Tax Implications of Various Cash Inflows and Outflows for Employee and Employer

TAXATION
Student Name
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Question 1
Issue
As per the case facts outlined, Amber has enacted certain transactions involving sale of certain
assets and other contractual agreements. In this background, it is essential to outline the various
tax liabilities that would potentially arise for Amber. The various issues in this regards are
indicated below.
1) Owing to liquidation to chocolate shop, proceeds would be obtained and it needs to be
outlined if capital gains tax would be applicable on any or all of these assuming the proceeds are
capital.
2) Owing to the contract regarding restrictive covenant, proceeds would be realised and it needs
to be analysed if this is revenue or capital and suitable taxation treatment discussed.
3) Owing to the apartment sale, the tax treatment of the proceeds and potential capital gains
implications of the same.
Law
The relevant law keeping in mind the various transactions have been discussed as indicated
below.
Sale of Shop
The first critical question that arises with regards to certain assets is whether these can be
labelled as capital assets or not. To answer the same, s. 108-5 ITAA 1997 is relevant since it lists
down the various capital assets from the perspective of taxation. A noteworthy aspect as per this
section is that capital assets does not consist of only tangible assets but also consists of intangible
assets (example: goodwill) (Woellner, 2015). Identification of assets as capital assets is a key
step as for a capital asset the proceeds arising from sale would be capital and hence tax free.
Thus, in case of capital assets sale, the only potential tax implications can arise on account of
loss or gain in capital owing to higher or lower cash proceeds when compared with the cost base.
Another vital point to note is that in case of trading stock any capital gains or loss would be
ignored from CGT liability in accordance with s. 118-25 ITAA 1997 (Sadiq et. al., 2015).
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Potential capital gains or losses can arise when a capital event takes place which are highlighted
in s. 104-5 ITAA 1997. In relation to sale of a capital asset, the relevant event is named A1. The
listing of correct capital event is imperative as every event has a particular methodology for
capital gains /losses computations which is outlined in s. 104-5 ITAA 1997. In case of asset
disposal, capital gains can be derived by finding the difference between asset cost base and
proceeds derived from sale (Coleman, 2015). Further, there are two methods provided in tax
legislation to avail capital gains concessions which are discount method and indexation method.
The discount method is explained under Division 115 ITAA 1997 and provides for a flat 50%
capital gains discount only when the underlying capital gains are long term which would happen
when the asset holding period would be higher than a year. The other method i.e. indexation
method aims to provide concessions by providing inflation adjustment in the cost base of asset
which would result in lower capital gains which are subject to CGT or capital gains tax
(Barkoczy, 2017).
Restrictive Covenant
A crucial issue in relation to restrictive covenant is the nature of proceeds which becomes a vital
aspect as revenue proceeds would be assessable income while capital proceeds would not be
assessable income. In case of capital receipts, the potential capital gains tax implications gain
prominence. Some direction with regards to ascertaining the nature of proceeds from restrictive
covenant can be obtained by analysing tax ruling TR 95/35. One of the noteworthy principles is
that any restriction imposed on any legally available right of the taxpayer though compensation
would result in capital proceeds (Krever, 2016). This is because the underlying right of the
taxpayer was an asset which has been restricted and adversely impacts future earnings potential.
The same is also reflected in a relevant case i.e. Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR
527 where constraint on the right to sue was levied in exchange for payments or compensation.
The honourable court indicated that if the right to sue was legally permissible to the taxpayer,
then the restriction of the same would lead to capital proceeds (Nethercott, Richardson & Devos,
2016).
Apartment
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It has already been discussed that capital gains or losses are computed only when there is a
capital event. However, death of the owner is not such an event and is not mentioned in s. 104-5
ITAA 1997. The asset typically passes on the legal heir and when there is asset disposal on the
part legal heir, then implications in terms of capital gains could arise. To compute the extent of
these capital gains, the market value of the asset at time of death needs to be deducted from the
proceeds obtained on asset sale (Krever, 2016). Another issue in sale of property relates to
signing of contract in current tax year and settlement in the next tax year. Guidance is provided
in accordance with tax ruling TR 94/29 which makes it clear that for such cases, CGT liability
has to be computed and levied in the same year as contract enactment irrespective of time of
settlement (Woellner, 2015). Also, certain residential apartments may be exempt from any CGT
liability if the same has been used by the taxpayer as main residence from the time of purchase.
This is as per subdivision 118-B ITAA 1997 which allows 100% exemption for any capital gains
derived from main residence same. Critical aspect for main residence is usage of property as
residence and no assessable income being derived from the house through rent or other means
(Barkoczy, 2017).
Application
Sale of shop
The boutique chocolate shop which has been liquidated by Amber comprised of following three
assets namely goodwill, equipment and stock. The relevant tax treatment of each is highlighted
as follows.
1) Goodwill – It is a capital asset as per s. 108-5 and hence sale proceeds would not be taxed.
Disposal of goodwill would be A1 event and hence the deduction of cost of goodwill from sale
price would provide the capital gains made on the transactions. Concession in the form of
Division 115 discount method would be applied as holding period exceeds one year. CGT would
be applied on the remaining capital gains.
2) Equipment – The treatment of equipment differs from that of goodwill owing to regular
depreciation and related taxation deduction that the taxpayer obtains. Thus, for computing the
capital gains or losses comparison between book value and market value ought to be drawn. A
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