Tax Law: Income Derivation, Capital Gain Tax Implications, and Negative Gearing

This article discusses income derivation, capital gain tax implications, and negative gearing in tax law. It explains the rules, applications, advantages, and disadvantages of these concepts. It also provides examples and case studies to help readers understand these concepts better.

Running head: TAX LAW
Tax law
Name of the Student
Name of the University
Author Note

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Answer 1A
Issue
The issue with respect to this case is that the income derived by Kristie by selling her property
would not be considered as income according to the ordinary concepts.
Rule
The rules of deriving ordinary income had been provided in the Income Tax Assessment Act
1997 in s 6.5. The section signifies that the income would be considered as an ordinary income if
it has been obtained through the general concept of income. Income is generally the profit which
is derived on a recurring basis by a person who had the intention of gaining profit. Thus OI
would be inclusive of business profits, salary or interest received.
Generally when a property is sold it is not considered as an ordinary income. This is
because a property is a capital asset and its sale results in the A1 event of CGT. However, if a
person carrying out a business to sale a property gains an income through the business it would
be treated as a ordinary income. This would be the case even if the transaction of selling the
property is an isolated transaction but had the intention was to make profit as per the case of FC
of T v Whitfords Beach Pty Ltd [1982] HCA 8.
Application
Ms Kristie had purchased a property so that she can make profit from it in the future and
use it after her retirement. However, she was delighted to hear that the property had been
rezoned. He decided to gain an approval from the council to construct an apartment and spent
about $15000 for it notifying her intention to make profit and turning the isolated transaction into

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a business transaction. In addition, it has been further stated that the work is provided to a
contractor who she has paid about $7m to construct an apartment. After the apartment is
constructed it has been sold by her at a price of$12m. This means that she had made a profit of
$5 million with the intention of making profit through an isolated business transaction. The
application of the case of FC of T v Whitfords Beach Pty Ltd clearly provisions that if a person
carrying out a business to sale a property gains an income through the business it would be
treated as a ordinary income. This would be the case even if the transaction of selling the
property is an isolated transaction but had the intention was to make profit. Thus the income
would be an OI.
Conclusion
Kristie has made an OI.
Answer 1B
The tax issue
Whether Dave would have any capital gain tax implications in relation to the information which
has been provided via the facts
The taxation rules under the ITAA 97
The legislations specifically deals with provisions in relation to Capital Gain Tax. This tax is
paid when there is a CGT event which includes the sale of a CGT asset. A person who is
carrying out business on his own account has the right to make claim for Small Business
Concessions under the Act.

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It can be stated in line with section 104.5 that any of the CGT events which are provided under
the section if take place that a person can claim the existence of a CGT event.
It is clear in line with s104-10 that sale of property is a CGT event and specifically CGT event
A1. The timing of this CGT event is the day of sale as in line with s104.5.
In connection with s 116-20(1), it can be stated that under the CGT event CGT can be derived by
deduction of Cost Bases from Capital Proceeds. A cost base is the total expenditure which is
procured in obtaining and maintaining the capital asset. The Capital proceeds are the amount
gained through the sale of the Capital asset. When CP is received in more than one sale than the
total CP is considered in line with s 116.40(1) or is reasonably apportioned. When, the CGT has
been calculated it can be reduced under div. 115 of the Act with 50%, in case the purchase has
been after 1991 September 21. There is also an indexation method which is applied for purchase
before 1991 September.
The Net Capital Gain of a person is entitled to be reduced further through the application of
provisions regarding SBC. These are a kind of concessions which is provided to those people
who indulge in small business activities. These reductions are irrespective of any deductions
through indexation or discount. However, there are various criteria which needs to be complied
with for the purpose of being eligible to claim a SBC. These concessions have been elaborated
under Division 152.A of the ITAA. There are primarily divided into four categories
1. 15 years concession - Subdiv 152-B Holding Asset for minimum 15 years and the age of
the Tax payer is minimum 55. (NO CGT TO BE PAID)
2. 50% concession- subdiv 152-c, if the above cannot be availed (50% reduction)

