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Taxation Law And Practice : Determination Of Income

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Taxation Law And Practice : Determination Of Income

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Question:
Describe about the Taxation Law and Practice for Determination of Income.
 
Answer:

Introduction:
Refer to the case study of Rip Pty Ltd it has been observed that the company needs proper guidance as per the Income Tax Law for determination of their income for the purpose of income tax considering revenues under different head with the proper conclusion to suffice the purpose of Income tax as per the law prevailing in Australia. Three are certain questions or situations given in the case study which are to be answered with proper guidance to the company. We are giving below the solutions to the questions to be answered with proper justification and with proper referencing with prevalent case studies.
Part A:
i) Refer to the decision in Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314. briefly describe the facts, issues and conclusion in that case.
Case study of Arthur Murray (NSW) Pty Ltd V FCT (1965) 114 CLR 314
Facts:
The company, Arthur Murray (NSW) Pty. Ltd was dealing with teaching students dances through the organization which was employed in the business of a dance school. The school used to collect the fees in advance from the students which the school accounted in a suspense account as per their normal accounting practice. The amount taken in advance for the charges of dancing school lessons had been kept in suspense account till the time the lessons had been extended to the students and after the time of rendering the lessons to the student, the said amount is going to be transferred to the revenue account of the company. Although there was no provision of refunding the amount as per the system for the students who were not attending the classes, there was the provision of making refund to the students as a normal practice for their non-attending the dancing course. The situation was creating confusion at the end of the Income Tax authority for determination of income of the company for a particular financial year related to derivation of income(Diane, 2015).
Issue:
The issue was raised about the status of the pre-paid money in lieu of tuition fees in advance in respect of the nature of the amount received as tuition fees in advance. The issue was the nature of the amount for the determination of the income of the company. The issue raised was if the amount of pre-paid fees for tuition had been derived as revenue in the year pertains to which the tuition fees had been accepted or in the financial year the amount of pre-paid tuition fees had been accepted(Diane, 2015).
Observation:
It is being observed going through the books of accounts of the company that the amount received as pre-paid tuition fees were being treated as advance payment till the time the service had been rendered to the applicants. In this situation, the court has to determine the nature of advance payments in respect of the revenue of the company.
 
Court observations and justification:
The Court had gone through the case with the merits and demerits to find out the gains the company enjoyed through this practice. The basic objective of the Court is to find out what gains the company had enjoyed through the process with the concept of Come Home of gains and to find out that the amount thus received is to be derived as real Come Home of the tax payer so far gains are considered. The Court tried to find out if the amount received as advance payment had been properly treated in the accounts of the tax payer as a gain to ensure the legality or soundness of business is affected so far the amount in question is considered taken as advance. It was being observed that the amount received such as advance payment was not putting any barrier legally in the proposition of the choice of the recipient with the amount as per its choice, the factor towards proving goodness of business on the part of the recipient to keep the money in contingency account with the concept of probability of paying it back fully or partially, with the provision of damages to be repaid. That is the hidden nature of those receipts. It was also being understood that the amount treated such can not be treated as income of the tax payer and to be treated as quality of revenue(IRD, 2006).
It is being observed that as per the normal practice of accounting and commercial practices, the amount such received as advance payment for the sales of goods or the services to be rendered was not considered as an amount to be credited to any revenue account till the time the goods sold or service rendered to the applicant who had paid the money in advance for the said purpose.  Hence the treatment of that amount in accounts is to be made by booking the same in suspense account with the next step of forwarding the same to revenue account when the goods had been physically sold with delivery or the service extended with the facility forwarded with the proof of discharge of obligation for which the advance payment was being justified and then the amount of revenue can be considered as income as epr the characters specified in the accounts(IRD, 2006).
Conclusion:
The Commissioner had considered the view ( MTG9-090) that this case may be treated as case reference in case of advance payment are treated as contingency amount and kept in suspense account to prove that the nature of this income should be treated as unearned income account of the taxpayer and would not be treated as income till the time the amount received as advance had been properly executed through the process of sales or services made with the effect of a balance day adjustment is done to gross revenue account for the purpose of exclusion  of gross revenue from unearned income to derive actual profit and loss account. There arose the argument of three situations which are symmetrical to the case of Arthur Murray in case of derivation of unearned income –
Specified term of contract
In case the receiver of the advance payment practices the concept of refund if specified in the contract or not like the example of goodwill,
The refund of payment by the receiver in case of non-execution of contract for the situation of non deliverance of good or services to be meant for(Coursehero, 2015).
The general income of RIP Pty Ltd consists of the income received from standard income for funeral process which are being recovered from insurance companies, like Transport Accident Commission and general life assurance companies for the deceased to whom the services are rendered for funeral on 30 days credit system. The other income derived from funeral services and allied activities are from the RIP Finance Pty Ltd by the fees received under instalment repayment plan.
As the amount received by the company under easy funeral plan is paid in advance, the relevance of Arthur Murray applies as the amount such received is of advance in nature and thus will not be treated as revenue. The amount thus received will be with the nature of unearned income as the amount received so is of advance in nature and should be kept in suspense account till the time the specific service towards funeral plan is being executed. The basic symmetry of RIP Pty Ltd and Arthur Murray case is that both the company is engaged in receiving money for an anticipated service which is due in future and not extending the service immediately after receiving the money. Hence the amount of both cases will be treated as unearned income and not to be booked as revenue in the accounts of the company. The amount meant for executed service is to be transferred from suspense account to the revenue account and will be treated as the income of the company for the financial year when the service is rendered. This situation is with the symmetry of Arthur Murray where the company received amount in advance to extend the tuition for dances from their school in advance. Hence as per Arthur Murray case, the amount of revenue to be identified for the purpose of Income tax purpose for any financial year is to be derived with the actual execution of the service and the respective amount there of to be transferred from suspense account to revenue account to determine the actual amount of income of the company(Ripparoo, 2015).
In case of advance payment received by any company for any sort of service to be rendered in future or any goods to be sold in future, the consideration of income in respect of such receipts is to be treated as unearned income and not to be considered as revenue for the financial year in which the amount had been received but the service had not been extended or the sales of goods had not taken place. The Commissioner has to accept the receipt of such amount as unearned income and to be treated the same as liability in the balance sheet of the company under the head of suspense account. The taxpayer also has to book the amount in their books as unearned income and to be kept in the liabilities to be featured in balance sheet of the company. It is moreover to be stated that the treatment of such amount is not allowed otherwise due to the nature of those receipts as advance payment for which the cause is not executed(Ato, 2015).
 
