THE UNIVERSITY OFNEW SOUTH WALES

School of Business Law and taxationAustralian School of Business

LEGT 2751 BUSINESS TAXATION

FINAL EXAMINATION

SESSION ONE 2008

DURATION:

READING TIME:

TWO HOURS

TEN MINUTES

TOTAL NUMBER OF QUESTIONS: FOUR

NUMBER OF QUESTIONS REQUIRED TO BE ATTEMPTED: TWO

Candidates are permitted to bring electronic calculators into the examination room.

There are no restrictions on the written materials that candidates may bring into theexamination room.

Candidates are not permitted to bring laptop computers into the examination room.Candidates may bring mobile phones into the examination room but they must be switchedoff and placed under the candidate's desk.

Do no consider the potential application of the STS (or SBE) rules in Division 328 of theITM 1997 in any of the questions in this examination.

Each question is of equal value.

Answer each question attempted in a separate book.

All answers must be written in ink.

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QUESTION 1

Martin purchases aderelict building on 1 January Y1 in Surry Hills for $500,000. To financethe purchase Martin borrows $500,000 at 10% from Big Bank Ltd. Prior to Martin's purchasethe building had been leased by its previous owner (a charitable organisation) to a women'srefuge at a nominal rental of $100 per week. At the time of Martin's purchase the lease to thewomen's refuge has a year to run.

Once Martin purchases the building he shouts, "I have a dream!" Martin's dream is that oneday the building will be a multicultural cafe, the 'World Community Cafe", where all will beable to come and eat. Its logo will be a globe of the world inside a coffee cup. To finance thepurchase Martin borrows $500,000 at 10% from Big Bank Ltd. On 14 February Y1 Martinapplies to the local council for permission to redevelop the building as a cafe. On 14February Y1 Martin also gives the women's refuge one month's notice to vacate thepremises. The women's refuge refuses to vacate and Martin incurs $10,000 in legal feesassociated with ejecting the women's refuge. The women's refuge finally vacates on 1 JuneY1.

The local council gives consent to the redevelopment on 1 May Y1. On 1 May Y1 Martin, tofully redevelop the building, borrows a further $700,000 at 10% from Big Bank Ltd. Martinredevelops the building so that, in external appearance, its roof looks like a globe of theworld inside a coffee cup. Inside the bUilding a system of pipes connect a central coffeemaking machine located in the globe shaped roof with individual nozzles on each table.The total cost of the redevelopment is $700,000 which includes $100,000 being spent on thecentral coffee making machine and the individual nozzles and the balance being spent onchanges to the external appearance of the building. Martin estimates the effective life of thecoffee making machine and nozzles to be 10 years and estimates the effective life of thechanges to the external appearance of the building to be 30 years.

The cafe opens on 1 November Y3. On 15th November Y3 Martin incurs $50,000 inunsuccessfully opposing an application for a registered design by a competitor, World CupCoffee. The design used by World Cup Coffee depicts a cup of coffee inside a globe of theworld.

Required:

1. Advise Martin whether the interest payments on each loan from Big Bank Ltd aredeductible under s8-1.

2. Advise Martin whether capital allowances under Division 40 can be obtained for: (a)the redevelopment of the external appearance of the building: and/or (b) theinstallation of the coffee making machine and pipes. Calculate any Division 40deductions that will be available to him in Y1 using the prime cost method.

3. Advise Martin whether he can claim deductions under Division 43 in respect of eitherof the items referred to in (2)(a) and/or 2(b) above and, if so, calculate thedeductions that he may claim in Y1.

4. Advise Martin whether the expenses of unsuccessfully opposing the application forthe registered design are deductible under s8-1.

...lp/ease see over for Question 2

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QUESTION 2

Entity is in the business of providing cleaning services.

If Entity were a resident taxpayer its receipts for the year ending 30 June 2007 would havebeen as follows:

$200,000

$20,000

$400,000

gain on pre CGT asset(shares in BHP Ltd acquired as an investment in August 1985)

gain on post CGT asset held for two years(vacant land acquired by Entity in May 2005; assume that this was notan active asset of the business)

cleaning revenues

Its expenses would have been as follows:

$100,000

$100,000

$100,000

Depreciation on cleaning equipment

Interest on borrowing to acquire a warehouse building

Tax Loss carry forward from YE 30/6/2006

Based on this information the accounting profit for YE 30/6/2007 is $420,000.

Consider the following alternative scenarios for the year ending 30 June 2007:a) Entity carried on business as a partnership of two partners: Tracy (an Australian

resident, who is a top marginal rate taxpayer aged 35); and Doug, (an Australianresident, aged 18, whose income from other sources is nil). Explain how the abovereceipts and expenses would be treated for tax purposes. Explain who would beliable to pay tax and calculate any tax payable.

b) Entity was a proprietary company that was trustee of the Entity Unity Trust with Tracyand Doug as the unit holders, each holding one unit. Neither Tracy nor Doug isunder a legal disability. Explain how the above receipts and expenses would betreated for tax purposes. Assume that the excess of receipts over expenses is fullydistributed. Explain who would be liable to pay tax and calculate any tax payable.Neither Tracy nor Doug has any capital losses from other CGT events. Explain theeffects, if any, of the distribution on the cost base of units.

