Principles of Taxation Law: Inheritance and Deductions Analysis

This assignment addresses key aspects of Australian taxation law, focusing on the income tax and capital gains tax (CGT) implications of inherited property. It analyzes four distinct scenarios related to property inherited by Tony and Hub, including rental income, property liquidation, and construction of a new house, with a focus on CGT exemptions and cost base calculations. Additionally, the assignment provides legal advice to Monica regarding the tax deductibility of various outgoings, such as property purchases, loan interest, repairs, doubtful debts, travel expenses, and membership fees, based on relevant legislation and case law, including sections of ITAA 1997 and precedents like Steele v DCT and FCT v Payne. The analysis delves into the specifics of capital expenditure versus deductible expenses, and guides on how to approach tax implications based on the facts of the case and relevant tax laws.

PRINCIPLES OF TAXATION LAW
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Question 1
On the basis of the given information, the key issue is to highlight the income tax and CGT
implications in relation to the inherited property left by Joe (Father) for Tony & Hub (Both
sons).
Case 1: The property continues to be as rent and no change
It is apparent that rent income has been received by the brothers to the tune of $ 12,000 and
this would be assessable income as per s. 6(5) (Reuters, 2017). Since both the brothers have
ownership on the property, hence the division of rent income between the two would be in
proportion to the ownership share from inheritance.
It is noteworthy that inheritance is not categorised as a CGT event even through it leads to
change in ownership but the asset has not been sold. Hence, the CGT consequences for the
given property would arise if the property is liquidated. The levying of CGT would be
contingent on a host of factors particularly time (Woellner, 2014).
Case 2: The house is liquidated and the proceeds diverted to other investments
In the context of dwellings that are inherited, there may arise a case where the residence or
asset has been purchased before September 20, 1985 (pre-CGT era) but the purchaser tends to
die after CGT comes into place. In accordance with s. 118-195, such assets would not be
levied any CGT provided the inherited asset from the deceased is liquidated within two years
from the time of death. Also, it is noteworthy that the above clause is independent of the
usage of the property during the two years (Kreyer, 2017). Thus, even if it is used for income
generation, then also CGT exemption would be available. For the situation at hand, Joe did
build house on the land in the pre CGT era but expired after CGT was in place. Thus, selling
of property on immediate basis would insulate the brothers from CGT implications
(Coleman, 2015). This is despite the fact that income generation has been done by renting the
property.
The sale proceeds would not be taxed owing to capital nature while the capital gains would
also be exempt. The investment of proceeds in other assets is not of relevance for the given
case (Barkoczy, 2017).
Case 3: Stripping of existing house and erection of new house

The first aspect that is noteworthy here is that there is improvement and not repairs in the
existing house since there is significant improvement which makes the house look like new.
This is important since s. 25-10 provides deduction for repairs of rental property. However, in
accordance with verdict in FCT v Western Suburbs Cinemas Ltd (1952) HCA 28, the expense
of $ 200,000 would be considered as capital improvement and thus out of the domain of s.8-1
owing to negative limb prohibiting deduction for capital outgoings (Gliders,et. al., 2014).
Thus, the net effect of the construction of new house and improvement in the old house
would be an increase in the cost base of the given property as per s. 110-25 since one of the
components of cost base is any capital expenditure which tends to enhance the value of the
underlying asset (Wilmot, 2014).
Case 4.1: Asset division and liquidation
The title of the two houses is being separated and the two would be liquidated. It is
noteworthy that even though the property is inherited and hence free but the market value of
the property at time of Joe’s death would be considered as acquisition cost (Kreyer, 2017).
Property acquisition cost = $ 1,000,000
Property improvement cost = $ 450,000
Total cost base (s. 110-25) = $1,000,000 + $ 450,000 = $ 1,450,000
Money generated from selling the two houses = $ 1,200,000*2 = $ 2,400,000
Gross capital gains from the transaction = $2,400,000 - $ 1,450,000 = $ 950,000
50% exemption under division 115 can be available which would reduce the taxable capital
gains to $ 475,000.
Case 4.2: Use the house for rent and then sell five years later
Till the time the houses are sold, the brothers would continue to have assessable income in
the form of rent. However, capital gains would arise when there is liquidation.
Total cost base (s. 110-25) = $1,000,000 + $ 450,000 = $ 1,450,000
Money generated from selling the two houses = $ 2,400,000*2 = $ 4,800,000
Gross capital gains from the transaction = $4,800,000 - $ 1,450,000 = $ 3, 350,000

