TAXATION LAW ASSIGNMENT QUESTION -
Fred and Wilma Hardrock have been married for many years.
They live in Sydney (NSW) and own an investment property in Townsville (Qld) at 1 Angel Place, Annandale, purchased in 2010 for $310,000. The annual rent from the property is $60,000. They share the profits and losses from the investment property equally after allowing for a salary of $20,000 a year to Wilma. They agreed at the outset of their marriage that their financial affairs would remain separate.
Over the years, the annual expenses for the Angel Place property have been steady at $2,500 for insurance, and $3,000 for agent's fees.
Wilma stays at home to care for their children, but deals with all the day-to-day issues in relation to the investment property, including negotiations with real estate agents, current and potential lessees, government bodies and others. Fred keeps the books for the property (as part of his record-keeping for his consulting activities), but does not have much time to devote to the property, and generally just discusses important issues with Wilma from time to time.
Fred is a consulting engineer in the mining industry, and has a home office which he uses as the base for his consulting operations. He investigated the consulting market for 12 months to determine the viability of the market (spending $5,000 on feasibility studies and expert advice), and then started out in 2010 on a very small scale, giving paid advice to 2 friends. However, he has built up his consulting operations and in 2013 resigned from his full-time job as a real estate salesman and devoted himself full-time to consulting. At that stage he had around 30 clients, and an average gross income of around $15,000, with expenses of $20,000.However, since 2015, he has had a steady clientele of some 500 clients, and an average annual income of $200,000.
Every year since 2012, Fred has claimed a deduction for 100% of the costs of his home office (electricity and lighting ($300),fire insurance ($500), newspapers ($350) and subscriptions to engineering journals (250)). Fred spends 80% of his time in the home office on consulting work, and 20% playing computer games in order to relieve the stress of his work.
Fred has also claimed deductions each year for travel from home to and between clients' premises where he attends on weekdays to provide on-site advice and to solve on-site problems. The number of clients Fred sees varies from day to day - sometimes he may visit only one client's premises, on other days he may visit up to 6. In the previousyear, Fred visited the premises of each of his clients at least once, with total motor vehicle costs of $15,000: $4,200 being the costs of travelling from his home to his first (or only) client's premises, $9,600 being the costs of travel between different clients' premises, and $1,200 being the costs of travel to and from his monthly Art Appreciation classes.
Since the consulting operations have been so profitable, Fred has become quite a collector of antique furniture. He regularly buys dinner table sets (usually comprising a table and 4-6 chairs). He recently purchased an Edwardian dinner table set (more than 110 years old) for $1,600 ($400 for the table and $300 for each of the 4 chairs).In accordance with his normal practice, as advised by his former tax adviser, Fred had negotiated with the vendor to buy each piece of the set separately.Soon afterwards, Fred received an offer of $15,000 for the set and again in accordance with his normal practice, sold each item to his buyer separately (the table for $5,000 and the chairs for $2,500 each).
Last year, Fred and Wilma spent $11,000 refurbishing the Townsville property: $8,000 to fix a decaying wall in the kitchen, and $3,000 to replace light fittings and windows in the lounge room. The kitchen wall has always been a problem, though it has worsened considerably in the last 18 months. The light fittings and windows were broken during a cyclone that struck Townsville last year. Wilma replaced the light fittings ($1,200) and installed stronger, cyclone-proof windows in all rooms, to prevent the problem recurring ($500 per room).
In light of the ongoing problems, Fred and Wilma decided to sell the Townsville property, and have accepted an offer of $850,000 from a developer, Mo Land.
Because things had been going so well and the potential sale of the Townsville property seemed imminent, Fred recently told Sam Sneak, a former tenant who owed $2,500 in unpaid rent, not to worry about repaying the debt, saying that "all is forgiven". The debt had been outstanding for some 12 months, and Sam had indicated that they would probably not be able to repay it. Wilma plans to claim a deduction for the $2,500 in her next tax return.
Some years ago, Fred and Wilma set up a discretionary family trust, with their children (Barney and Betty) as beneficiaries. Both children are in their early twenties, but Barney was diagnosed in 2016with a serious mental illness and is currently in a psychiatric institution.
In the 2016/17 income year, the trust estate earned income calculated under trust law principles of $90,000. The net income of the trust estate, calculated under s 95 ITAA36 was $120,000, because some of the expenses allowable under trust law principles are not deductible under taxation law. Fred as trustee had in the past distributed the income from the trust equally between Barney and Betty, but in light of Barney's illness, in 2016/17 while Fred allocated the usual 50% of trust income to Betty, he allocated only 30% to Barney, and held the remaining 20% in the trust pending Barney's recovery.
The Australian Taxation Office has just written to Fred and Wilma, advising them that they have been selected for a tax audit. Fred and Wilma accordingly come to you for advice.
ADVISE Fred and Wilma on:
1. The potential assessability for income tax purposes to Fred and/or Wilma of any of the events outlined above.
2. The availability of a tax deduction for any expenses mentioned above.
3. Any tax implications relating to the family discretionary trust.
Attachment:- Assignment File.rar