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tutorial 2 Questions & Solutions

tutorial 2 Questions & Solutions
tutorial 2 Questions & Solutions

Tutorial 2 – Questions & Solutions

17 August– 21 August 2009

(Employment and Personal Property)

Question 1

(a) Kerry Grey is in the ladies’ fashion business geared towards the younger fashion-conscious end of the market, and she has been selling her lines of clothes from a shop at No. 1001 Parnell Road for several years. Last November, another retailer named Susan Cristal opened a shop about 200 metres down the road at No.1055 Parnell Road, and from which she sold a similar range of clothing. The two shops are called “Kerry’s” and “Susan’s” respectively.

Over recent months, Kerry Grey experienced a serious downturn in her turnover caused by the new shop attracting customers away from her. She suspects the situation was exacerbated by the similarity in the styles of the two shops.

Last week Kerry negotiated with Susan to pay her $35,000 to cease trading, reinforced by a restrictive covenant under which Susan is not to compete with Kerry within a radius of 1 kilometre of her shop at 1001 Parnell Road and for a period of 5 years. Kerry borrowed the money for this from ASB Bank.

Discuss the tax treatment of the payment of $35,000 which has been made to Susan. Is the payment deductible for Kerry against her income receipts? Will Susan be liable to pay tax on the receipt of the money?

(b) On receipt of the payment she has received, Susan immediately closed down her 1055 Parnell Road premises and opened up a new fashion shop in Ponsonby Road selling a similar line of products.

Susan then negotiated a surrender of the lease of her Parnell Road shop premises to her landlords CS Investments Ltd. and she paid $5,500 for this. The lease was only a short-term lease for a term of two years at a rent of $8,000 per annum

Discuss the tax treatment of the surrender payment of $5,500 for both Susan and CS Investments Ltd. Is the payment deductible for Susan, and is it taxable in the hands of CS Investments Ltd.?

(c) Some months later, Kerry decided that she could do with additional premises in order to expand following an upturn in her business. It happened that 1055 Parnell Road, recently vacated by Susan, was still on the market to rent.

Kerry is able to negotiate for a payment by CS Investments Ltd. to her of $10,000 in consideration of her entering into a new lease for a term of 5 years at a rent of $7,500 per annum. This payment is particularly useful for Kerry since it will provide funding for fitting-out the premises.

Discuss the tax treatment of the payment of $10,000 for both parties. Is the payment deductible against CS Investments Ltd.’s income profits, and is the rec eipt taxable in the hands of Kerry?

Question 2

Todd is an accountant who returned from working in the UK a few years ago with $75,000 in savings. He was concerned about rising inflation in New Zealand, and he wanted to invest the money in such a way that will protect the value of his capital.

Todd decided to invest in the share market.

He deliberately bought shares that were not performing well in the hope that they would increase both their dividend yield and their share value. When this happened, Todd sold the shares and re-invested the money in other undervalued shares. Over a period of 4 years Todd purchased 15 parcels of shares, holding them for periods of between 6 months and 2 years. During this time he increased the value of his capital by $15,000, while making $8,000 in dividends.

(a)The IRD claim that Todd was in the business of trading in shares. Do you agree?

(b) The IRD claim that Todd bought all the shares for the purpose of resale. Do you

agree?

(c) The IRD claim that Todd was engaged in an undertaking or scheme using the

shares in order to make a profit. Do you agree?

ComLaw301 Tutorial 2 Solutions

Q1: (a)

Is the payment deductible for Kerry against her income receipts?

Issue: whether $35,000 is capital or revenue?

Facts: elimination of competition

Advantage: Kerry will have no competition.

It’s not a normal thing that people doing business every day.

The money was a loan from bank, it is on the balance sheet, so it’s a fixed capital.

Enduring benefit test: In fashion industry, 5-year is a long period, so it has a capital nature.

The $35,000 will help Kerry earn income, so there is a Nexus. But the capital limitation says there is no deduction.

Therefore, she cannot get deduction for the $35,000, since it is capital. Section DA2(1): the capital limitation.

Will Susan be liable to pay tax on the receipt of the money?

Receiving $35,000 is not a part of Susan’s ordinary business activity, and by applying the enduring benefit test, Susan could get cash flow money to come in. Although she could not operate a shop on Parnell, it does not affect the business structure. The payment to her is not circulating because it is not a part of trading clothes, it is a fixed capital. (Apply the same tests which applied on Kerry)

(b)

Is the payment deductible for Susan

Susan’s case is different from CIR v McKenzies, in McKenzies’ case, the tenants only paid 2 year’s rent for surrender of the 32 years lease, it gives more revenue favor than in Susan’s case (2 years lease, $8000/yr, paid $5,500 for surrender of the lease). When company enters into long-term lease, it takes on a burden, because it ties to the lease, it loses its flexibility. In McKenzies’ case, the surrender of lease took off the burden on McKenzies, which gave McKenzies a big relief. Another difference is that, after McKenzies’surrender, they ceased trading, so any payments would be on capital account anyway, because they were not in business anymore. They could not have got deductions and they would not have returned the income, because it was part of the income and they were not in trading. And here, Susan is still in trading.

Is it taxable in the hands of CS Investments Ltd.?

If CS investments Ltd.’s ordinary course of business is leasing, then $5,500 is a revenue, and it is taxable. FCT v Cooling will support this issue.

If the only premise that CS Investments Ltd. owns is this one, then this premise represent the

series structure of asset, then the negotiation of the lease will have an impact on the structure of business.

(c).It is deductible to the landlord, but not taxable in hands of Kerry. Wattie and Another v CIR.

Question 2(a)

Issue: if Todd was in the business of trading in shares?

Section: CB 5: Business of dealing in personal property.

CB4: Personal property acquired for purpose of disposal. YA1

Cases needed to mention are CIR v National Distributors Ltd. and Grieve v CIR.

Todd was not in the business of trading in shares.

Also can mention the case CIR v Stockwell (passive activity).

(b)

CB4 applies here. And yes, he was caught for dominant purpose of resale, because he bought undervalued shares to hedge against inflation. Again, cases CIR v National Distributors Ltd. and CIR v Stockwell apply here. Also mention case Williams Property Development Ltd v CIR. This case does not apply here, but we also need to mention it to show that we understand in some circumstances, a contingent purpose can become a dominant purpose.

(c)

CB 3, YA1 apply here. Because todd was not in the business of trading shares, and there are not many business items here, so it is unlikely to be a scheme.

Hints to identify Capital/Revenue issue:

1.Look the size of money that’s been in the transaction, lump sum of money to cure

disadvantage or gain advantage. E.g. eliminate competition, expending.

2.Is it an ordinary business operation? Or is it extraordinary? If it is extraordinary, then it is

likely to be a capital/revenue issue.

Nexus: Link; if there is a link between the income derived and the expenses incurred, then there is a nexus.

In Sun Newspapers v FCT, the money was capital, since in order to avoid the competition, it took over the owner ship of the rival company, and its business structure was changed as a result. Contrast to BP Australia Ltd v FC of T, there is no competition, and its business structure was not changed, there is recurring in this case, since when they sign the contract that implied it may be recurred again. And the payment came out circulating capital, because it was like you cannot sell what you are selling until you made such payment, it also could be argued to be part of ordinary

course of business activity.

Fixed Capital: Things shows on balance sheet, ie. aseets, money at bank, loans.

Circulating Capital: that is the everyday operation what business does. Normal P&L. (Tie to sth to earn the money, get the ability to earn money.)

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