For the past five years, Fika, Dex, and Jemma have been working together in a retail store in a local shopping mall. They are all passionate home bakers, obsessed with competing on Australia’s Home Baker TV show. For the entire time they worked together, there has been a small vacant space in the same shopping mall that their retail store is located. Three years ago, they were successful in getting onto the Australia’s Home Baker TV show (as a team of three) and made it to the semi-finals before being voted off the show. Based on their success, the three discussed and committed to opening their own kitchen store, with a test-kitchen for cooking classes in the vacant space. Two years ago, they formed a partnership, and opened their kitchen store. Since then, the generated income have been significantly higher than expenses for all years in business. The three have agreed that they would each work in the store part time on the weekends, as well as manage their large social media following, to keep the employment costs down. In the current tax year, they hire Jeffrey, a former co-worker, as a full-time employee to manage the store during the week. His salary costs are $70,000 plus superannuation contributions. The partnership purchased approximately $40,000 worth of general inventory in the prior tax year, and sold $15,000 of that general inventory in the current tax year.
Fika, Dex and Jemma had formalised their discussions with a written partnership agreement (for the FDJ Partnership) that states all income and expenses are equally spit between the three of them, except for certain interest payments. There are two relevant interest payments: first, Fika provided a cash loan to start the business, and each year the partnership will pay $5,000 in interest to Fika. Second, Dex and Jemma provided a capital contribution to purchase certain capital fitouts as part of the built-in test kitchen. Dex and Jemma split the cost of the capital contribution, and the partnership agreed to pay $12,000 in interest per year on that loan, again split between the two.
(a) Please discuss the tax consequences of the above partnership expenses for the current tax year. Support your answers with case and/or legislative authority, and show calculations where appropriate. You do not need to calculate any superannuation contributions; merely address the tax consequences. (10 marks)
(b) Please discuss the tax treatment differences, if any, if the partners had structured the business as a corporation. Assume that any profits exceeding expenses would be distributed to Dex, Fika and Jemma. (10 marks)
Dex comes from a wealthy family; his favourite personal chef taught him how to bake in the summer between years 8 and 9. Dex doesn’t want his co-workers to know, but he actually lives off his investments and funds from a trust set up by his grandparents. He only worked retail with Fika and Jemma because he enjoys being a ‘regular person’. When Dex turned 18, he purchased a 23 hectare property in the Hunter Valley, entitled ‘HonestAcre’. Currently, HonestAcre is split between being leased to a sheep farmer (20 hectares) and an orchard with pear trees (3 hectares). The Orchard has a small holiday house that Dex stays in or rents out on ‘Hippestcamp’ app. The Orchard is also home to a herd of goats. Dex keeps the goats for two reasons. First, he primarily enjoys watching the goat antics outside the window when he visits. Second, he appreciates that the goats keep the yard tidy by eating most of the weeds. Otherwise, Dex does not make any profit from the goats. In fact, they are generally more costly than hiring a mowing company. A veterinarian is on call if there are issues with the goats.
Dex’s friend Alex is a local real estate developer. Alex approached him to purchase the 20 acre land leased to the sheep farmer for $2,000,000. He’s asked Dex to sell to him for ‘mate’s rates’ and take 10% off the market price, and in return Alex will make sure that the road and development faces the pear orchard so that future development of the pear orchard is more attractive. Dex agrees and proposes to enter into the contract for sale with Alex via his company, Dex Investments Pty Ltd (Company). Dex assumes that if the Company enters into the sale agreement with Alex, rather than Dex selling the property in his individual capacity, tax savings will be achieved. The market rate for the property is estimated at $2,200,000.
Dex also holds shares with various Australian public companies who have a tax rate of 30%.
Dex hands you the following paperwork and receipts (if date is not noted, assume it is from the current tax year at issue)
• Transfer of title from Original Owner to Dex for HonestAcre in 2017. (Market value at transfer was $1,300,000; the $1,000,000 was the value for the 20 hectare sheep farm).
