Tax Implications of Capital Asset Liquidation, Restrictive Covenant and Inherited Property

TAXATION
STUDENT ID/NAME
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Question 1
Issue
In the underlying scenario, the key objective is to outline the potential tax implications of the
transactions that taxpayer Amber has entered in the given year in wake of the relevant
legislation and relevant authorities.
1) The applicability of CGT (Capital Gains Tax) in relation to the liquidation of a capital
asset i.e. shop sale.
2) To determine if the proceeds derived from restrictive covenant related contract would be
capital or revenue which has significant implications for resultant taxation.
3) The applicability of CGT (Capital Gains Tax) in relation to sale of one bedroom apartment
which Amber has inherited from her uncle.
Law
The relevant law for the key issues identified in the given scenario is discussed below.
Shop Sale
There are various capital assets which are listed in s.108-5 ITAA 1997 with one of these
being goodwill and the sale of these assets could potentially give rise of CGT implications.
Trading stock does not fall within the ambit of s. 108-5 as any capital gains or losses on this
are ignored in line with s. 118-25 ITAA 1997 (Reuters, 2017). A potential reason for this
differed treatment is that strictly speaking it is a raw material and consumed in the business
and hence not a capital asset but a current asset whose sale produces ordinary income as per
s. 6(5) (Barkoczy, 2017).
With regards to capital assets, the CGT implications would arise when a particular capital
event takes place in accordance with s. 104-5 ITAA 1997. When a capital asset is disposal, a
capital event named A1 occurs. This event highlights that computation of respective capital
gains need to be carried out by deduction of underlying cost base of asset from the asset sales
proceeds. With regards to capital gains computation, ITAA1997 provides two techniques for
the same (Coleman, 2015). One of these relates to s. 115-25 ITAA 1997 and is called
discount method. In this method, 50% rebate is offered on long term capital gains (Wilmot,
2016). Long term capital gains arise when a given capital asset has been possessed by the

taxpayer for more than 1 year. Discount method is not applicable for short term capital gains.
Also, the other method is indexation method where the capital gains are reduced by
enhancing the cost base of the asset by applying the impact of inflation (Krever, 2016).
Restrictive Covenant
The critical issue with regards to restrictive covenant is to highlight is the underlying
proceeds would be revenue or capital. This assumes significance in the backdrop of capital
proceeds being exempt from any tax implications except any possible CGT for any capital
gains or losses that may have been derived. A relevant case in the given scenario is Reuter v.
FC of T 93 ATC 4037; (1993) 24 ATR 527 (Krever, 2016). This party related to
compensation being paid to for waiver of right to sue which is a legal right. The discussion
regarding the case highlighted that any proceeds arising from imposing restriction on a legal
right would be considered as capital proceeds. This would be because the legal right is a
capital asset capable of enduring advantage in the future and hence restriction on the same
yields capital proceeds. This thought can be extended to restrictive covenant where also the
seller of the business has the legal right to set up a new business at the place and time deemed
suitable. However, by accepting restrictions on this right, the underlying proceeds ought to be
capital which has also ben advocated in the discussion in tax ruling TR 95/35 (Nethercott,
Richardson & Devos 2016).
Inner City One bedroom apartment-
Any asset which has been purchased before September 20, 1985 would be termed as pre-
CGT asset and the CGT implications on such assets would not exist as per s.149-10 ITAA
1997 (Woellner, 2015). In relation to deceased estates, any capital loss or gains which must
be levied for any ownership period of the dead owner would be ignored. Also, it is
noteworthy that death of the owner is not a capital event as per s.104-5 (Krever, 2016).
When the asset passes on to the legal heir, then for CGT computations, it is assumed that cost
of acquisition of asset would be equal to the market value at time of death. This is despite the
fact the legal heir has been provided the asset without any cost. Also, a crucial aspect in sale
of capital assets is when the enactment of sale contract and obtaining of complete sales
proceeds do not coincide or fall in the same tax year. In such cases, tax ruling TR 94/29
highlights that CGT implications would arise in the same tax year when the sale contract for
the asset has been executed irrespective of when the resultant cash is received. Also, in case
of house which the taxpayer uses as main residence, Division 118-B ITAA 1997 can be