BULAW5916 Implication of Tax on Agency Contracts Assessment Answer
Taxation Law and Practice Assignment
Tax Rules and their compliance is changing day to day with their rules of enforcement. The actual tax liability of assesse is determined with the help of tax planning and its compliance. This report is comprised of two different parts, in the first part the implication of tax on agency contracts is being discussed. In the second part the capital gain or loss on the land and building is calculated. Indexed cost of acquisition and sales proceeds of the land and building are also allocated to ascertain the capital gains/ losses. The tax laws are being analyzed and interpreted for the consequences of the contract. There the analysis is to be done as per income tax act 1997 and before implementation of the act.
The rules of taxation clearly states that the income which is assessable of the assesse is inclusive of all the amounts or incomes which are directly relatable to trading activities, renting of property and from carrying on any professional service as well as the amounts generated from other sources. Assesses taxable income also includes amounts that are received from the statutory grounds such as income from gambling, dividend income, gain on sale of capital assets and the type of allowances which are directly related to the operating activities of the company (Australian taxation office, 2020).
It is very necessary to access the correct taxable income of assesse as every person is liable to pay taxes if he/she falls in the category of person liable to pay tax. The liability of tax is determined after the computation of the taxable income of the assesse. In the present case ABC Ltd entered into agency agreement with Indian shipping company for a period of 30 years. In between the term of agreement companies agreed to cancel the agreement and an amount of $ 4 million was paid by Indian shipping company to ABC Ltd in the form of compensation. Here now, we will discuss some of the relevant case laws to determine whether the amount received by ABC Ltd forms part of its income or not
As per the rules and by laws of Australian Tax Act 1997, the amount that is received in relation with the variation or cancellation of commercial or other trade contracts that are made for carrying out the business are to be considered as in the nature of income. As the payment is in the form of lump sum amount that doesn’t mean that it not income (Barkoczy, 2016). The same has been proved in courts and judgment has been passed by the court in the case of Heavy Minerals Pty Ltd v Federal Commissioner of Taxation, 1966. In this case the amount of compensation which is received in lump sum is treated as income of the assesse and would form part of the taxable income. (Cumming, 2005). Furthermore, it is difficult for the assesse to determine the nature of the amount received. As the amount received can be of the nature capital or income (Gropp, & Kostial, 2000). For the same purpose, there is set of two different criteria to access whether this forms party of income or capital:
1. The agreement entered into is part of the fixed framework.
2. The agreement is only related to the profit making of the company or that forms part of the essential part of the business
The above tests were decided in the proceedings of the case Van Den Berghs Ltd V Clark (Tax Inspector)
In the present case issue is regarding the cancellation of the agency agreement. The amount of consideration which is received by ABC Ltd by Indian company is to be treated as income or that constitutes a capital asset. This case is related to Californian Oil Products Limited v Federal Commissioner of taxation. In this case the company has entered into an agency agreement with a shipping company and that shipping company comprises of 1/3 shares of profit of the company. So the termination of agreement and resultant compensation received in this case is treated as income of the company as the main interest is shipping business of the company.
The cancellation of agency agreement of the Indian company with ABC Ltd is the crucial profit making segment or merely just a part of its financial and merchandise business for that we need to know about the profit structure of the company. Indian company forms 60% profit of the ABC Ltd that means it forms the crucial part of the working of ABC Ltd and the minor segments keep on working. Here the cancellation of contract directly affects the business of ABC Ltd and also other minor activities relating to the business of shipping were also terminated with the termination of the agency contract. Indian company constitutes 60% of the profit of ABC Ltd. This means that the company is carrying on its operation rather the fact that the agreement with the shipping company is effecting the major part of the profit of the company. This states that the agreement has no capital effect on the companies operation, so the compensation is treated as income of the company.
This clearly states that the agency contract forms the crucial part of the company’s operation. Contrary to that the company has not came to an end with the termination of the agency contract that means it is not of capital nature. As the shipping sector is only one area of the company (Dalley, 2010). The compensation payment received by ABC Ltd is considered as income as this is because of the loss of profit and cannot be considered as loss of a profit earning asset as provided in the case of Fleming and Co. where compensation received for loss of income of the company is considered as income because the assesse has suffered loss of profit not any asset of the assesse has gone. The shipping company is not having a separate entity it comes under ABC Ltd. Hence the compensation received by ABC Ltd is to be classified as income.