• Conveyance costs on acquisition of HonestAcre paid by estate (12/01/2017) = $13,000
• Conveyancing costs to subdivide the two sections of HonestAcre to produce the farm/orchard = $10,000
• Small repairs to replace part of a broken fence and irrigation section at HonestAcre sheep farm = $5,000
• Legal fees relating to sheep farm fencing dispute with neighbouring property = $60,000
• Total income from holiday house on ‘HippestCamp’ = $32,000
• Costs related to fixing the holiday house deck and painting at the holiday house (rented for half of the year) = $5,000
• Costs related to expanding the holiday house deck by about 50% = Decking and labour $8,000; paint supplies $1,000. Dex overbought paint supplies (by double) so Dex used the extra to paint his apartment.
• Dividend receipts from shares: A $9,000 dividend franked to 80% and an unfranked dividend of $6,000.
• Veterinarian cost for checking the herd of goats in the spring-time $2,500
• A trip to Scotland to investigate purchasing a goat stud to breed with local goats $6,000.
Advise Dex as to the proper tax treatment that should be adopted in his current year tax filing for the above receipts and expenditures. Please provide relevant statutory and/or case citations.
(You can assume there are no tax consequences for the transfer of the property from Dex to the Company to enable the relevant transaction. You do not need to perform calculations for any dividend but please describe the process for determining tax liability, if any). 20 marks.
Chris Evans and Britt Fauley are controlling shareholders of NeverDone Pty Ltd. NeverDone Pty Ltd makes its profit by selling building supplies at a discounted rate to building and land developers. NeverDone Pty Ltd has been offering discounted building supplies since its incorporation in 2012. NeverDone Pty Ltd has two warehouses, one in West Geelong and one in Bendigo. The warehouses and accompanying land were valued at $900,000 each as of the end of last tax year. Four years ago, NeverDone Pty Ltd purchased three adjacent blocks of land in a new development in Bendigo for $300,000 each, with the intention of building a high-rise development. NeverDone Pty Ltd had not previously purchased and developed land as part of their business enterprise, but the property was within walking distance of their warehouse in a neighbouring up and coming residential area.
Massive neighbourhood protests occurred when the high rise development plans were made public. The neighbouring property is a heritage building and gardens and believes that the high rise will block the sun from the garden. The trustees of the heritage property filed an appeal with the Victorian Civil and Administrative Tribunal (VCAT). NeverDone Pty Ltd sought advice from their lawyers, and based on this advice Chris and Britt have instructed their architect to instead design three residential duplexes to be built on the land. Legal and planning fees in relation to all three properties amounted to a total of $30,000 for the three townhouses. Shortly after the VCAT decision, the warehouse in Bendigo floods and is damaged beyond repair. After the flood, NeverDone Pty Ltd accounts manager realised that the insurance on the building had lapsed. The contents were insured under a separate policy. However, Chris and Britt realise they must manage their incoming cash flow, and NeverDone Pty Ltd subsequently arranged to build the duplexes for $550,000 each
NeverDone Pty Ltd sold the three duplexes for $1.5 million each, and the value of the Bendigo property (land only as the building is gone) is now $100,000.
Alongside the above corporation’s activities, Chris earns a substantial income from investments. Chris wants to protect as much income from taxation as possible, so she sets up the Evans Family trust, which is a discretionary trust. The beneficiaries of the trust are Chris’s child Sel (37 years old) and her grandchild Stacia (7 years old). The trust resolves to distribute a $15,000 payment to Sel and a $7,000 payment to Stacia. Chris still believes she is paying too much tax. At the tennis club one day, she overhears a friend Thom, discussing a possible way to minimise tax. She approaches Thom directly, and he says he can lower her tax by entering an arrangement where Thom ‘loans’ Chris $50,000 for a new business venture (which would never proceed). On receipt of the $50,000 loan amount from Thom, Chris would hand back the $50,000 cash to Thom, but continue to take a deduction for interest paid on the dodgy loan. Thom has no other income, but is very popular at the Tennis Club and claims he’s been participating in this arrangement with other patrons for over a decade with no issues. Chris estimated that she could take approximately $5,000 a year in interest payments as a deduction and she proceeds with the transactions.
(a) Discuss how to categorise the receipt of funds for the sale of three properties and financial loss of the warehouse for income tax purposes. Provide relevant law and analysis. (8 marks)
(b) Explain how the trust income is taxed and who will be liable for the tax. Provide relevant law and analysis. (6 marks)
(c) Discuss the tax implications of Chris’ actions. Provide relevant law and analysis. (6 marks)