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3. Retirement Concession- The money moves to superannuation funds if TP is aged
minimum 55
4. Rollover – in case of rollover
The person who is making a claim form SBC have to ensure that they have fulfilled two
conditions for the purpose of gaining the Concession.
The first precondition is in line with s152-10(1)(a) of the ITAA. The section requires the
existence of a CGT event which has to take place with respect to the assets of the person who is
making a SBC claim.
The claim can be made if any of the CGT events such as A1 or D1 take place in relation to the
assets of the Tax Payer. Section 152-12 allows disposal of contractual rights related to business
to be eligible for SBC as it is event D1.
In line with s152-10(1)(c)(i) the second precondition requires total business turnover to be less
than $2m in the previous year. The alterative of satisfying this condition is that the condition is
that the assets owned by the tax payer must not exceed $6m even if they are not in connection of
the business which has been sold. However the total asset of a person does not include his
primary place of residence in line with s118-110.
The compliance with the two pre-condition does not in itself make a person eligible for the SBC.
They still have to pass the Active test. In line with s152-40 of the Act a person can sale SBC in
case the CGT event is related to an active CGT asset. The asset has to be used by the tax payer
for business purpose.
Application of the Tax rules

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The Door business belonging to Dave have been sold at a price of $2400000. This includes a cost
of $40000 for good will in relation to the business (CGT event A1). He has been additionally
provided with $80000 for selling his contractual rights (CGT event D1). In addition he has been
provided with $30000 as compensation for restraint of trade. This is to be paid in three
instalments but would be capital proceeds under the modification rules. Thus the total sale
proceeds in this situation would be the sum of all money received by Dave which is $25100000.
The total cost base has to be determined next. The cost base would be the price of acquiring the
business. Here the cost base would be $900000 + $100000. Therefore the net capital gain would
be CP-CB which is $1510000.
The business was purchased after 21 September and was held for more than a year. Thus she can
claim 50% discount under div 15. The total CGT is $755000.
Now, it needs to be determined whether Dave can claim SBC. Dave can claim SBC if he satisfies
the two pre-conditions first. The first precondition is satisfied as there is a CGT event A1 and D1
in relation to the assets owned by company. The second pre-condition with respect to turnover is
not satisfied as the turnover of the business is more than 2m. Thus, the total value of his assets
of Dave requires calculation as to whether they are less than $6m.
Here, Dave does not have assets worth more than $6m as his overall assets account to only
3250000.
Assets of Dave
Particulars Amount

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CG on business
sold 1510000
Insurance Policy 200000
property Shares 650000
Apartment in Coburg 330000
superannuation 400000
invest shares 160000
Total 3250000
The house in which he resides will not be added for calculation and the house he just sold will
be added in the calculation. Thus, the preconditions are satisfied. The sale of business also passes
the active test as it is used to carry out business by Dave. Thus he can claim SBC. In addition the
SBC he can have is 50% discount as he cannot have 15 years SBC because of his age and tenure
of business. Thus the total CGT would be reduced by 50%. On the other hand retirement would
make his funds move to superannuation.

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Question 2
The term negative gearing is associated with financial leverage, which states that the
investor can borrow any amount that will enable them in purchasing an investment that can later
turn out as an income. However, the income that will be generated from the asset needs to be less
than the amount that has been spent in purchasing that particular asset by the investor. Incomes
like depreciation and the interest for a loan are also considered as negative gearing (Nicholls
2014). There are benefits of tax on a negatively geared investment that is enjoyed by the
investor. The treatment of it will be as tax and can be subtracted from the taxable income of the
investor or shown as a capital gain for the sale of that particular investment (Blunden 2016).
The use of negative gearing also has many advantages such as it helps in reducing the
rate of affordability for the property that the investors want so that it can help in improving the
level of standards with respect to the people in Australia. The real estate sector is the most
taxable industry in the country and with the use of negative gearing property, the rate of
investment can be decreased to a great extent. It will also help in decreasing the supply of the
real estate properties and at the same time increase the cost of rent (Jacobs 2015). The capital
growth is also on the rising side due to the fact that the investors have different choices from
where the property can be selected. This will enable the investors in purchasing those properties
that are highly in demand in the market so that it can help in earning profits. The gains that are
associated with the sale of the investment will be more than the loss that may be incurred by the
investor (Kelly et al. 2013).
Another major advantage of using negative gearing is that it also allows in enjoying an
increased rate of depreciation. The investors can depreciate the properties that has been

