Understanding Capital Gains Tax And Legal Expenses In Australia

Case study: Brent Wilson

Brent Wilson is one of your tax-accounting clients. He is a 45 year-old psychiatrist employed by Mindful Pty Ltd (a chain of mental health clinics in Melbourne) 3 days per week, and he also sees private patients in his own consulting room on his remaining time.

Brent sends you the email below following up on a meeting where you discussed the potential tax consequences of the sale of his house, the tax treatment of legal fees incurred in relation to a lawsuit settled in May 2019 and the preparation of his 2018/19 tax return.

Required

1) Applying the relevant legislation, identify and discuss the tax implications related to the sale of Brent Wilson’s house, and calculate any net capital gain which may arise thereof. 

2) Applying legislation and case law, advise Brent Wilson on whether he could claim a deduction in relation to the legal fees incurred in May 2019.

3) Considering the information provided by Brent Wilson as well as your answer to items 1 and 2 above, prepare Brent Wilson’s statement of taxable income and calculate his final tax liability including Medicare Levy for the year ending 30 June 2019, stating the applicable legislation and case law (note: calculation of private health insurance rebate not required).

As stated in the “section 108-5 of the ITAA 1997” capital assets is usually referred as the form of property or any kind of the legal equitable rights which is not treated as the property.

As stated in the “section 108-5 of the ITAA 1997” capital assets is usually referred as the form of property or any kind of the legal equitable rights which is not treated as the property. As stated under the “section 108-5 of the ITAA 1997” the land and building are not considered for the capital gains tax purpose (Barkoczy 2014). As stated in “section 104-10 (1) of the ITAA 1997” CGT event A1 happens when the CGT asset is sold. For a taxpayer it becomes vital to determine the time when the CGT event took place particularly when the taxpayer entered into the transactions for selling the asset.

As explained by the Australian taxation office a taxpayer’s house is generally not included for the capital gains tax purpose. Nevertheless, the taxpayer can claim for the full amount of main residence exemption. However if the taxpayer makes any portion of the house for the purpose of generating taxable income then the taxpayer in such situation can claim for the partial main residence (Brokelind 2015). For an individual taxpayer in order to ascertain the value of the capital gains it becomes vital to understand the market value of the residence when the house was employed for producing taxable income.

A taxpayer is generally held eligible for the main residence exemption when the dwelling satisfies the criteria for main residence. On noting that the taxpayer holder one or more than one dwelling then in such situation it is necessary for the taxpayer to determine which one dwelling qualifies as the main residence and eligible for exemption (Grange, Jover-Ledesma and Maydew 2014). Whether the main residence is regarded as main dwelling for the taxpayer is reliant on the question of fact.

As stated by the Australian taxation office in order to ascertain the amount of capital gains or loss it is reasonable for the taxpayer to determine the amount up to which the money has been borrowed to acquire the property (James 2013). On noticing that the taxpayer has used the main residence for producing the assessable income, in such a situation the taxpayer is believed to have held the asset up to the extent when the home was initially employed for generating the taxable income.

According to the Australian taxation office capital gains or loss that are assessable constitutes the amount which is practically have association to the degree where the taxpayer is allowed to claim the deduction for the sum of interest occurred in borrowing for purchasing the asset (Jover-Ledesma 2014). In most of the situation the proportion of floor area or the portion of the home is set aside for producing the assessable income and the time up to which the taxpayer has utilised the home for generating the assessable income.

CGT event A1 happens when the CGT asset is sold.

In the current case it is noticed that Wilson used 10 square metres of his 200 square metre house for running his personal consultancy. Hence, the portion of dwelling that is employed by Brent for producing the assessable income stands 5% of the total area. The capital gains tax for Brent for the year ended 2019 has been computed below;

As stated under the “section 8-1, ITA Act 1997” legal expenses are treated to have been allowed for deductions given the legal expenditure have originated from the result of taxpayers revenue generating activities (Kenny, Blissenden and Villios 2018). However, legal expenditure are not treated as deductions when the expenses that is incurred by the taxpayer is capital, domestic or private in nature or occurred in the derivation of the exempted income.

