Auditing And Assurance Services for Sale of a Property

Case Study 1: Capital Gains Tax

Capital gains are the returns realized from the sale of a property or an investment. According to the eighth schedule of the income tax act 58 of 1962, it can be the sale of common stock, furniture, one’s premises, land, property, equipment, and so forth. It calculated by taking the amount realized from the sale less any amount incurred while buying the asset or investment (Berube, & Pinto, 2010). The sales price may include other costs such as any legal costs, contract expenses, and commission expense incurred et cetera while the buying price can include the stamp duty, license of the property, GST, legal fees, maintenance, renovation costs and so forth. If one realizes capital gains from the sale, he is subject to the capital gains tax.  However, if one realizes a capital loss, he is subject to a tax shield benefit.

 In this case, study, Fred bought his holiday home at a price of $ 100,000. During his purchase, he incurred other costs like stamp duty amounting to $ 2,000 and legal fees amounting to $ 1,000. Three years later, he employed someone to build a garage for a salary of $ 20,000. The total cost incurred by Fred while purchasing the house was therefore $ 123,000. In February this year, a buyer offered $ 800,000, to buy his house (‘indexing capital gains’, 2010). During this sale, he incurred other expenses like legal fees amounting to $ 1,100 and commission of the real estate agent amounting to $ 9,900. The costs incurred during the sale are inclusive of GST. Currently, the GST tax rate is 10%. This implies that to determine the capital gain for Fred we must first pay GST. This is worked out as shown below:

From the above calculation, Fred incurred $ 1,000 in legal fees and $ 9,000 in the commission of the real estate agent. Assuming that Fred incurred a net capital loss $ 10,000 from the sales of common stock last year, what would be the capital gain of Fred (VanDorn,  Allen, & Bailey, 2009). Since this is grouped under ordinary share capital, it will affect the capital gains of Fred. Here, Fred paid a total net price of $ 800,000 when selling his home. The tables below show the total purchase cost and the total cost incurred by Fred when he sold the holiday home.

Total Cost Incurred while Purchasing

Purchase Price

$ 100,000

Stamp duty

$ 2,000

Legal expenses

$ 1,000

Cost of building garage

$ 20,000

Total Purchase price

$ 123,000

Total Cost Incurred while Selling Holiday Home

Selling Price

$ 800,000

Legal fees

$ 1,000

Commission of the real estate agent

$ 9,000

Net loss incurred from sale of shares

($ 10,000)

Total Selling Price

$ 800,000

When calculating the capital gains or loss, one must note that the cost they purchased the property at will not be the same in future as it will be affected by market conditions such as inflation (Ricardo, 2012). The inflation rate for January 2016 was 0.8%. This uses the indexation method of computation of capital gains. The cost incurred by Fred would therefore be:

Since these are long-term capital gains, they must first discount at a discount rate of 50% and then a taxed at a rate of 15% as shown below.

Assuming that Fred did not incur a net loss from the sale of shares but rather from the sale of an antique vase, then the capital gains would be different. This is because the antique vase is not capital but an asset, therefore it will not be included in the total cost incurred while selling the holiday home. The tables below show the total buying cost and selling costs incurred while selling the holiday home.

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

Commission of the real estate agent

$ 9,000

Total Selling Price

$ 810,000

Fred would therefore realize a capital gain of $ 686,016 as shown below:

Fred would therefore incur the following capital gains tax:

From the two scenarios above, Fred would have to pay a higher tax on long-term capital gains on the sale of his holiday home if he incurred a net loss from the sale of shares than when he incurred the net loss from the sale of his antique vase.

Case study 2: Fringe Benefits Tax

Part A

According to s 8-1 of the income tax act 1962, a fringe benefit is any benefit a corporation gives to the employees in addition to their basic wages (Salanié, 2011). It can be cash, goods, services and so forth. It can also be insurance premiums, paid vacations, leave allowance, vehicle allowances, pension plans for when they retire, house allowances and so forth.  

In this case, Emma, an employee of Periwinkle Pty Ltd., received a vehicle from the firm on May 2015. The car was bought at a cost of $ 33,000 inclusive of GST. Emma used the car for both work and private purposes. For the period ending 31 March 2016, Emma travelled 10,000 kilometers (Rumpf, & Miller, 2009). During this milestone, she incurred total costs of $ 550 inclusive of GST for the repairs of the vehicle and other expenses, which the enterprise later reimbursed. On September, Emma received a loan amounting to $ 500,000 at an interest rate of 4.5%. She used the loan to purchase a holiday home In France worth $ 450,000 while the remainder of $ 50,000 she lent to her husband to purchase the shares at no interest rate (Engdahl, 2011). The interest rate accrued from buying private property is not deductible while if it is incurred from buying an income generating asset or investment then it is deductible for tax purposes (Rumpf, & Miller, 2009). Emma also purchased a bathtub from the organization for 1,300. The corporation incurred a cost of $ 700 to manufacturer the bathtub and selling price to its customers is $ 2,600 per bathtub, which means that there would be lost contribution.