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purchased by them so that it can allow in decreasing the overall cost of the property. The amount
that has been depreciated will help the investor in enjoying tax benefits, as the income that has
been gained after the property has been purchased. The investor will also gain form it, as it will
help in getting a refund on the tax for the amount that has been depreciated. Another major
advantage of using negative gearing is that it will allow the investor to save the tax to a
maximum extent. The reason behind this is that the amount which is being lost for the property
can be gained by the investor by showing it as an income from other property. The major reason
for this is that the amount spent through the depreciated value and cash flow can be recovered as
loss and taxation benefits can be enjoyed by investors when they purchase negatively geared
properties (Baker et al. 2016).
Another advantage of negative gearing is that the investors are given a chance for
developing the property. The main reason for this is that the properties that help in maintain the
cash flow in a positive manner will help the investor in limiting their purchases. This will result
in converting the property in to multiple properties so that it can become an asset with respect to
negative gearing. This provides an opportunity to earn a better rate of return by the investor. The
final advantage of this strategy is that it allows the investors in selecting the properties that are
secure and safe. This is because there are more options that are available to the investor
regarding the properties that are negatively geared so that their investments are secured in nature
(Crook and Kemp 2014).
The disadvantages of using negative gearing is that the property is more costly than the
amount that is being earned from the rent. This results in incurring losses than the other incomes
that the investor may have from the property. The negatively geared asset may result in incurring
losses in the initial years for the investor due to its affordability and the gains from the capital

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asset may require a long time. The Australian Council of Social Services (ACOSS) gives an
overview that the tax relief in addition to the tax discounts can be achieved by the investor
through the capital gains (Yates 2016). This has increased the chances of speculative purchases
within the real estate sector in the country and has increased the prices of property for the
common people. Additionally, the affordable rate of property does not get improved with the
reforms in the taxation clauses. It leads to a situation where the price of the property increases
and the rate of new investments is also on an increasing side (Blunden 2016).
Another disadvantage of negative gearing is that the cash flow cannot be maintained.
This is because the flow of income that is passive in nature gets rejected through the use of this
strategy. The investment needs to be purchased so that it can help in increasing the capacity to
spend so that it can ensure that the negative gearing keeps on running. Moreover, the debts and
bills that are arising from the property has to be paid by the investor so that the property can be
secured. Another major disadvantage for negative gearing is that the gains from the capital is
affected in a negative way as well due to the fact that the investor is mainly dependent in the rate
of fluctuations that is taking place in the market. This results in taking a bigger risk regarding
financial benefits from the negative gearing property (Worthington and Higgs 2013).
Another disadvantage is that the serviceability level is also associated with assets that are
negatively geared. The negatively geared properties have to be maintained in an efficient manner
by the investor so that it can result in increasing the level of profit for the investor. In the
beginning stages, the investor has to spend money so that the negatively geared property can be
maintained and help in earning profits in the future when the property is being sold off by the
investor. The maintenance cost is also very high that results in maintaining a portfolio with

