Phil enters into a contract to purchase a restaurant (including the premises) for $800,000 which he wishes
Question:
Phil enters into a contract to purchase a restaurant (including the premises) for $800,000 which he wishes to continue to run as a restaurant for the indefinite future. However, the restaurant becomes unprofitable, so a year later, he arranges for the business to borrow $200,000 from his friend Donna (at commercial interest rates). However, it appears that the loan is unable to be repaid because the restaurant continues to lose money.
Consequently, Phil and Donna enter into a plan, where in exchange for the loan being forgiven, the premises and land on which the restaurant is located on are to be sold, and Donna is to be entitled to 50 per cent of the profit from the sale. After the agreement is entered into, Phil and Donna arrange for the restaurant premises to be demolished, the land subdivided into two lots, which are then sold separately. As agreed, the profits from this sale are split 50/50 between Donna and Phil.
Required: Ignoring capital gains tax, discuss whether Donna's share of the profits generates ordinary income.
Where appropriate, support your answer with legislative and case authority.
Auditing Cases An Interactive Learning Approach
ISBN: 978-0132423502
4th Edition
Authors: Steven M Glover, Douglas F Prawitt