Smart & Clever Ltd. Case Study
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This report was commissioned by Smart & Clever Ltd . Its purpose is to advise the shareholders and the company on the tax implications of their transactions or intended decisions. Smart & Clever was formed in 2003 to buy, subdivide land and construct houses for sale. There has been a capital gain of $300,000 in the 2005 income year and the company gave a loan of $50,000 and brought a boat. There are also some questions over the sale of other property not owned by the company and also questions concerning the family trust. Research has been made on the relevant primary and secondary resources. This report analyses the problems and offers recommendations on how handle them.
Profits made on the sale of shares can be taxed primarily according to the three situations set out in IT04 ss CB 2, CB 3, CB 4. These situations occur when the taxpayer is in the business of dealing in personal property, the personal property had been acquired for the purpose of resale and any amount derived from the transactions has arisen from a profit making undertaking or scheme. Company shares are a form of personal property for the purposes of IT04 ss CB 2, CB 3, CB 4 as s OB 1 defines personal property in relation to ss CB 3 and CB 4 as not including land or an interest in land personal property lease asset and means any personal property subject to a lease; and does not include any livestock or bloodstock. In the case of C of IR v National Distributors Ltd (1989) 11 NZTC 6,346 (CA) the tests to apply when determining whether shares were acquired for the purpose of resale were considered.
The key issues to come out this case are
was the taxpayers dominant purpose in acquiring the shares was that of resale
knowledge that the shares would not be owned for ever did not by itself make proceeds from a subsequent sale taxable
a taxpayer who buys shares for no specific purpose other than general financial benefit will satisfy the onus of proving resale was not the main purpose of purchase
In applying these facts to Garys case it would appear that Gary is not in the business of buying and selling and that he brought them with no specific purpose other than general financial benefit. Gary therefore would be liable for tax on the gains made from these shares.
The sale of Garys shares does not have financial arrangement implications ss EW 5(12) states that a share, or an option to acquire or to dispose of shares, is an excepted financial arrangement, if the share is acquired, or the person becomes a party to the option, on or after 20 May 1999. The assumption has been taken that Gary acquired his shares after 20 May 1999 and there fore the share transactions are excluded from the term financial arrangement.
We need to ascertain if Garys niece is an associated person. S OD 7(c) defines any two persons associated if they are relatives, relatives are defined in s OB 1(c)(i) as a person connected with another person by blood relationship, that is, one is within the fourth degree of relationship to the other. Section GC 15(1) states that if a benefit were it provided to an employee would be a fringe benefit is provided to an associated person it is deemed to have been provided to the employee.
The meaning of a fringe benefit is set out in s CX 2(1)(a) and states a fringe benefit is a benefit that is provided by an employer to an employee in connection with their employment; and arises in a way described in sections CX 9. Section CX 9(1) states that a fringe benefit arises when an employer provides a loan to an employee.
The amount of fringe benefit tax to be paid on the loan will be work out on the amount by which the prescribed interest on the loan is more than the amount of interest that accrued on the loan in that period according to ss ND 1d(a) of the Income Tax Act 2004.
The use of the boat falls under entertainment as set out in s CX25(2) which states entertainment as described in s DD2 is a fringe benefit when the employee does not receive or use it in the course of employment or consequence of their employment duties and the employee may choose when to receive or use the benefit. Section DD 2(4)(a) includes the use of pleasure craft as entertainment.
The use of the boat by Alan and Gary is a benefit provided to shareholder-employees and maybe considered as a dividend or fringe benefit under s CD 12(1) which states that unclassified fringe benefits provided to an employee who is a shareholder maybe treated as a dividend if the company chooses, under section CX 16(2). Section CX 16(2) states that when a company has provided a non-cash benefit to an employee who holds shares in the company, the company may choose to treat the benefit as a fringe benefit or a dividend. Section CX 16(5) explains that if the company chooses to treat it as a dividend it must give notice to the Commissioner of the election referred to in subsection (2) within the time allowed for filing a fringe benefit tax return for the period in which the benefit was provided. There is an exclusion to s CX 16(2) set out in s CX 16(3) and it states that s CX 16(2) does not apply when a non-cash benefit is provided by a company to a non-executive director of the company.
When considering if the capital gains made by Smart & Clever are taxable we to see what constitutes income when selling land. The New Zealand Master Tax Guide (2005), states that gross income includes all amounts arising from the sale of land if it was acquired for the purpose or intention of sale. The intention for sale must have been there at the time of purchase as property brought with no particular intention and then sold at a capital gain will not amount to a purpose of sale. The Income Tax Act 2004 sets out the rules for the sale of land acquired for land development or subdivision business in s CB 8. section CB 8 states an amount that a person derives from disposing of land is income of the person if they dispose of the land within 10 years of acquiring it; and at the time they acquired the land, they carried on a business of developing land or dividing land into lots, whether or not the land was acquired for the purpose of the business.
To see if Alan Smart and Smart & Clever Ltd are associated persons again we need to look at s OD 7(1)(b)(i)(ii) which states a company and any person where at the time the person has a voting interest in the company equal to or exceeding 25%; or in any case where the person has a market value interest in the company equal to or exceeding 25% will be associated.
If the shares of Smart & Clever were to be owned by the family trust they would be associated as s OD 7(1) has a special