50% exemption under division 115 can be available which would reduce the taxable capital
gains to $ 1,675,000 (Wilmot, 2014).
Question 2
The aim is to offer a legal advice to Monica regarding the tax deductibility for the various
outgoings based on legislation and relevant case law.
a) “Purchase of rental property worth $500,000”
It can be seen that Monica had spent $500,000 in order to buy a property that can be used for
deriving income for her. Hence, it may be possible that outgoings to the tune of $500,000
would be taken for tax deduction under s. 8-1 ITAAA 1997(Reuters, 2017). However,
according to subsection 8-1 (2) ITAA 1997, the amount which is categorised under capital
outgoings would not be considered for tax deductions. Hence, the amount of $500,000 which
is a capital expense would not be tax deductible under section 8-1 because the expense has
been incurred for buying an asset and not for acquiring any trading stock. Further, as the
capital expenses are tax deductible under s. 40-880 depending on whether the capital expense
is of business nature or not (Kreyer, 2017) In the present case, the capital expense of
$500,000 is not of business nature and therefore, no tax deduction is applicable for Monica of
the amount of $500,000.
b) “Principle and interest investment loan amount of $450,000 to finance a rental property
purchase”
 “Establishment fee of $5,000”
According to s. 25-25 ITAA 1997, the establishment fee for loan is reported as borrowing
expenditure for the taxpayer and has also used for deriving assessable income because it has
used for renting a property. Thus, the amount $5,000 is tax deductible for Monica.
 “Paid loan payment interest of $11,250 and the principal amount of $10,000”
According to the judgement given in Steele v DCT (1999) HCA 7, the loan amount which has
used for purchasing a property that would be used to derive assessable income would be
considered for tax deduction. In present case, Monica is using the loan amount for renting a
property that would derive assessable income for her under s. 6(5) ITAA 1997and hence,

would be tax deductible (Reuters, 2017). However, the loan repayment amount is considered
as capital outgoing and would not be taken for tax deduction as per s. 8-1.
c) “Expenditure incurred on repairing of cost $45,000 prior to renting”
In the accordance of s. 25-10 ITAA 1997, the expenses incurred on repairs and maintenance
would be considered for tax deduction in the same income year on which the repairing has
been done and the assessable income has been received (Woellner, 2014). It is essential to
note that repairing has been established prior to renting and hence, the expenses would be
categorized as capital expenditure which would not be tax deductible as per s. 25-10
(Barkoczy, 2017). However, this amount would be considered into the cost base of the rental
property and would not be deductible.
d) “Doubtful debt of $500”
As per s. 25-35(1) ITAA 1997, the doubtful debt of the taxpayer would be considered for tax
deduction only when the doubtful debts are reported as assessable income either in the
current year or in the last year income statement (Gliders,et. al., 2014). Hence, the amount
$500 would be tax deductible for Monica only when she has reported $500 as her ordinary
income for current financial year. It is noteworthy that if Monica has not reported $500 as her
ordinary income then she cannot claim any tax deduction on this amount.
e) “Expense of $500 incurred due to travelling”
The relevant case law is FCT v Payne (2001) 46 ATR 228 case, where the travelling
expenditure incurred on the part of taxpayer in regards to travel between the workplaces
which are unrelated would not be considered for tax deduction under s. 8-1(Woellner, 2014).
However, deduction for travel expenses between unrelated workplaces is permissible under s.
25-100(1). The travel expense of $500 has incurred between Monica’s office and her
university would be tax deductible only when the university is paying her for her teaching
job.
f) “Membership fee of $450 for Australian Financial Planners Association and $500 for golf
club”
It can be noticeable from the case that membership fee for the Australian Financial Planners
Association would provide professional benefits to Monica as she is a financial advisor.
Further, the membership fee would play a significant role in deriving assessable income.

Hence, the membership fee of $450 would be categorised as business expenditure and would
be tax deductible as per section 8-1(Wilmot, 2014). Further, the membership amount of $500
paid to the golf club would also be tax deductible under s. 8-1 because Monica used golf club
for the entertainment of the clients which shows clear indication of the process of making
professional relationship with the clients. Hence, as per verdict given in Hayley v FCT (1958)
100 CLR 478 case, the amount is tax deductible (Coleman, 2015).

References
Barkoczy, S. (2017) Core Tax Legislation and Study Guide 2017. 2nd ed. Sydney: Oxford
University Press Australia
Coleman, C. (2015) Australian Tax Analysis. 4th ed. Sydney: Thomson Reuters (Professional)
Australia.
Gilders, F, Taylor, J, Walpole, M, Burton, M. and Ciro, T (2014) Understanding taxation law
2013.6th ed. Sydney: LexisNexis/Butterworths
Krever, R. (2017) Australian Taxation Law Cases 2017.2nd ed. Brisbane: THOMSON
LAWBOOK Company.
Reuters, T. (2017) Australian Tax Legislation (2017).4th ed. Sydney. THOMSON REUTERS.
Wilmot, C. (2014) FBT Compliance guide. 6th ed. North Ryde:CCH Australia Limited.
Woellner, R. (2014) Australian taxation law 2014.8th ed. North Ryde: CCH Australia.