Portfolio Report Instructions
Learning Outcomes
Understand and evaluate fundamental tax concepts relating to income and deductions.
Critically reflect on taxation problems arising in relation to individuals, business entities and trading structures. Communicate appropriate technical advice in relation to these problems.
Objective
Consider the various income and deduction scenarios set out below and provide appropriate technical tax advice.
TRADING STOCK
1. What role does trading stock play in income measurement?
2. Briefly describe the objective of section EA 1 and section EB 3 and explain how this objective is achieved.
3. Can the following items/services be trading stock?
Give a brief statement of the reason for your "yes" or "no" answer.
- Shares
- Land
- Services that a professional firm refers to as "work in progress"
- Spare parts held for warranty purposes
- Spare parts held for minor repairs to the taxpayer's machinery
- Consumable aids
4. Smooth Dudes Ltd manufactures shoes. It has filed a tax return and has had an assessment. A review of the company's tax accounting by its auditors shows that the company could pay less tax if it used the replacement method (rather than the cost method) of valuing trading stock.
Smooth Dudes Ltd asks you as their tax advisor if they can change their trading stock valuation method choices in their tax returns and claim refunds. The last four year's income tax returns are not statute-barred.
5. Gun Manufacturer Mike decides to sell his manufacturing business, Lock, Stock and Barrel. He sells his business to a friend. The business is sold for $2.1 m. made up of:
Guns $250,000
Ammunition $50,000
Plant & machinery $300,000
Land $1,000,000
Building 500,000
Total sale price $2,100,000
Mike's accountant recommends that Mike may be able to minimise his tax exposure on the sale of the guns, ammunition and plant & machinery by attributing a larger portion of the arms-length value to the land. The figures in the sale and purchase agreement appeared as:
Guns $120,000
Ammunition $30,000
Plant & machinery $150,000
Land $1,300,000
Building 500,000
Total sale price $2,100,000
Is there any tax risk inherent in the advice provided by Mike's accountant? Explain your reasoning.
DEPRECIATION and CAPITAL/REVENUE BOUNDARY
Table 1: Capital/Revenue Boundary
For each of the situations, identify the asset and consider whether the items constitute a repair (deductible) or a replacement (capital).
Assume that all of the assets referred to are used for business purposes.
Table 2: Dilapidation Repairs
For each of the questions, decide whether the item is deductible or not and give a brief reason for your decision.
DEPRECIABLE INTANGIBLE PROPERTY
Bruce has taken up a 7 year non-renewable franchise agreement for the operation of a restaurant in a prime Tauranga location. The franchise cost Bruce $140,000. The agreement provides that the franchise will terminate if Bruce does not meet the turnover target set for the restaurant. Bruce has difficulty getting good staff, and a significant competitor business has opened up nearby.
After 4 years, Bruce's restaurant business has not met the turnover targets. At the beginning of year 5, the franchisor terminates the agreement.
What is the tax treatment of the franchise agreement payment of $140,000?
What is the adjusted tax value of the franchise at the end of year 4? How should Bruce treat this amount for tax purposes?
TABLE 1 :: CAPITAL/REVENUE BOUNDARY
Magic Motors tow truck is not running smoothly. The truck has a damaged head. Magic Motors fit a new motor of the same type and size
A wild storm on Wellington's southern coast blows all of the windows out of the airport control tower. All of the windows are replaced.
The external security fence of a privately operated prison farm is in poor condition. Three dangerous prisoners have escaped. The fence is dug up, removed and replaced.
The landlord of a commercial office building decides to replace all of the carpeting in the office building.
The landlord of a block of residential flats replaces all of the single-glazed windows with double-glazed windows to reduce noise and condensation.
A 100 metre long tar-sealed driveway is in need of resurfacing. Before the seal work is done, the driveway is extended by 20 metres. The extension cost for the extra 20 metres is capitalised. The entire driveway is resealed at a cost of $12,000.
A hotel operator that owns the 7 storey hotel land and buildings replaces the suspended ceiling and decorative staircase in the street level reception area
TABLE 2 :: DILAPIDATION REPAIRS and DEMOLITION COSTS
Does Inland Revenue's policy allow a deduction for repairs to a recently acquired assets in some circumstances?
Does the price paid for the asset have an influence on the deductibility of repairs carried out soon after purchase?
Zoom Air acquires a second-hand helicopter for its scenic tourism business. Two weeks after acquisition, the helicopter is due for its annual check-up. Is the cost of the check up and work done as a consequence deductible?
Zoom Air acquires a helicopter that is in poor condition. Zoom pays $150,000 for the helicopter. Zoom spends $70,000 making the helicopter safe and flyable. Is the $70,000 cost deductible?
LEASE PAYMENTS and RECEIPTS
Alex is the landlord of a number of properties. He knows that there have been changes to the tax treatment of lease incentives. He asks you to set out in table format the income tax treatments for both the landlord and the tenant of the following situations. Assume that there is a six year lease in place for $240,000 pa.
1. Alex pays $60,000 up front cash inducement to a new tenant.
2. Alex gives the new tenant a 3 month rent-free holiday (amounts to $60,000).
3. Alex makes a $60,000 contribution to the new tenant's fit out. The tenant will own the fit out. The fit out will cost $90,000 in total.
4. What will happen for each of the scenarios 1-3 above if the building is sold two years into the six year lease?
5. Assume that, instead of the landlord selling, the tenant wishes to surrender (give up) her lease. She will pay an agreed surrender fee of $70,000.
6. If there is a right of renewal for a further six years, does this change the tax treatment of the inducement, rent-free holiday or fit out contribution?
LAND TAX - BRIGHTLINE TEST
Kevin Lee is a Chinese national who has been active in the New Zealand property market. He has asked you to provide advice on the following situations.
1. Kevin is not sure whether he has met the information requirements that apply to his property transactions. Summarise for Kevin the information and obligations for Kevin as a non-resident.
2. Kevin entered into a contract (contingent on the title being issued) to buy an apartment off the plan in a new development in Queenstown. The contract was dated 31 August 2015. Title for the apartment was obtained in June 2016. Kevin signs a contract to sell the apartment in July 2016.
3. Kevin bought a serviced apartment in Auckland on 10 November 2015. He leased the serviced apartment to a management company. The company offered the apartment to the public for short term lettings. Kevin's lease is with the management company, not with the visitors and holiday makers who rent the apartment. Kevin decides to sell the apartment within two years of buying it.
4. Kevin also bought a house in Auckland in November 2015 for $950,000. There was a slump in the New Zealand property market. In July 2017 Kevin sells the property for $820,000.