Taxation: Deductibility of Expenses and Capital Gains Tax on Asset Sale

This article discusses the tax deductibility of expenses incurred by taxpayers in relation to repair, legal expenses, and business outflows. It also explains the capital gains tax on asset sale for antique collectors and investors.

TAXATION
STUDENT ID:
[Pick the date]

Question 1
The tax deductibility of the various transactions is outlined as follows.
(a) In accordance with tax ruling TR 97/23, the expenses incurred by the taxpayer in relation
to kitchen fitting replacement post damage is considered as repair. The facts provided clearly
highlight that there was no intention to improve the character and thereby the same material
and layout has been used (Krever, 2016).
Potential options for taxpayer (i.e. Ruby Pty Ltd) to claim deduction for the above repair
expenses are in the form of s. 8-1 ITAA 1997 and s. 25-10 ITAA 1997. The former provides
100% deduction in the year of incurring the expenses provided the taxpayer is able to develop
a sufficient nexus between the outgoing and assessable income generation (CCH, 2013).
Additional condition is that the underlying expenditure must not be capital in nature. With
regard sto s. 25-10 ITAA 1997 deduction for repairs is permissible provided the underlying
expenditure is not capital in nature (Barkoczy, 2015).
In relation to kitchen fittings, TR 97/23 highlights that the underlying nature of these fittings
is essentially permanent in nature and hence these are considered to be part of the property as
a whole. Key examples could be cupboard, plumbing, fixed stove, sink. The implication is
that any repair related expenditure would be considered as capital and reflects in asset cost
base in accordance with ss. 110-25(5) ITAA 1997. Owing to the capital nature of this repair
expenditure, tax deduction would not be available (Sadiq et. al., 2016).
(b) It is apparent that the incurring of legal expense is in relation with the rental property
which produces assessable rental income. Hence, the underlying deductibility of the legal
expense would be contingent on whether the underlying expense is capital or revenue in
nature (Gilders, Taylor, Walpole, Burton & Ciro, 2016).
A crucial test to difference between the two has been highlighted in British Insulated and
Helsby Cables Ltd v. Atherton [1926] AC 205 case. The judge advocated that based on the
nature of the advantage derived from the outgoing, the expenditure nature can be judged.
Typically, in relation to capital expenditure, the advantage derived must be enduring or long
lasting and not limited to only a given period (Deutsch, Freizer, Fullerton, Hanley & Snape,
2016).

It is noteworthy that the taxpayer has a real estate business whereby negligence related claims
tend to frequently arise. Hence, the legal expense is not providing an enduring advantage as
the benefit would only be limited to the negligence liability which would be limited in impact
to the year when the case is settled. As a result, the underlying revenue would be revenue and
deduction under s. 8-1 ITAA 1997 is available to the company (Woellner, 2014).
(c) Before moving into real estate, the company was a manufacturing company dealing with
engine and associated parts. For manufacturing businesses, it is common that customers are
at times provided defective parts which may lead to litigation. This would not only lead to
financial outflow but the impact of this would also be on the reputation and thereby could
adversely impact the future business (Gilders, Taylor, Walpole, Burton & Ciro, 2016).. In
wake of this, it can be said that the underlying amount cannot be deducted under s. 8-1 ITAA
1997 because of the underlying capital nature. However, taking into consideration that the
above claim amount was essentially an outflow related to business, hence, 100% tax
deduction over five annual equal amounts can be availed as per. s. 40-880 ITAA 1997
(Barkoczy, 2015).
Question 2
In the given scenario, the concerned taxpayer is an individual named Betty who is both an
antique collector and also an investor. As a result, it would be appropriate to assume that the
various transactions regarding asset sale would be capital and not revenue transactions.
Transaction 1- Painting Sale
As per s. 149-10 ITAA 1997, there is an asset class categorised as pre-CGT asset owing to
their purchase before September 20, 1985. The key reason for the categorisation of this asset
class is that the present CGT (Capital Gains Tax) regime came into existence only on
September 20, 1985 and hence prior to this date, no tax was levied on any capital gains or
capital losses derived from asset sale. Further, for pre-CGT assets, there is a 100% exemption
from CGT (Krever, 2016).
In the given case, the underlying asset is a painting which would be a collectible as per s.
118-10 ITAA 1997. Further, the sale of the painting would yield capital proceeds which are
non-taxable in accordance with s. 116-5 ITAA 1997 (Barkoczy, 2015). Also, considering that

the painting is a pre-CGT asset, hence the underlying capital gains realised on asset sale
would be ignored. Hence, it may be concluded that there is no tax implication of the painting
sale for Betty (Gilders, Taylor, Walpole, Burton & Ciro, 2016).
Transaction 2- Shares
Based on the underlying date of purchase, it is apparent that none of the shares is a pre-CGT
asset. Also, the share sale initiates an A1 CGT event as per s. 104-5 ITAA 1997. The A1
CGT event tends to deal with the disposal of asset. While the proceeds from share sale would
be exempt from tax, CGT would be levied on any capital gains derived from sale. In order to
derive the capital gains, a key input required is the cost base (CCH, 2013). The cost base has
five key elements in accordance with s. 110-25(1) ITAA 1997 and these are summarised
below.
The computation of the capital gains on the given shares is indicated below.

Total capital gains = 30700 + 30000 -6000 = $ 54,700
As per s. 102-5, previous capital losses need to be adjusted against shares but this is not
possible for sculpture since it is a collectible item (Sadiq et. al., 2016).
Hence, net capital gains = 54700 – 7000 = $ 47,700
As the holding period of all shares is in excess of one year, hence the gains are long term and
s. 115-25 ITAA 1997 discount method would be applicable (Woellner, 2014).
Taxable capital gains = 0.5*47700= $ 23,850
CGT liability = 0.3*23850 = $7,155
Transaction 3: Violin
A violin would be recognised as a collectible as per the definition in s. 118-10 ITAA 1997. In
the given case, it is apparent that Betty tends to use the violin under consideration for
deriving personal entertainment and that too on a frequent basis. Under the given
circumstances, it would be appropriate to classify the underlying violin as a personal use item
as indicated by s. 118-10 ITAA 1997 (Krever, 2016). A key requirement for these assets as
per ss. 108-20(1) is that for the application of CGT on any potential capital gains is that the
purchase price must exceed $ 10,000 (Woellner, 2014). The underlying violin which has been
sold has a cost price of $ 5,500 which does fulfil the above mentioned requirement and hence
no CGT would be applicable on the capital gains resulting from violin sale.

References
Barkoczy, S. (2015) Foundation of Taxation Law 2017. 9th ed. Sydney: Oxford University
Press.
CCH (2013), Australian Master Tax Guide 2013, 51st ed., Sydney: Wolters Kluwer.
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. (2016) Australian Taxation Law Cases 2017 2nd ed. Brisbane: THOMSON
LAWBOOK Company.
Sadiq, K, Coleman, C, Hanegbi, R, Jogarajan, S, Krever, R, Obst, W, & Ting, A
(2016) , Principles of Taxation Law 2016, 8th ed., Pymont: Thomson Reuters
Woellner, R (2014), Australian taxation law 2014 7th ed. North Ryde: CCH Australia