Wednesday, December 4, 2019
Taxation Law Implications on Investment
Question: Discuss about the Taxation Law Implications on Investment. Answer: Introduction The following assignment presents tax implications on investment acquisition with respect to the provisions and regulations of Income Tax Assessment Act (ITAA), 1997 and code of conduct under TASA 2009. The report covers the discussion on permanent establishment in Australia through various brokers for Alex Tan and Ryan Tan, Singapore resident brothers. The report states the permanent establishment from Melbourne and Cambrai property operations along with the relevant tax implications on the business operation income. Further, the report presents the residential status of the brothers and the relevant tax liability in Australia with respect to the exposure in tax. Considering the acquisition of properties and investment in securities the report highlights the application of capital gain taxation rules as per ITAA 1997 for the sale of securities including the construction and demolition of townhouses and beef business. Another part of the report presents the tax implications on the disposal of the townhouses with respect to the provisions on income from other sources. The assessees planned to dispose the townhouses to raise the required funds for the improvement of property in Cambrai including the purchase of animals for re-establishment of commercial herd. In view of the principles of ITAA 1997, the report highlights the discussion on identification of operation from Cambrai property as business to avail the deduction of business losses for future years. For the purpose of contingency funding options, the report presents the analysis and tax implications for the interest deduction during the taxation year. Considering the acquisition of property and business operations of Alex and Ryan in Australia the assignment highlights the analysis of structure options for tax liability including the points of strengths and weaknesses of the possible options. Permanent establishment in Australia As per the regulations of ITAA 97, permanent establishment refers to the place at which the assessee carries the business operations or the person carries the business through an agent subjected to the permanence of the place. According to the section 6(1) ITAA, 1997 permanent establishment can be fixed business place, construction or an agency that occurs under the tax treaties of Australia. Fixed place of business consists of three components i.e. the business should be operated through a fixed or particular geographic area along with the level of permanence to the assessee (Chaudhri v FCT 2001 ATC 4214). Place is another essential component that involves facilities or sources to conduct the business activities while third component business refers to the activities to be carried on partly or wholly at the permanent place (Higgins, Omer Phillips, 2015). Similarly, construction site is regarded as permanent establishment only if the tenure of construction is more or equal to the am ount of time mentioned in the ITAA regulations. Additionally, agency refers to the permanent establishment that is controlled by the principal while activities are undertaken by the agents at a fixed place of business. Accordingly, mere use of brokers would not result in permanent establishment in Australia unless the criteria under section 6(1) ITAA 97 is duly complied with since brokers are individuals assist in acquiring the specific requirements at a given point of time against the brokerage charges (Chirico et al., 2015). Establishment and tax implication of Melbourne and Cambrai operations In the present case study, Alex and Ryan planned to acquire two properties in Australia consisting of rundown abandoned factory in a suburb of Melbourne while the other was 5000 hectare farm property near Cambrai. Considering the rules of ITAA 1997 section 6, permanent establishment refers to the place through which or the place at which a person carries the business operations. In present situation it has been observed that the two brothers decided to expand business operations in Australia and therefore planned to acquire two properties. It was decided that the property in Melbourne would be re- constructed to build townhouses while the other property in Cambrai would be repaired for improvements to carry the operations of commercial herd. It has been observed that both the properties to be acquired with the intention to create fixed place to operate business activities and not temporary. Further, the brothers themselves would conduct operations on both the properties and not throu gh any agent; therefore, ITAA 97 rule on controlling the business does not arise but regulation of TASA 2009 is applicable (Mason Harrison, 2015). Since the criteria of ITAA 1997 section 6(1) has been complied with in terms of business operations at a fixed place, the operations in Melbourne and Cambrai will be regarded as permanent establishment. Income from the business operations from permanent establishment is taxable in Australia as per ITAA 1997 if the taxpayer belongs to the treaty country if the business activity is conducted through fixed place in Australia. Further, gain or loss on sale of assets as a permanent establishment part would be taxable Under Capital Gain Taxation (CGT), ITAA 1997 including