Tax Implications for Sale of Business and Employee Benefits

TAXATION
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Question 1
Issue
The key issue in the given scenario is to ascertain the appropriate tax treatment of following
three transactions with regards to taxpayer Amber.
1) Sale of boutique chocolate shop with special reference to the potential CGT (Capital Gains
Tax) implications.
2) Proceeds from restrictive covenant imposed during sale of business - Capital proceeds or
revenue proceeds?
3) The sale of inner city one bedroom apartment with particular reference to inheritance of
capital asset and the computation of potential CGT implications that may arise.
Law and Application
In the given section, the transactions enacted by Amber would be analysed in light of relevant
legislation, tax rulings and case law to determine the applicable taxes.
Sale of boutique chocolate shop- Law
The definition of capital assets is highlighted in s. 108-5 ITAA 1997 which includes amongst
other assets goodwill along with plant & machinery that may be used in business. However,
the same cannot be said about trading stock which as per s. 70-10 ITAA 1997 s used in the
business and would be essentially converted into final goods which would be sold to
consumers (Coleman, 2015). As a result, s. 118-25 ITAA 1997 states that any capital gains or
loss that tends to arise on account of a CGT event would be disregarded if the underlying
asset is trading stock. This is because trading stock is part of the business and hence any
profit or loss arising from the same would be reflected as assessable income in accordance
with s. 6-5 ITAA 1997.
With regards to s. 104-5, whenever there is a disposal of a capital asset, then it corresponds to
event A1. In such cases, the capital gains or losses would be derived by subtracting the cost
base of the underlying asset from the sales proceeds of the asset (Reuters, 2017).
Additionally, for the computation of capital gains that would be subject to 30% CGT, there
are namely two methods i.e. Discount Method and Indexation Method. The taxpayer has the
choice to use either of the two methods so that the CGT liability can be minimised. The

discount method as outlined in s. 115-25 ITAA 1997 provides 50% discount on the capital
gains provided the asset has been held in excess of one year. No discount under s. 115-25 can
be availed for assets which are held for less than a year (Deutsch, Freizer, Fullerton, Hanley
& Snape, 2015). In case of indexation method, revised cost base is used for the computation
of capital gains.
Sale of boutique chocolate shop- Application
The first critical aspect is that the proceeds that Amber receives with regards to the business
assets would be capital proceeds and hence no tax would be applicable on these proceeds.
However, for capital gains made on the various assets related to the shop, CGT may be
applicable in accordance with the discussion carried out above. With regards to shop, there
are different assets which need to be segregated particularly with regards to presence of
trading stock (Reuters, 2017).
With regards to goodwill, the proceeds from sale are known and also the cost is given with
regards to the shop. As a result, the capital gains can be derived in accordance with s. 104-5
and event A 1 (Deutsch, Freizer, Fullerton, Hanley & Snape, 2015). Further, the discount
method would be applied in order to compute the taxable capital gains since the shop was
purchased in 2010 and sold in 2018 thus making the resulting capital gains as long term.
In relation to the equipment, the capital gains or capital loss would be derived by considering
the sale value of equipment and the book value of equipment at the time of sale. This is
imperative since depreciation is charged on the equipment and hence the original cost cannot
be considered for capital gains computation. Also, discount method would be applied in this
case since capital gains are long term.
In relation to the trading stock with the shop, capital gains would be disregarded in line with
s.118-25 ITAA 1997 and thus these no capital gains would be levied on the same.
Restrictive Covenant- Law
The key issue with regards to restrictive covenant is to determine whether the underlying
proceeds would be capital or revenue in nature. This is imperative so that it can be
ascertained whether the receipts are revenue or capital. This is essential as revenue receipts
would be taxable but the same is not true with regards to capital receipts. A relevant case law
is Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527 where there was an agreement

between parties whereby right to sue was not allowed (Nethercott, Richardson & Devos,
2016). A critical aspect highlighted was that if a payment has been derived with regards to
restricting a legitimate right that the taxpayer has, then the underlying proceeds would be
capital in nature. The same logic can be extended to restrictive covenant which prohibit the
seller of a business from opening a business in certain geography and for certain time and
hence restraining the legitimate right the seller has to open a new business. Therefore, the
proceeds derived from the same would be capital in nature which has also been supported by
tax rulings TR95/35 and TR 94/D33 (ATO, 2018).
Restrictive Covenant- Application
In the given case, Amber has received an additional sum of $ 50,000 for signing a separate
contract with the buyer of the business whereby she is not allowed to open a similar business
within the radius of 20 km from the shop sold for a period extending to 5 years. It is apparent
that the restrictive covenant tends to restrict the rights available to Amber with regard to
opening shop and hence the proceeds from this contract would be capital in nature on which
no tax would be applicable. However, CGT may apply on any capital gains that may be
related to the contract.
Sale of one bedroom apartment-Law
As per s.149-10 ITAA 1997, any capital asset acquired before September 20, 1985 would be
considered as pre-CGT asset and the capital gains tax would not be applicable on any capital
gains or losses arising from the sale of such asset irrespective of holding period and the
quantum of capital gains (Nethercott, Richardson & Devos, 2016). In relation to deceased
estates, it is imperative to note that CGT implications before the death of the concerned
owner are disregarded. Also, even though the estate is inherited but the market value at the
time of death tends to serve as the cost base of the asset so that any CGT liabilities that may
arise from the sale of the asset may be computed. Also, with regards to TR 94/29, in
situations where the contract for sale is signed or executed in a given year but proceeds are
obtained in the next tax year, the CGT is payable in the same year when the sale contract is
executed and the CGT liability ought to be computed in accordance with the contract sale
terms as set in the sale contract (Kreyer, 2016). As per Division 118-B main residence
exemption is available when the taxpayer tends to use the given house as main residence. In
case of deceased estates, this benefit is extended to the taxpayer who has inherited the
property (Hodgson, Mortimer & Butler, 2016).