Taxation Treatment of Various Transactions and Benefits - Desklib

TAXATION
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Question 1
Issue
The central concern based on the given factors is to highlight the relevant taxation treatment
in relation with the transactions mentioned below that have been encountered by Amber
(taxpayer).
1) Possible capital gains arising from chocolate shop sale and levying of CGT (Capital Gains
Tax) on the same.
2) It needs to be determined if restrictive covenant related proceeds that have been derived
from a separate contract would be categorised as revenue or capital proceeds.
3) Possible capital gains arising from the inner city one bedroom apartment sale needs to be
highlighted considering the inheritance aspect involved and the underlying implications.
Law and Application
The various transactions of interest have been analysed below whereby first the relevant law
is stated and then the same is applied in the wake of the given case facts.
LAW - Sale of shop
In accordance with s.108-5 ITAA 1997, goodwill is one of the capital assets on which capital
gains tax would be levied. However, this is not true for trading stock since in this context s.
118-25 ITAA 1997 states that any capital gains or loss implications from the sale of trading
stock would not be considered for computing CGT liability (Reuters, 2017). One reason for
the same is that it is a consumable in the business which is sold to customers either directly or
after further processing and therefore is responsible for producing assessable income under s.
6-5 ITAA 1997 (Coleman, 2015).
As per s. 104-5 ITAA 1997, event A1 corresponds to the sale of any capital asset. In the case
of A1 event, the underlying capital losses or gains can be computed y considering the selling
price of the asset under consideration and deducting the asset cost base from the same.
Besides, before the application of capital gains @ 30%, there are two methods for
computation of capital gains that need to be highlighted (Reuters, 2017). One of these is the
discount method highlighted in s. 115-25 ITAA 1997 whereby for long term capital gains, a
50% deduction is allowable. The gains would be long term only when the said asset has been

held for more than a year. If this condition is not fulfilled, then the discount method cannot be
applied. Additionally, as per the indexed method, the cost base of the asset is increased so as
to reflect the impact of inflation and hence reducing the taxable capital gains.
APPLICATION- Sale of shop
It is imperative to note that the proceeds from the sale of shop would be considered as capital
proceeds as the underlying asset is a capital asset and these proceeds would be exempt from
tax. However, the same cannot be said about any capital gains that may be derived on account
of any capital gains or losses that Amber may have made. It is critical to note that the shop
sold by Amber comprises of a host of assets and all these do not have similar treatment with
regards to capital gains. The relevant treatment of these is discussed below.
Goodwill is a capital asset and the sale of business has resulted in A1 event. Also, the cost
and sales proceeds related to goodwill have been segregated and hence using the approach
highlighted in s. 104-5, the capital gains can be computed. Owing to the shop being held for
more than one year, the capital gains arising from sale of goodwill would be long term and
hence discount method can be deployed for reducing the taxable capital gains to 50%.
With regards to the equipment used at the shop, the resultant capital losses or gains can be
computed by deducting the equipment book value from the sales proceeds. It is noteworthy
that the equipment cost price is not used for capital gains or losses computations since there is
depreciation on the equipment which would be already deductible by the business for tax
purposes. Besides, this asset has also been held for more than a year and hence the resultant
capital gains would be long term thereby allowing the application of discount method for
reduction in taxable capital gains. With regards to the trading stock, s. 118-25 would be
applied and hence any capital gains or losses in this case would be ignored.
LAW -Restrictive Covenant
The major issue in context of the proceeds derived from agreeing to a restrictive covenant is
to ascertain if the proceeds would have revenue or capital characteristics. This becomes
pertinent question since tax can be levied only on revenue receipts and not on capital receipts.
In order to ascertain the nature of proceeds, a case law worth discussion is Reuter v. FC of
T 93 ATC 4037; (1993) 24 ATR 527 (Sadiq, et. al., 2015). In this case, an agreement was
enacted between the contracting parties which related to giving up the right sue for a
particular payment. In the legal discussion on the facts of this case, it was noted that by

taking away any right which any given individual legally has, there is restriction imposed and
hence any proceeds received in lieu of the same would be considered as capital receipts. The
same line of thinking can be extrapolated in case of restrictive covenant whereby the
legitimate right of the seller to establish a new business is curtailed owing to which a restraint
is created. As a result, the proceeds obtained in the process would be termed as capital in line
with the discussion in various tax rulings such as TR 95/35 (ATO, 2018).
APPLICATION – Restrictive Covenant
As per the case facts, Amber has signed another contract which restricts her from establishing
a similar business for a distance within 20 km radius for a total time period of 5 years. For
agreeing to the restrictive covenant, Amber has obtained a sum of $ 50,000. The given clause
clearly restricts Amber’s otherwise legal right to establish another business wherever she
seems suitable and whenever she finds it. Since the contract aims to restrict the rights
available to Amber, hence the underlying receipts would be capital and would not attract any
taxation. But, it is possible that CGT may be levied on potential capital gains that may arise
from the contract.
LAW - One bedroom apartment-
A pre CGT asset is one which was bought in the era when CGT was not applicable and for
such assets no CGT implications arise as has been highlighted in s.149-10 ITAA 1997, With
regards to deceased estates, any capital gains or losses corresponding to the period before the
death of the given individual would not be considered (Barkoczy, 2017). Also, it is
noteworthy that through inheritance, the asset comes as free only but the acquisition cost is
taken as the market value of the asset when inheritance takes place. This would be used for
computation of future capital gains if required (Deutsch, Freizer, Fullerton, Hanley & Snape,
2015). Further, in asset sale it happens at times that the contract for sale is signed in one year
but the cash settlement of the contract stretches to the next year and hence there may be
confusion with regards to when CGT would be applicable. Clarity in this regards can be
obtained by TR 94/29 which makes it clear that the capital gains tax would be applicable in
the year of enactment of sale contract for the given asset. Besides, if the taxpayer uses the
given house as main residence, then CGT exemption is permissible under Division 118-B
(Kreyer, 2016). It is necessary that the property must not be used for rent income even though
the taxpayer may be out of town or country.