ii)  Advise the company of the tax treatment of $16,200 in ‘Forfeited Payments Account’ in item (iv).
The amount of $ 16,200 is an accumulated amount which had been generated from the unpaid service charges from the subscribers who had opted for the Easy Funeral Plan but did not continue to pay regular subscription for the said purpose. The same amount is being credited in the Forfeited Payments Account. The treatment of this amount should be in the nature of Reserve and Surplus and to be kept in Asset side of the balance side. This amount is not to be treated as any sort of income of the company, hence does not attract any income tax against this amount as this is not a taxable income for the company. This amount of reserve and surplus can be treated as contingency amount which can be sued for the future to face any such occurrence for which the fund is required. The tax treatment of this amount of $ 16,200 is to be treated as transfer of liability under the accounting head of Easy Funeral Plan to the Asset of Reserve and Surplus under the accounting head Forfeited Payments Account for the taxation purpose(Hines & Bar, 2012).
Part B:
i)  RIP Pty Ltd holds a stock of three types of caskets as well as a range of accessories (such as religious and secular icons). In June 2016 the company prepaid $25,000 for material to be delivered in August 2016. The company obtained considerable discounts for the advance purchase.
As the amount of $ 25,000 had been paid in June 2016 for procuring the trading stocks of caskets and other accessories in advance to get the benefit of good discount, and as the materials will be delivered in August 2016, the amount is to be considered as advance payment to the vendors. The treatment of this amount of $ 25,000 should be done in accounts as current assets under the account head of Prepaid Expenses. As the amount such paid is under the current assets and will be debited to respective consumable account when the goods will be physically received from the vendor, till then the amount will be kept Prepaid Expenses and to be considered as current assets of the company for the tax computation purpose. When the consumables will be delivered, the same amount will be treated as component of profit and loss account through expense head of the company books of accounts under consumables(Ato, 2012).
ii) A fully franked cash dividend of $21,000 was received from RIP Finance Pty Ltd.
Item ii is related to Franked cash dividend of $ 21,000 which was received from RIP Finance Pty Ltd. this is an income in the books of accounts of RIP Pty Ltd and to be considered so for the tax purpose of the company. But as the dividend had been paid or credited from RIP Finance ltd as franked dividend, it is assumed that the dividend had been paid after tax on profit, and to avoid double taxation the tax on franked dividend is not required to be levied on RIP Pty Ltd(Hill, 2013).
 
