Cassandra Pty Ltd, an Australian resident company for tax purposes, purchases land with a derelict building on it in Melbourne on 1 January 2014 for $500,000. Between 1 January and 1 February 2014 Cassandra Pty Ltd spends $100,000 on demolishing the derelict building. On 2nd February 2014 Cassandra Pty Ltd enters into a contract with Oz Build Pty Ltd (an Australian resident company for tax purposes) to construct a theatre building on the Melbourne land. The total cost of construction was $1,000,000 with Cassandra Pty Ltd paying a deposit of $100,000 on signing the contract and making nine progress payments of $100,000 each month during the period of construction.
Cassandra Pty Ltd borrowed $1,200,000 from Big Bank Ltd (an Australian resident bank) on 15th January 2014 on an interest only basis at a rate of 5% to partly fund the purchase of the land and the construction of the theatre building. The balance of the purchase price and costs of construction were paid from Cassandra Pty Ltd’s retained earnings. Cassandra Pty Ltd paid stamp duty of $10,000 on the purchase of the land. Legal fees associated with the purchase of the land were $2,000.
Construction of the theatre is completed on 1 October 2014 and, following a month of rehearsals, the first play, ‘The Paris Of The South’, performed by Cassandra Pty Ltd takes place. The play is successful and Cassandra Pty Ltd’s revenues from the play for the year ending 30 June 2015 were $200,000.
Following the successful season of ‘The Paris Of The South’, Cassandra Pty Ltd decides to produce Bizet’s opera ‘Carmen’ at the theatre. Because of the scale of the opera Cassandra Pty Ltd spends $150,000 on enlarging the stage at the theatre and $200,000 on construction of an orchestra pit on 1 February 2016. Cassandra Pty Ltd pays for the cost of enlarging the stage from its retained earnings. Following the enlarging of the stage and the construction of the orchestra pit, performances of Cassandra Pty Ltd’s production of ‘Carmen’ commence on 1 March 2016 and run until 30 June 2016. Cassandra Pty Ltd has revenues of $150,000 from this season of ‘Carmen’ at the Melbourne theatre.
Oscar Pty Ltd, an Australian resident company for tax purposes, purchases the land and theatre building from Cassandra Pty Ltd on 1 July 2016 for $3,000,000. Cassandra Pty Ltd uses the $1,200,000 of the sale proceeds to repay the loan from Big Bank Ltd. During the entire period of the loan interest had been payable at the rate of 5% per annum on an interest only basis. Cassandra Pty Ltd paid interest at that rate each month through the term of the loan.
Shortly after Oscar Pty Ltd purchases the theatre Melbourne suffers a mild earth tremor. At about the same time Oscar (the sole shareholder and director of Oscar Pty Ltd) watches a documentary about earthquake damage in Christchurch New Zealand. As a result Oscar decides to have strengthening works carried out on the theatre building in Melbourne so that it can withstand an earthquake of similar force to the Christchurch earthquakes. Earthquakes are very rare in Melbourne and there has never been a recorded incidence in Melbourne of an earthquake of the same force as any of the Christchurch earthquakes. Oscar is advised by his engineer that the strengthening works will only increase the life of the building if there is an earthquake of equivalent force to the earthquakes that have occurred in Christchurch.
The strengthening works commence on 10th July 2016. Oscar Pty Ltd agrees to pay the builder (Earnest Constructions Pty Ltd, an Australian resident company) on an instalment basis throughout the works. The total amount payable will be $500,000 payable by 4 equal instalments over a sixteen month period. The first instalment is paid on signing the construction contract on 1 July 2016. The contract calls for each of the remaining instalments to be paid on the first day of November 2016, the first day of March 2017, the first day of July 2017 and the first day of November 2017.
Oscar Pty Ltd opens the theatre as The Wild Theatre. The first play that is performed at the theatre is ‘Boy versus Wild’ written by Oscar. In December 2016 Oscar Pty Ltd employs carpenters, stage and lighting technicians, a finance manager, and a marketing manager. The salary cost for these employees is $15,000 per week. Oscar directs the play himself. Oscar Pty Ltd also spends $50,000 in January 2016 for material to be used in constructing sets for the theatre. After the play has been performed the sets will be demolished and sent to the local Waste Disposal Centre. Oscar Pty Ltd also enters into contracts with several actors to rehearse the play for six weeks and perform in the play for a period of three months. The contract with the actors sets their pay at $500 per rehearsal and $1000 per performance increasing to $1500 per performance if more than 50% of performances in the first month are sold out.
After six weeks of rehearsals in February and March 2017 ‘Boy versus Wild’ opens at the Wild Theatre on 1 April 2017. Unfortunately for Oscar Pty Ltd and the actors none of the performances in September are sold out. Patrons in the theatre complain about the disruption to access caused by the earthquake strengthening works that are still proceeding. As a result Oscar Pty Ltd refuses to pay the 1 July 2017 and 1 November 2017 instalments on the building works. Earnest Constructions Pty Ltd commences court proceedings for breach of contract and suspends the building works on 2nd November 2017.
1. Advise Cassandra Pty Ltd of the capital gains tax consequences of the above transactions for it. 10 Marks
2. Advise Oscar Pty Ltd as to whether, and if so when and to what extent, any of the above expenditures that it incurs will be deductible to in for Australian income tax purposes. 10 Marks
3. Advise Ernest Constructions Pty Ltd as to whether and, if so, when the instalment payments in relation to its contract with Oscar Pty Ltd will be included in its assessable income. 5 Marks
Students who believe that further information is required before giving a definitive advice on any of these issues should state clearly what that information is and should state clearly what assumptions they have made in answering the question. No further information about the facts of the question will be provided by lecturers or on Moodle.
REFERENCES – students may find the following references useful in answering the assignment but are not required to refer to these authorities and can refer to other authorities if they consider them to be relevant. Although the list might look intimidating, what is required is ascertaining the relevant principle and applying it to the facts.
Income Tax Assessment Act1997
s6-5; s8-1; s25-10; Div 40 generally and in particular s40-180; s40-185; s40-195; Div 43 generally and in particular s42-210; s43-230 and s43-235; s103-15; s104-10; s108-55; s110-25; s110-35; s110-45; s116-20
Wangaratta Woollen Mills (1969) 119 CLR 1 (what is plant)
Imperial Chemical Industries of Australia and New Zealand Ltd v FCT (1970) 120 CLR 396 (what is plant)
Carpentaria Transport Pty Ltd v FCT (1990) 21 ATR 513; 90 ATC 4590 (what is plant)
Broken Hill Co Pty Ltd (1969) 120 CLR 240 (treatment of costs of demolition)
Arthur Murray (1965) 114 CLR 314 (advance payments)
J Rowe & Sons Pty Ltd(1971) 124 CLR 421 (instalment sales)
W. Thomas & Co (1965) 115 CLR 58 (initial repairs)
Placer Pacific Management Pty Ltd 95 ATC 4459 (post cessation expenditure)
Steele 99 ATC 4242 (pre commencement expenditure)
Commonwealth Aluminium (1977) 77 ATC 4151 (defeasible obligations)
Carden(1938) 63 CLR 108 (and other cases on the cash v accruals issue)
Australian Gas Light Co 83 ATC 4800 (contingent right to payment)
BHP Billiton Petroleum (Bass Straight) Ltd2002 ATC 5169