the filing of Australian income tax return (Bimonte Stabile, 2015). Since, Alex and Ryan belongs to Singapore which is a treaty country and the operations on property held as permanent establishment in Australia, the brothers are liable to pay taxes on income from such operations as per ITAA 1997. Residency of the brothers and tax exposure in Australia The brothers would be considered as Australian resident for taxation purpose if they are actually present in the country for 183 days or more either continuously or with splits whereas the residential status of permanent establishment would be separate entity (Johnson Poterba, 2016). In the given case, the length of the two brothers stay in Australia is not mentioned clearly hence it can be said that if their stay is more than 183 days then Alex and Ryan would be considered as Australian resident. Accordingly, the brothers would be liable to pay income taxes arise from operations in Australia including any other income arising in the country. Moreover, permanent establishment is regarded as a separate entity hence, the income from such operations would be taxable as business income under Australian taxation system. The asset income i.e. loss or gain from sale of assets employed in permanent establishment operations would be taxable under Capital Gain Taxation. Application of CGT rules Profit on sale of shares is taxable under CGT rules, ITAA 1997 if the shares held by the taxpayer as an investment either for short- term or for long- term. In case the shares are held for long term then the cost element is reduced by applying indexation method at a specific taxation rate as per ITAA 97. On the contrary, if the shares held for short- term period then the indexation method would not be applicable for reducing the cost of acquiring shares. Moreover, the income on sale of shares acquired under business trading then profit or loss from the sale of such shares would be considered as ordinary business income. Besides, the net assets of the brothers throughout South East Asia valued to $7.5 million and acquired from their father valued to $1 million that is located in Singapore would be taxable as per the Singapore taxation system (Pomeranz, 2015). For the purpose of demolition and construction of townhouses the brothers are eligible to claim deduction if they have main residence in Australia as per their choice under section 118-150 ITAA 97 (Ndikumana, 2015). Since the brothers do not own any main residence in Australia, they are entitled to claim exemption for the part of townhouse to be used for residential purpose. Further, disposal of townhouses and beef business would constitute the tax liability for the brothers according to ordinary business income under Australian Income Tax since the sale of townhouses and beef business would be done as a part of business operations. Share portfolio Amount $ (million) Sales proceeds 1.75 Less: Brokerage 0.02 Less: Initial value of shares 0.63 Gain/ (loss) on sale of shares 1.11 (Source: Created by author) Alex and Ryan are required to pay tax on the income from sale of shares under CGT ITAA 1997 at the rate of 33.33% as long-term assets. However, the brothers are eligible to claim 50% deduction on the taxable amount. Tax Implication on disposal of townhouses The purpose of acquiring the property, construction of townhouses including the disposal was to earn profit and to raise funds in regular intervals for the brothers in Australia. The intention of raising funds includes the generation of funds to carry out improvement and repair work on Cambrai property to re-establish commercial herd. Further, the intention to sell the townhouses involves profit earning and to raise funds at regular intervals hence, the income will be taxed as ordinary business income. Property valuation (profit/ loss) Cost of Fitzroy block 1.25 Brokerage and fees 0.02 Demolition cost 0.26 Cost of subdivision 0.04 Construction Cost 2.40 Interest cost (annual) 0.04 Total Cost 4.00 Less: Estimated sales proceeds 2 undeveloped blocks 0.65 6 town houses 4.80 2 residence town houses 0.68 Total Sales 6.13 Estimated Profit (Total Sales- Total Cost) 2.13 (Source: Created by author) Computation on expenses and expected income from Melbourne property reflected expected income, therefore the brothers are eligible to pay tax on income u/s 6-5 ITAA 97 in the year it is actually earned. Tax implication on operations from Cambrai property Alex and Ryan acquired the property at Cambrai in order to re-establish the operations of commercial herd therefore, it will be considered as ordinary business under permanent establishment. In view of the decided case of Liftronic Pty Ltd v FC of T (Liftronic), section 6-5 of ITAA 97, it was concluded that the income from the property as a business operation and with the intention to earn profit was subjected to ordinary income tax. Accordingly, all the expenses related to acquisition of property in Cambrai would be allowed as deduction under ordinary business taxation section 6-5 ITAA 97. Further, the losses from the commercial herd operation would be considered as deduction for business losses in subsequent years. Alex and Ryan planned and decided to consider contingency funding for the purpose of conducting business operations on the Australian properties that is created to meet the expenditure in urgent time