c) Entity was a proprietary company that was not a trustee. Tracy and Doug were theonly shareholders, each owning one share. Explain how the above receipts andexpenses would be treated for tax purposes. Assume that the excess of receiptsover expenses is fully distributed. Explain any relevant obligations that the dividendimputation system would impose on Entity pty Ltd. Also explain the effect of anyrelevant rules affecting the extent to which dividends paid by Entity pty Ltd could befranked. Explain the circumstances in which, given the facts stated above, apayment of a dividend could give rise to a franking deficit tax liability for Entity ptyLtd. Explain any adverse tax consequences for the company that might arise for it ifa franking deficit tax liability arose. Explain the percentage to which Entity pty Ltdwould need to frank the distribution if it wished to avoid paying franking deficit tax.Explain the tax effects for Tracy and Doug of a distribution franked to thispercentage. Assume that as at 1 July 2007 there was a zero balance in Entity'sfranking account. Assume also that all instalments of tax payable by Entity incomearising in the year ending 30th June 2007 are paid by that date.

....lp/ease see over for Question 3

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QUESTION 3

Frank is an expert in Trade Practices Law and is offered a position as a professor byScientia College pty Ltd a newly established private university located in Sydney. Assumethat Scientia College pty Ltd pays corporate tax at the rate of 30% on its assessable income.Scientia College pty Ltd offers Frank the following salary package:

SalaryCar with a lease value ofEntertainment allowanceReimbursement of personal research library expensesEmployer superannuation contributions

$160,000$ 60,000$ 20,000$ 10,000$ 20,000

Frank estimates that he will garage the car at home and will drive 30,000 kilometres a year,none of which will be for business purposes. Frank estimates that the operating expensesfor the car will be $300 per month. The lease payments are $900 per month.

Frank is aware that Scientia College pty Ltd would have paid him a greater salary if some ofthe non cash benefits paid to him had not been subject to Fringe Benefits Tax. Advise Frankof the amount of Fringe Benefits Tax that Scientia College pty Ltd will be liable to pay on thesalary package offered to him. Assume that Frank has an adequate level of private healthinsurance.

Before waiting for your advice, Frank takes up Scientia College pty Ltd's offer and startsworking as a professor. Frank then also takes up a position as a part time consultant withTeachers, a boutique law firm specialising in Trade Practices Law. Frank charges Teachersan hourly consulting fee. Teachers also reimburses Frank for taxi fares for travel to and fromScientia College and Teachers' office in the Sydney CBD. On Friday evenings Frank joinsthe Teachers staff for drinks. As he does not wish to drive home after these evenings Frankcatches a taxi home and Teachers' reimburses him for the taxi fare. Discuss whetherTeachers is liable for Fringe Benefits Tax on the reimbursement of the taxi fares. Wouldyour answer to this part of the question differ if Teachers paid Frank a taxi allowance of $200per week which Frank could use for taxi trips as he pleased?

.. .lp/ease see over for Question 4

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QUESTION 4

Ocker Pty Ltd is an Australian resident and is a private company for Australian tax purposes.All of its 10 shareholders are Australian residents. It currently operates a wholly ownedsubsidiary, Happy Pty Ltd, incorporated in the newly independent country of Euphoria whereit conducts active business operations. Production and sales activities of Happy Pty Ltdgenerate 50% of the worldwide income of Ocker Pty Ltd. The rest of Ocker Pty Ltd's incomeis Australian sourced.. The rate of Euphorian corporate tax paid by Happy Pty Ltd is 45%.Happy Pty Ltd distributes all of its after tax earnings as dividends to Ocker Ltd. There is nodividend withholding tax in Euphoria.

Ocker Pty Ltd is concerned about the high levels of total tax that will be borne on itsEuphorian income if it is ultimately distributed to its underlying Australian shareholders. Toreduce its global corporate tax Ocker Pty Ltd decides to incorporate a second subsidiary,Moore Pty Ltd, in Utopia (another newly independent country bordering Euphoria). Utopiaimposes a corporate tax at a rate of 5% on a similar tax base to that used in Australia. Theoffshore production facilities are relocated to Utopia where the labour costs are higher thanthose in Euphoria. Moore Pty Ltd sells the manufactured product to Happy Pty Ltd whichthen sells the product retail in Euphoria. Assume that all sales are at arm's length prices.

As Utopia has no thin capitalisation rules, Ocker Pty Ltd funds the Moore Pty Ltd by 80%internal debt and 20% equity. Assume that Ocker Pty Ltd has no external borrowings. Theearnings of Moore Pty Ltd after Utopian tax are distributed to Ocker Pty Ltd as dividends.Utopia imposes a withholding tax of 15% on both dividends and interest.

Australia does not have a Double Taxation Agreement with either Euphoria or Utopia. BothHappy Pty Ltd and Moore Pty Ltd are 100% owned by Ocker Pty Ltd. Assume that neitherHappy Pty Ltd nor Moore Pty Ltd carries on business in Australia through a permanentestablishment.

Advise Ocker Pty Ltd:

1. Whether the restructuring is likely to lower its global corporate tax rate.2. Whether the restructuring is likely to lower the total level of tax paid on a

redistribution of profits, arising from its offshore sales, to its underlying Australianresident shareholders.

3. Whether the restructuring is likely to infringe the general anti-avoidance provisions inITAA36 Part IVA. Consider both the potential application to Ocker Pty Ltd and to theunderlying resident shareholders.

END OF PAER