Revenue law and taxation
At the start of the 2015 income year, Luke and Linda Lucky set up an eBay account to sell some of their belongings and save for an overseas holiday. Setting up the account was free. During this first income year, their total sales were $20,000 and this all related to second hand personal items sold below their cost or items sourced cheaply from garage sales or giveaways. However, Luke and Linda discovered through this process there was an untapped market for low-cost home decorator items.
Therefore, at the start of the 2016 income year, Luke and Linda began to import low-cost home decorator items that are similar to expensive designer pieces. They sell the items through their eBay account. Luke and Linda have spent $16,000 during the 2016 income year acquiring stock. Some of the stock is sold exactly as it was purchased, whereas some stock is modified through embellishments, painting, customisation etc. All listings are made with a minimum bid price that represents 210% of the cost price. Up until 30 June 2016 Luke and Linda have made total sales of $38,000 in relation to sales of stock items. Their current orders in progress show a 30% increase in sales volume for July 2016 compared to the same month the previous year.
During the income year, one of Luke and Linda’s customised items was featured on a popular home renovating TV show. This resulted in an influx of orders that they would not have been able to fill given the small nature of their business. They therefore sold the rights to their design to a large retail company and were paid a lump sum of $200,000 in exchange for transferring the original design, existing stock and materials to the company. The agreement states that they are entitled to $1.20 per additional item sold for a period of 12 months, after which all rights to manufacture the items rest with the retail company. Up to 30 June 2016, 20,000 items had been sold by the retail company, with payment due to be received in July 2016.
Luke currently has a full-time job as an engineer and Linda works part-time as a teacher. Linda is also working on a website which will launch in May 2017. The website will allow them to sell their stock directly online without the need for eBay auctions.
- a) Discuss with reference to appropriate legislation, case law and/or rulings whether Luke and Linda are carrying on a business for taxation law purposes in either the 2015 or 2016 income years. b) Discuss with reference to appropriate legislation, case law and/or rulings whether any amounts received in relation to the sale of the design are ordinary income in the 2016 income year c) Briefly discuss with reference to appropriate legislation, case law and/or rulings whether the cash or accruals basis of accounting would apply to Luke and Linda.
Baby Warehouse: Baby Warehouse is a retail baby goods business located in far north QLD. Following a cyclone, its main retail premise in Cairns was damaged. The cyclone caused substantial damage to the roof and car park. The car park gravel surface had been washed away leaving many holes and loose stones. This has left it unsafe and unattractive to potential customers. The engineer’s report estimated that about 50% of the carpark was damaged. The owners were advised by an engineer that should a cyclone occur again, the damage would be even greater. Therefore it was decided that the entire car park be resurfaced and replaced with reinforced concrete. It was estimated to have cost $110,000 to replace the gravel in the carpark with new gravel, whereas the new concrete is costing the company $200,000. This amount was paid on 30th June 2016.
Additionally, the company paid $42,000 to have the whole roof replaced. The cyclone caused damage to several parts of the roof and guttering causing it to leak. The building is approximately 4 years old. The same materials were used as was previously used on the roof (ceramic tiles). It would have cost $30,000 to have all the broken tiles replaced. The company was invoiced for the $42,000 on 1 June 2016 and paid a deposit of $10,000 at that time. The remaining amount was paid on 15 July 2016. The roof construction work was completed on 15 May 2016.
As a result of the cyclone damage, considerable financial strain has been placed on the business. Baby Warehouse has joined a group of local business people who are considering legal action against the council for failure to implement and erect up-to-date cyclone warning systems. The lobby group believes that these warning systems would have given business owners more time to put in place protection strategies for their businesses. Already the group has engaged a lawyer and Baby Warehouse’s share of these legal fees for the 2016 income year was $15,000. It is envisaged that mediation will occur in the 2017 income year. If a positive outcome is reached for the group, this is likely to be in the form of compensation to cover loss of income and repair costs.
Required: Discuss with reference to appropriate (and most relevant) legislation, case law and/or rulings whether the expenses described above are deductible for Baby Warehouse in the 2016 income year. You should discuss each tax issue separately.
Format required:- Legal Issue> Law> Application> Conclusion.
Identification of legal issues, legislation and case law: Overall the student has identified the deduction issues, legislation and where appropriate case law and rulings.
Application: Demonstrated level of understanding of the repair and timing issues in relation to Baby Warehouse through the application of the identified law.
Demonstrated level of understanding of the legal expense deduction issues through the application of the identified law.
Conclusions: Overall, the student has drawn appropriate and valid conclusions after applying the law.