In this question, Emma is entitled to input tax credits for any GST incurred on the purchase of the goods (Frankel, 2008). Therefore, Emma’s fringe benefits include the vehicle she received from the company, reimbursements on expenses incurred while using the vehicle, and the loan she received. Below are her fringe benefit tax consequences:

Car allowance- The firm bought her a car costing $ 33,000, which was subject to GST. However, Emma is entitled to receive an input tax credit for GST she would have incurred. The GST rate is 10%. Emma would therefore pay. However, this amount would be credited implying that she would not incur it (Gentry, 2012). Therefore, the total amount for the car allowance eligible for fringe benefit is which is deductible under the income tax act sec 58.

Reimbursement for expenses incurred on car- Emma incurred a cost of $ 550 for repairs and other expenses relating to the vehicle (Kenny, n.d.). Periwinkle Pty Ltd. However, the firm reimbursed this Emma this amount. This means that this is a fringe benefit, which is deductible.

Loan borrowed- Emma borrowed a loan from the company of $ 500,000, which was subject to a 4.5% interest rate. She used some of this money buy a home worth $ 450,000 while she gave the remainder of $ 50,000 to her husband to buy stock. Here, the holiday home is private property to her and therefore no interest would be deducted on it (Jacob, n.d.). The purchase of shares is an income generating investment, which is interest deductible. However, since the purchase of shares do not generate income for her but her husband and therefore she will not pay any interest on it. In this case, only the principle of $ 500,000 is eligible for fringe benefits and is deductible under the income tax act sex 58.

Emma therefore incurred a fringe benefit tax liability of $ 259,822.50 as shown below:

Part B

Considering that Emma used the remaining $ 50,000 to purchase shares herself, she would be subject to interest, which would be deductible for tax purposes (Meredith, 2014). According to the case study, any interest incurred or accrued while buying or investing in an income generating asset is deductible (Marks, 2009). Emma acquired the loan on 1 September 2015 up to 31 March 2016 is eight months. Below is the interest she paid during that period.

This shows that for the period ending 31 March 2016, Emma was liable to pay an interest amounting to $ 1,500 (Frankel, 2008). The interest would be added to the loan before claiming any fringe benefits as shown below:

Emma’s fringe benefit tax liability would be $ 255,240 as shown below:

From the calculation above, Emma is liable to pay a fringe benefit tax of $ 259,087.5. If she lent the $ 50,000 however to her husband to buy the shares from Telstra, she would have incurred a higher amount (Azam, n.d.). In the previous assumption, the $ 50,000 was not used by Emma to buy the shares from Telstra, therefore she is not liable to pay the interest but her husband is (Holbik, & Macaulay, 2010). This means that in the previous assumption, no interest was charged for the purchase of income generating investment (‘Singhania, & Singhania, 2013). In this question, since she was the one who used the $ 50,000 she would be liable to pay interest before taxing the fringe benefit.

References

Azam, R. (n.d.). Couples Taxation in Israel: A Call for Separate Taxation. SSRN Electronic Journal. Retrieved on 13 September 2016.

Berube, W. & Pinto, C. (2010). Taxation, tax policies and income taxes. New York: Nova Science Publishers. Retrieved on 13 September 2016.

Gentry, W. (2012). Capital Gains Taxation. Palgrave Dictionary of Economics. Retrieved on 13 September 2016 from doi:10.1057/9781137336583.0201.

Frankel, V. (2008). Fringe benefits. New York: NAL Jam. Retrieved on 13 September 2016.

Holbik, K. & Macaulay, H. (2010). Fringe Benefits and their Federal Tax Treatment. The Journal of Finance, 15(3), 453. Retrieved on 13th September 2016 http://dx.doi.org/10.2307/2326211/

VanDorn, W. G., Allen, M. S., & Bailey, A. C. (2009). Taxation. Eagan, MN: West. Retrieved on 13 September 2016.

Engdahl, S. (2011). Taxation. Farmington Hills, MI: Greenhaven Press.

Retrieved on 13 September 2016.

Indexing capital gains. (2010). Washington, D.C.: Congress of the U.S., Congressional Budget Office.  Retrieved on 13 September 2016.

Jacob, M. Cross-Base Tax Elasticity of Capital Gains. SSRN Electronic Journal. Retrieved on 13th September 2016 from http://dx.doi.org/10.2139/ssrn.2466298/

Rumpf, H. A., & Miller, H. E. (2009). Taxation. Englewood Cliffs, NJ.

Retrieved on 13 September 2016.

Kenny, P. Realisation versus Accruals Capital Gains Taxation in Australia. SSRN Electronic Journal. Retrieved on 13th September 2016 from http://dx.doi.org/10.2139/ssrn.2340884/

Marks, B. (2009). Understanding fringe benefits tax in Australia. North Ryde, N.S.W.: CCH Australia. Retrieved on 13 September 2016.

Ricardo, D. (2012). On the principles of political economy, and taxation. Düsseldorf: Wirtschaft und Finanzen. Retrieved on 13 September 2016.

Salanié, B. (2011). The economics of taxation. Cambridge, Mass.: MIT Press. Retrieved on 13 September 2016.

Singhania, V. K., & Singhania, K. (2013). Taxmann’s taxation of fringe benefits: With fringe benefits tax planning on CD: Also incorporating CBDT’s explanatory notes on FBT (circular no. 8/2005, dated 29-8-2013). New Delhi: Taxmann Publications. Retrieved on 13 September 2016.

Meredith, F. M. (2014). Fringe Benefits. Columbia, MO: Tigress Press. Retrieved on 13 September 2016.

 

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