period. Accordingly, amount of interest incurred to borrow contingency funding would be allowed as deduction from taxability provided the amount of funds are utilized only for considering business operation and not for any other personal purpose as per section 6-5 ITAA 97. In the case judgment of Dixon J in Sun Newspaper Ltd and Associated Newspapers Ltd v FC of T, CLR 337 it was decided that if expenses for acquiring funds are recurring in nature then it would be considered as revenue in nature. Purchase price of Cambrai property 3.25 Brokerage and fees 0.06 Repairs 0.85 Capital improvements 0.50 Depreciation @25% 25% on (3.25+0.85+0.50) 1.15 Interest expenses 0.06 Total cost 5.87 Total Revenue in the initial year Nil Total Loss 5.87 (Source: Created by author) Loss from the Cambrai Property during the initial years would be considered for adjusting with the profit from Melbourne property, since both constitutes the criteria of permanent establishment. Business structure options In the given case study, it has been stated that the brothers are considering different business structure to utilize the property for business operations activities in Australia along with the consideration of borrowing loan funds. One option of acquiring loan fund is acquisition from the Singapore head office while the other option is to borrow the loan funds from the Melbourne branch of Singapore bank. In case the brothers acquire funds from Singapore head office then they would be able to save interest charges whereas if the funds borrowed from Singapore bank, Melbourne branch they will be entitled to claim interest deduction. In case of John Fairfax Sons Pty Ltd v FC of T, CLR 30, advantages for borrowing the loan amount and deduction of interest charges was considered. Further, conducting the business operations under one company structure provides several benefits along with certain disadvantages with respect to the tax implications. In case the company is incorporated in Singapore, the brothers would still be entitled to pay tax in Australia due to the rules of permanent establishment (Du Zhang, 2015). However, if the company is incorporated in Australia then the brothers will be entitled to receive benefits on DTAA being the owners from a treaty country, Singapore. On the contrary, if the brothers consider the business property as two separate organizations as wholly owned subsidiary then the compliance of accounting standards on consolidation financial statements would be mandatory. It has been mentioned that the brothers do not plan to consolidate two companies but if they are willing to operate the business as wholly owned subsidiary then it is mandatory to follow the consolidation accounting principles. Additionally, in case of partnership business structure the business income is taxable in the hands of the partners while the partnership tax return is required to be filed to declare the relevant incomes and deductible expenses. The partners are liable to pay taxes on income from partnership business as per the percentage of share that increases their individual tax liability as per Australian Taxation System. Moreover, in case of capital gain taxes each partner is liable to pay taxes according to the share of asset each partner owns as the verdict formed in Scott v FC of T (2002) 50 ATR 1235ATC. Accordingly, the tax liability of the individual partners becomes higher while the deduction for partners salary is also not allowable in the partnership business income. Considering the trust structure in Australia, it is not regarded as a separate taxable entity whereas it is important to file the tax return. According to ITAA 97, beneficiaries of the trust entitled to declare the income and required to pay the tax liability in their books in compliance with Division 30 TASA 2009. Recommendation In view of all the business structure provided above, it has been observed that organization as two separate entities under wholly owned subsidiary is not recommended since it incorporates several accounting and taxation principles. Additionally, incorporation of business as one company requires compliance of several regulations but the taxation rate is comparatively lower i.e. 30%. On the other side, the tax rate for individuals as applicable in case of partnership business is based on progressive rates between 0 to 45% including the tax liability under trust business structure. Considering the tax implications of all the business structures it can be said that the tax liability for a single company is the lowest however, it includes compliance of several regulations as per accounting principles and standards. Besides, partnership business has several advantages with respect to the acquisition of fund, business-controlling responsibility, management of business expenses and other sh are of profits and liability. Moreover, one of the major drawbacks of partnership business is the burden of tax liability on partners that can be up to 45%. Therefore, it is recommended that Alex and Ryan should consider one company business structure to operate the business operations from the properties in Australia. Conclusion In view of the tax implications on operations in Australia, it can be concluded that Alex and Ryan are eligible to claim the tax liability under ITAA as permanent establishment. 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