As per Income Tax Act 1997, an assets form part of Capital Gain Tax if the asset of acquired on or after 26th June 1992. As per Taxation rule 95/35 the compensation payment which are received in the termination of any financial or business contracts results into a CGT asset. As the reimbursement of right in the form of compensation will create a disposal of an asset (Sitkoff, 2003).
In the present case the company entered into an agency agreement with a shipping company and then after some years of operation the shipping company is willing to terminate the contract. The termination of the agreement resultant into some compensation which the company receives from the shipping company because the agreement is terminated before its tenure (Rasmusen, 2004). As per Income Tax Act 1977 the compensation amount which is received in result of termination of any agency agreement results into a CGT Asset. Before the establishment of this Act as held in the case of /2008; Australian Pasture Seeds (AAT/2008); Dixon (2008), compensation amount is judged on the basis of two criteria’s as if it is forming the crucial part of the business of the company and with the termination of the agreement the company comes to closure then it will be treated as of capital nature. On the other hand if the business continues to operate that the compensation is considered as income in nature.
After the imposition of Income Tax Act 1997 and held in the case of Tennant v Smith (Surveyor of Taxes): HL 14 Mar 1892, any agency contract that is entered between the companies will form the crucial part of the business and any profit or loss in the form of compensation arising from the same will result in the company’s asset or liability (Barnett, 2012). In this case the company entered into agreement on 1 August 1993 this attracts the rules of Income Tax Act 1997. The date when the agreement is entered between the companies will be considered as the date of acquisition and date on which the agreement comes to an end will be considered as the date of disposition. Hence the CGT provisions will be attracted for the agreement.
In the present case commencement work has taken place on 14 April 1997 and completed on December 1998. The Cost of land and Building on the day was $ 1.33m and $ 5m. On 02 January 2020 the company received an offer for sale of both land and building for $ 11 m. After the sale of land and building the company recorded a profit of $ 45, 80,000. To calculate the capital gain or loss for ABC Ltd we need to separate the CGT assets cost and sales price.
The provisions of Section 116-40 of Income Tax Assessment Act 1997 says that, the capital proceeds from a payment in a transaction with more than one CGT event (more than one item in the sale) must be split up/apportioned on a reasonable basis (Burman, 2010). As per Apportionment Rule, apportionment is done as under:
Land: CB = 1.33/ (1.33+5)
Building: CB = $5m/ (1.33+5)
Now, as per section 116-40 of Income Tax assessment Act 1997, the capital proceeds are being distributed in the proportion of the cost of building and land
Capital proceeds from sale of land and building =$11m
Capital Proceeds of Land (21%) = $2.31m
Capital Proceeds of Building (78%) = $8.69m
To know the capital gain or loss indexed cost of acquisition is subtracted from the capital proceeds of the asset. For the same we need to ascertain the indexed cost of acquisition of land and building.
Indexed cost of acquisition land = $ 13, 30,000 X (116.6/63.8)
= $ 24, 30,690
Indexed cost of acquisition building = $50, 00,000 X (116.6/67)
= $ 87, 01,493
For the above calculations the index taken is Customer price index as the cost inflation index for these years is not available.
Capital Gain/ loss = Sale proceeds – Indexed Cost of acquisition
Capital Gain/Loss Index on land = $23, 10, 000 - $ 24, 30,690 = $1, 20,690 (Capital Loss)
Capital Gain/ Loss Index on building = $86, 90,000 - $87, 01,493= $11,493 (Capital Loss)
The above calculation shows that combining the capital loss of both land and building company has suffered capital loss of $ 1, 32,183.But, in the books of company the profit amount is booked at $ 45, 80,000. The company has overstated its profit in its profit and loss account as company has encountered loss of $ 1, 32,183 in the sale of land and building.
The above course work, it can be seen that with the changes in taxation policies there can be many effective changes in the assessable income of the assesse. This is all about the implication of tax laws on the agency contracts and their effectiveness on the agency contracts. There is a brief analysis about the compensation that is resulted from the termination of the agency contract and its treatment. The implication of Income tax assessment act 1997 on the termination of agency contract and the treatment of compensation received from the same. The capital gain is also ascertained from the sale of land and building of the company and also indexation of cost of acquisition is also done as per the rules of Income tax assessment Act 1997. The under and over statement of profit is ascertained with the help of cost inflations. Proper analysis of the company’s profit and loss statement is made.