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Capital Gains Tax : Political Economy and Taxation

Question:

Discuss about the Capital Gains Tax for Political Economy and Taxation.

Answer:

Case Study 1: Capital Gains Tax

Capital gains are the profits earned or the returns realized from the sale of a property or from the sale of an investment. It can be the sale of shares, the sale of furniture and fittings, the sale of a building, the sale of land, the sale of property, plant and equipment and so forth. It calculated by taking the amount realized from the sale of the property or investment less any amount incurred while buying the equipment (Berube, and Pinto, 2010, Pp.300). The sales price may include any legal fees, contract fees, commission fees incurred and so forth while the buying price can include the stamp duty, property license, goods and services tax, legal fees, repair and maintenance, renovation fees or costs and so forth. If one realizes capital gains from the sale of his or her property or the sale of his or her investment, he is subject to the capital gains tax. If one realizes a capital loss on the other hand from the sale of his or property or even his or her investment, he is subject to a tax shield on the capital loss.

 In this question, Fred bought his holiday home in 1987 in Blue Mountains at a price of $ 100,000. During his purchase, he incurred stamp duty of $ 2,000 and legal fees of $ 1,000. Three years later that is 1990, he engaged a builder to build a garage for a pay of $ 20,000. This implies that the total cost he incurred while purchasing the house was $ 123,000. In august last year, he signed a contract to sell his house. In February this year, a purchaser offered $ 800,000, which settled the sale of the house (‘indexing capital gains’, 1990, Pp.231-250). During this sale, he incurred legal fees of $ 1,100 and real estate agent’s commission of $ 9,900. The case study further states that the legal fees and the real estate agent’s commission are inclusive of GST, which is the goods and services tax. The current GST tax rate is 10%. This implies that for us to determine the net capital gain for Fred we must first deduct the goods and services tax from legal fees and the real estate agent’s commission incurred on the sale of the holiday home. This can be calculated as shown below:

From the calculation above, it is evident that Fred incurred $ 1,000 in legal fees and $ 9,000 in real estate agent’s commission. The case study further assumes that Fred incurred a net capital loss $ 10,000 last year from the sales of shares (Hughes, and Tingley, 1966, Pp.1-5). Since this is share capital, it will affect the capital gains of Fred. This implies that Fred paid a total net price of $ 800,000 when selling his holiday home. The tables below shows the total purchase cost that Fred incurred when he bought his holiday home in 1987 and the total cost incurred when he sold the holiday home in February this year.

Total Purchase Cost

Buying Price

$ 100,000

Stamp duty

$ 2,000

Legal fees

$ 1,000

Cost of building garage on the property

$ 20,000

Total Purchase Cost

$ 123,000

   

Total Selling Price

Selling Price

$ 800,000

Legal fees

$ 1,000

Real estate agent's commission

$ 9,000

Net loss from sale of shares

($ 10,000)

Total Selling Price

$ 800,000

When calculating the capital gains or capital loss, one must not that the cost they purchased the property at will not be the same in future. This implies that it will include an inflation rate as per the year the property was sold (Ricardo, 2001, Pp.1167-1198). The inflation rate as at 2016 is 0.8%. This method of calculation of capital gains is called the indexation method. The cost that Fred incurred as at February this year would be:

To calculate the long-term capital gains tax, the capital gains is first discounted at a rate of 50% and then a tax rate of 15% is applied as shown below.

The case study also tells us to assume that Fred did not incur a net loss from the sale of shares last year but rather from the sale of an antique vase. When we consider this scenario, the capital gains tax shield will not be the same. This is because the antique vase is not considered as capital to Fred but as his asset, therefore it will not be included in the selling price. The tables below show the total purchase and selling costs incurred by Fred.

Total Purchase Cost

Buying Price

$ 100,000

Stamp duty

$ 2,000

Legal fees

$ 1,000

Cost of building garage on the property

$ 20,000

Total Purchase Cost

$ 123,000

Total Selling Price

Selling Price

$ 800,000

Legal fees

$ 1,000

Real estate agent's commission

$ 9,000

Total Selling Price

$ 810,000

Below is the calculation of the capital gains that would be realized from this scenario.

Below is the calculation of the capital gains tax that Fred will incur.

From the two scenarios in this case study, it is evident that Fred would have to pay a higher long-term capital gains tax on the sale of his holiday home if he incurred a net loss from the sale of shares rather than when he incurred the net loss from the sale of the antique vase.

Case study 2: Fringe Benefits Tax

Part A

Fringe benefits are any benefits a company gives to his workers in addition to the basic salary or wages he or she receives (Salanié, 2011, Pp.390). It can be in cash form, goods or even services. It can also be in insurance form, paid vacations, car allowances, pension plans, house allowances and so forth. Any fringe benefits realized by the employee are tax deductible by calculating the fringe benefits tax.

