
be charged on the same and this amount would be available for deduction from
taxable income.

 Fuel and Airplane Maintenance cost - These are essential costs for the company as
airplane are required for training and fuel would be incurred. For these regular
business expenses, deduction is available under s. 8-1 ITAA 1997.
 Marketing and advertising costs are also business expenses that are regularly incurred
for attracting new clients and hence these are revenue expenses with deduction under
s. 8-1 ITAA 1997.
 In relation to mobile phone provided to instructors, no FBT would be levied but
depreciation on the same may be claimed over the useful life of the asset.
 Solicitor fees with regards to lease for Simulator would be a revenue expense and
hence general deduction would apply for this case.
 The amount spent by the company on the travel and stay of Dale Wise would be
deductible under s. 8-1 ITAA 1997 since it is an imperative expenditure related to
training and production of assessable income through upgrading and entering new
business avenues.
Conclusion
On the basis of the above discussion, the following recommendations may be offered.
 The ordinary income would be derived on accrual basis from the services offered to
various airlines. Also, the cash and non-cash based lease incentives obtained from
CAC for changing the base would be considered as ordinary income. Additionally, the
compensation receipts from the settlement (i.e. $ 750,000) would be considered as
ordinary income and thereby assessable in the given tax year.
 On the sale of land, while the proceeds would not be taxable but on account of capital
gains, CGT liability to the tune of $217,878 would le levied. Further, the interest
charges on loan are adjusted in the land cost base.
 Also, the company would have FBT liability arising from extension of lunches,
Christmas party and car fringe benefits.
 The solicitor expenses related to settlement case along with payment of restrictive
covenant proceeds would be capital expenditure and hence deduction would be
available over a five year period.
 For furniture and mobile phone, depreciation related deduction may be permissible
provided the same is used for business.

 The remaining expenses are considered as deductible expenses under s. 8-1 ITAA
1997 owing to there being a direct nexus between these expenses and assessable
income production. Also, these expenses are revenue in nature.

References
Barkoczy, S. (2017) Foundation of Taxation Law 2017 (9th ed.). North Ryde: CCH
Publications.
Coleman, C. (2015) Australian Tax Analysis (4th ed.). Sydney: Thomson Reuters
(Professional) Australia.
Deutsch, R., Freizer, M., Fullerton, I., Hanley, P., & Snape, T. (2016) Australian tax
handbook. 8th ed. Pymont: Thomson Reuters.
Gilders, F., Taylor, J., Walpole, M., Burton, M. & Ciro, T. (2016) Understanding taxation
law 2016. 9th ed. Sydney: LexisNexis/Butterworths.
Krever, R. (2017) Australian Taxation Law Cases 2017 (2nd ed.). Brisbane: THOMSON
LAWBOOK Company.
Reuters, T. (2017) Australian Tax Legislation 2017 (4th ed.). Sydney. THOMSON
REUTERS.
Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., & Ting, A.
(2015) Principles of Taxation Law 2015 (7th ed.). Pymont: Thomson Reuters.
Woellner, R. (2015) Australian taxation law 2015 (8th ed.). North Ryde: CCH Australia.