Noting the instances in “Snowden & Wilson Pty Ltd (1958) v FC of T CLR 431” the commissioner of taxation allowed the company with the deduction for the costs that is occurred in the defending the before the royal commission investigation of its business practices (Kenny 2014). Similarly, in “Hallstorms Pty Ltd v FC of T (1946)” legal expenses are usually viewed as the outlays on the revenue account or as the outlays of capital nature dependent upon the purpose for which the incidentals were occurred. 

Correspondingly the law court in “Magna Alloys & Research Pty Ltd v FC of T (1980)” allowed the company with an allowable deductions for the legal expenditure that was occurred in defending the claims of secret commissions (Sadiq et al. 2018). The taxation commissioner stated that the necessarily incurred does not mean unavoidable or essentially essential. However the important matter of the fact is that the expenditure must have to be appropriate and incurred for the business carried on with the objective of deriving taxable income.

Evidently in the current situation it is noticed that Brent reported an occurrence of $25,000 that was paid as the legal fees for defending himself against the claims of negligence medical. Citing the case of “Snowden & Wilson Pty Ltd (1958) v FC of T CLR 431” it can be specified that the legal spending that is incurred by Brent when he carried on the business for obtaining the taxable income (Taylor et al. 2018). Furthermore, the most important subject is that the legal expenses that is incurred by Brent was for the purpose of deriving the assessable income.

A taxpayer’s house is generally not included for the capital gains tax purpose.

Quoting the instances of “Hallstorms Pty Ltd v FC of T (1946)” the legal expenses that is incurred by Brent should be characterised as the outcome based on the revenue account (Woellner et al. 2018). Correspondingly the decision of federal court in “Magna Alloys & Research Pty Ltd v FC of T (1980)” the legal expenses that is incurred by Brent will be classified as the revenue account and hence will be permitted for deductions under the positive limbs of “section 8-1, ITAA 1997” since it is occurred in the derivation of assessable income.

“Section 6-1, ITAA 1997” defines earnings from the individual effort. The earnings from the individual effort refers to the proceeds that is obtained from the salary, wages, and proceeds from business, gratuity, pensions and payment received for any services rendered. “Section 6-5, ITA Act 1997” defines the ordinary income (Woellner et al. 2018). As per the “section 6-5, ITAA 1997” ordinary income refers to the income that are received by the taxpayer in the ordinary business course. The court in “Scott v CT (1935)” held that the income is not the word of art and involves appropriate examination of the facts in deciding the receipts as the ordinary income (Kenny 2014). The court held that receipts should be treated as the ordinary income in agreement with the ordinary concept and the usage of mankind.

Similarly citing the case of “Scott v CT (1935)” it can be stated that the receipts of gross salary and proceeds from the consultancy business by Brent is an income under the ordinary meaning (Sadiq et al. 2018). The earnings would be treated as the taxable earnings under the ordinary impressions of “section 6-5, ITAA 1997” since it is derived by the taxpayer in the ordinary course of business.

In the positive limbs of “section 8-1, ITA Act 1997” an individual taxpayer is permitted to entitlement for the deductions from their chargeable earnings relating to any losses or expenditures up to the degree that is occurred in the generation of assessable income or it has been necessarily occurred in performance of business activities with the purpose of attaining chargeable earnings. Similarly Brent reports expenses incurred for subscriptions and cleaning purpose. The expenses were occurred in the generation of assessable income and hence will be permitted for deductions under “section 8-1, ITA Act 1997”. 

References:

Barkoczy, S. 2014. Foundations of taxation law 2014.

Brokelind, C. 2015. Principles of law.

Grange, J., Jover-Ledesma, G. and Maydew, G. 2014 principles of business taxation.

James, S. 2013. The economics of taxation.

Jover-Ledesma, G. 2014. Principles of business taxation. [Place of publication not identified]: Cch Incorporated.

Kenny, P. 2014. Australian tax 2014.

Kenny, P., Blissenden, M. and Villios, S. 2018. Australian Tax 2018.

Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., Obst, W., Teoh, J. and Ting, A. 2018. Principles of taxation law.

Taylor, C., Walpole, M., Burton, M., Ciro, T. and Murray, I. 2018. Understanding taxation law 2018.

Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D. 2018. Australian taxation law.