In this case, study, Emma who is an employee of Periwinkle Pty Ltd. received a car from the company on May 2015. The car cost the corporation $ 33,000 to purchase it inclusive of the goods and services tax. Emma did not use the car for work only but also for private purposes. For the period from 1 May 2015 to 31 March 2016, Emma travelled 10,000 kilometers to and from work and for her private leisure activities (Kaplow, 2006, Pp.100-219). During this milestone, Emma incurred total expenses of $ 550 inclusive of the goods and services tax for the repairs of the car and other expenses, which was later reimbursed by the company. On 1 September 2015, Emma borrowed a loan worth $ 500,000. This loan was subject to an interest rate of 4.5%. She used this loan to purchase a holiday home worth $ 450,000 while the remainder of $ 50,000 she lent to her husband to purchase the shares of Telstra Corporation at no interest rate. The case study further suggests that the interest rate realized from the purchase of private property is not deductible while if the interest is incurred from the purchasing an income generating property, asset or investment is deductible for tax purposes (Kaplow, 2006, Pp.100-219). Emma also purchased a bathtub from Periwinkle Pty Ltd. for 1,300. The organization incurred variable costs of $ 700 to manufacturer the bathtub and it normally sells the bathtub for $ 2,600 to its customers, which implies that there, is lost contribution.

In this question, we assume that Emma is entitled to input tax credits for any goods and services tax incurred on the purchase of the goods (Frankel, 2008, Pp.101). Therefore, Emma’s fringe benefits include the car she received from Periwinkle Pty Ltd., the reimbursements on repairs, and the loan she received less any interest she would have paid for the loan. Below are the fringe benefit tax consequences of Emma:

Car she received- Here, the company bought her a car amounting to $ 33,000 which is subject to goods and services tax (GST). However, the case study states Emma is entitled to receive an input tax credit for a goods and services tax she would have incurred. The goods and services tax rate is 10%. Emma would therefore pay. However, this amount would be credited implying that she would not pay it. Therefore, the total amount for the car eligible for the fringe benefit is which is deductible for tax purposes.

Reimbursement on repairs and other expenses- While using the car, Emma incurred a cost of $ 550 for repairs and other expenses relating to the car. The firm however reimbursed this cost to Emma. This implies that this is a fringe benefit, which is deductible for tax purposes.

Loan acquired- Emma borrowed a loan from the organization amounting to $ 500,000. The loan was subject to a 4.5% interest. She used this amount to buy a holiday home worth $ 450,000 while she gave the remainder to her husband to buy shares. Here, the holiday home is private property therefore no interest would be deducted on it. The purchase of shares by her husband is an income generating investment, which is interest deductible. However, since it does not generate income for her she will not pay any interest on it. In this case, only the principle amount of loan of $ 500,000 is eligible for fringe benefits and is therefore deductible for tax purposes.

Below is the calculation of the fringe benefit tax liability incurred by Emma.

Part B

If Emma used the remaining $ 50,000 to purchase shares herself instead of lending it to her husband, she would be subject to interest, which would be deductible for tax purposes. The case study states that the interest incurred on the purchase of property or any investment that is income generating is deductible for tax purposes (Frankel, 2008, Pp.101). In this case, the interest rate to be applies is 4.5% per annum. Emma acquired the loan on 1 September 2015. Up to 31 March 2016 is around eight months. Below is the calculation of the interest to be paid during that period by Emma.

This implies that for the period ending 31 March 2016, Emma was eligible to pay an interest amounting to $ 1,500 (Frankel, 2008, Pp.101). This interest rate would be deducted from the loan before claiming any fringe benefits as shown below:

Below is the calculation of the fringe benefit and the fringe benefit tax liability that Emma would be eligible to pay.

From the calculation above, Emma is liable to pay a fringe benefit tax of $ 259,087.5. This amount has decreased from the amount where she lent the remainder of $ 50,000 to buy the shares from Telstra (Azam, n.d., Pp.99). In the previous question, since the amount of $ 50,000 was not used by her to buy the shares from Telsra, she is therefore not liable to pay the interest but rather her husband is. This implies that in the previous question, no interest was charged for the purchase of income generating asset or investment. In this question, since she was the one who used the remaining amount of $ 50,000 she would be liable to pay interest before taxing the fringe benefit that is main reason for the deviation.

References

Berube, W. and Pinto, C. (2010). Taxation, tax policies and income taxes. New York: Nova Science Publishers. Pp.300. Retrieved on 12 September 2016.

Indexing capital gains. (1990). Washington, D.C.: Congress of the U.S., Congressional Budget Office.  Pp.231-250. Retrieved on 12 September 2016.

Hughes, P. and Tingley, K. (1966). Taxation of capital gains. London: Taxation Pub. Pp.1-5. Retrieved on 12 September 2016.

Ricardo, D. (2001). On the principles of political economy and taxation. London: Electric Book Co. Pp.1167-1198. Retrieved on 12 September 2016.

Salanié, B. (2011). The economics of taxation. Cambridge, Mass.: MIT Press. Pp.390. Retrieved on 12 September 2016.

Kaplow, L. (2006). Taxation. Cambridge, Mass.: National Bureau of Economic Research. Pp.100-219. Retrieved on 12 September 2016.

Frankel, V. (2008). Fringe benefits. New York: NAL Jam. Pp.101. Retrieved on 12 September 2016.

Azam, R. (n.d.). Couples Taxation in Israel: A Call for Separate Taxation. SSRN Electronic Journal. Pp.99. Retrieved on 12 September 2016.

 

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