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respect to investment. The investor is then limited to a return that can come from a single
property (Hulse, Reynolds and Yates 2014).
From the above comparison it can be stated with respect to fairness that it allows the
investor in purchasing the assets that are safe, which will in turn provide a higher rate of return.
The asset may incur losses in the introductory phase but will provide greater returns to the
investor in the future. The major reason for this is that the investor has many options from where
they can choose the negatively geared properties (Groenhart 2014). The governmental revenue
on the other hand may get reduced, as the investor will be enjoying huge benefits with respect to
taxation. This indicates that the collection of revenue for the government will be less from these
properties. This will also hamper the development of the country, as the government cannot
spend more on developing the society (Rowley, Ong and Haffner 2015).
The investors will also be enjoying the cash flow that is positive in nature because the
assets that are negatively geared will help in providing better rate of return. This will result in
increasing the income of the investor with respect to the asset that has been purchased by them.
The bills and debts for the property also needs to be paid by the investor, which results in
securing the property so that the property does not incur any losses in the market. The level of
efficiency is also increased in the market by the investor due to the purchase of the negatively
geared assets, as the properties that are available in the market can be purchased easily (Pawson
and Milligan 2013). The increase in the efficiency level can be understood through the gains that
are associated with the capital asset, as these properties are heavily dependent on the rate of
fluctuations that are present in the market. The potential investors that are present in the market
can purchase the property that are negatively geared when the condition of the market is low or

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stable. This helps the investor in purchasing the asset that will give them a tax benefit (Birell and
McCloskey 2016).
Therefore it can be concluded that the negative gearing has positive and negative effects
with respect to the fairness, governmental revenue and the level of efficiency in the market. The
government will be at a loss in Australia, as the investor will enjoy tax benefits on the property
that has been purchased by them from the market. The investor will also have to bear the losses
in the initial years and pay the bills and debts of the property but after a period of time, the
property will help in increasing the level of profit. The level of efficiency will also tend to
increase, as the investors will be able to get the best properties that are present under negative
gearing.

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Reference List
Baker, E., Bentley, R., Lester, L. and Beer, A., 2016. Housing affordability and residential
mobility as drivers of locational inequality. Applied geography, 72, pp.65-75.
Birrell, B. and McCloskey, D., 2016. Sydney and Melbourne’s housing affordability crisis report
two: No end in sight. Canberra: The Australian Population Research Institute.
Blunden, H., 2016. Discourses around negative gearing of investment properties in
Australia. Housing Studies, 31(3), pp.340-357.
Crook, T. and Kemp, P.A. eds., 2014. Private rental housing: comparative perspectives. Edward
Elgar Publishing.
FC of T v Whitfords Beach Pty Ltd [1982] HCA 8.
Groenhart, L., 2014. Understanding the spatial impacts of direct and indirect government
housing expenditure. Melbourne: AHURI.
Hulse, K., Reynolds, M. and Yates, J., 2014. Changes in the supply of affordable housing in the
private rental sector for lower income households, 2006–11. AHURI. Melbourne & Sydney,
Australia, AHURI.
Income Tax Assessment Act 1997
Jacobs, K., 2015. The ‘politics’ of Australian housing: The role of lobbyists and their influence
in shaping policy. Housing studies, 30(5), pp.694-710.

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Kelly, J.F., Hunter, J., Harrison, C. and Donegan, P., 2013. Renovating housing policy (p. 1).
Melbourne: Grattan Institute.
Nicholls, S., 2014. Perpetuating the problem: neoliberalism, commonwealth public policy and
housing affordability in Australia. Australian Journal of Social Issues, 49(3), pp.329-347.
Pawson, H. and Milligan, V., 2013. New dawn or chimera? Can institutional financing transform
rental housing?. International journal of housing policy, 13(4), pp.335-357.
Rowley, S., Ong, R. and Haffner, M., 2015. Bridging the gap between housing stress and
financial stress: The case of Australia. Housing studies, 30(3), pp.473-490.
Worthington, A. and Higgs, H., 2013. Macro drivers of Australian housing affordability, 1985-
2010: An autoregressive distributed lag approach. Studies in Economics and Finance, 30(4),
pp.347-369.
Yates, J., 2014. Protecting housing and mortgage markets in times of crisis: a view from
Australia. Journal of Housing and the Built Environment, 29(2), pp.361-382.
Yates, J., 2016. Why does Australia have an affordable housing problem and what can be done
about it?. Australian Economic Review, 49(3), pp.328-339.

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