iii) An amount of $57,000 was paid on 1 March 2016 for two year’s rental of storage space. The lease expires on 28 February 2018. In the company’s financial accounts an amount of $9,500 was expensed and $47,500 capitalised.
The amount of $57,000 had been paid for the rent of the storage space for the financial years 2016-17 and 2017-18. Out of this amount $ 9,500 is being paid for the rent of 2016-17 and is being featured in the profit and loss account as expense for the financial year of 2016-17. Hence this amount is to be considered as the expense in P & L A/c for 2016-17 for tax purpose. For the amount of $ 47,500, the amount had been paid for the advance rental of the storage space. The accounting of this amount is to be considered as Prepaid Expenses and to be featured in current assets of the balance sheet. This amount will not feature in the p & L A/c of 2016-17, but it will feature in the P & L a/c in financial year of 2107-18 as expense for derivation of tax(Austlii, 2001).
iv) On 1 June 2016 the managing director of RIP commenced three months long service leave and was paid $22,000 in advance. In the company’s accounts the amount was debited against a Provision for Long Service Leave Account.
Long service leave is a payment towards the employee for their long term service rendered by them when they cross the tenure of service of 15 years as per I T Rule of Australia under the sub division of 83-B of the Income Tax Assessment Act ,1997(ITAA1997). RIP Pty Ltd had paid the managing Director $ 22,000 on 1st June, 2016 as advance against his Long Service Leave for the subsequent three months and had been debited in the Provision for Long Service Leave Account as a sign of gesture of normal practices of the company. As the amount had been paid under the scheme of the company for rewarding long service leave, the amount is an expense to the company and to be treated in the subsequent months as expense for the tax purpose(Iknow, 2014).
v) In 2013 the company’s Board of Directors decided existing accommodation was inadequate and it resolved to construct a purpose built facility. In that year $250,000 was paid for preliminary architectural designs. In 2014 land costing $1.25m was acquired and $50,000 paid to demolish an existing structure. Construction of the new premises commenced on 1 September 2014 at a cost of $2.5m. Fitting and equipment was installed on 1 June 2015; operations began on 1 August 2015. On-site car parking costing $125,000 was completed on 30 September and landscaping of the site was completed on 31 January 2016 at a cost of $40,000.
Refer to item (v), the company had taken the decision to construct a purpose built facility by demolishing the existing structure. The decision had been taken in 2013 and instantly the company had chosen the land and started the framework with architectural designing. Later on the company had started the working through the actions of procurement of land, and construction of different buildings. The respective steps incurred cost to the company which they had incurred through the period from 2013 to 2016(Hill, 2013).
 
There is allowance of deduction of Australian Income Tax Law for the capital expenses for construction which is being ratified under section 43-20 of I T Act, Australia; ITAA 36. The deduction is allowed on different expenditures for construction. A table is being given below which may give the idea of deduction under the act and the tenure of deduction the company be able to claim when such construction takes place after 1979:

Year of Action

Project

Cost

Deduction % age

Duration

2013

Designing – Architectural

$2,50,000.00

nil

 

2014

Cost of Land

1.25 million

nil

 

2014

Demolition of existing structure

$50,000.00

4%

25 years

2014

construction of new premises

2.5 million

4%

25 years

2015

Car Parking construction

$1,25,000.00

4%

25 years

2016

landscaping

$40,000.00

4%

25 years

 
 
References:
Ato. (2015). Fringe benefits tax (FBT). Retrieved September 09, 2016, from https://www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/
Ato. (2012). What is a fringe benefit? Retrieved September 09, 2016, from https://www.ato.gov.au/General/Fringe-benefits-tax-(FBT)/In-detail/Employers-guide/What-is-FBT-/
Austlii. (2001). CORPORATIONS ACT 2001 – SECT 45A. Retrieved September 09, 2016, from https://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s45a.html
Coursehero. (2015). Arthur murray nsw pty ltd v fct 1965 114 clr 314. Retrieved September 09, 2016, from https://www.coursehero.com/file/p6ddtac/Arthur-Murray-NSW-Pty-Ltd-v-FCT-1965-114-CLR-314-The-taxpayer-was-a-dance/
Diane. (2015). G arthur murray nsw pty ltd v fct 1965 114 clr 314 o. Retrieved September 10, 2016, from coursehero: https://www.coursehero.com/file/p6jaej5/g-Arthur-Murray-NSW-Pty-Ltd-v-FCT-1965-114-CLR-314-o-Tax-implications-High/
Hill, J. (2013). Corporate taxation . Retrieved September 10, 2016, from deloitte: https://www2.deloitte.com/content/dam/Deloitte/us/Documents/Tax/us-tax-ice-country-highlights-australia.pdf
Hines, M., & Bar, V. (2012). Tax implications of damages; https://www.deverslist.com.au/Tax%20Implications%20of%20Litigation.pdf.
Iknow. (2014). Legislation. Retrieved September 10, 2016, from iknow: https://www.iknow.cch.com.au/topic/tlp622/overview/long-service-leave
IRD. (2006, February 08). When does derivation occur in relation to land sales with a deferred settlement, by business taxpayers who provide vendor finance? Retrieved September 10, 2016, from IRD: https://www.ird.govt.nz/technical-tax/questions/questions-general/qwba-derivation-land-sales.html
Ripparoo. (2015, February 28). Sanrusk 2014 Financial Statements. Retrieved September 10, 2016, from ripparoo: https://www.ripparoo.com.au/wp-content/uploads/Ripparoo-Lodge-Ltd-2014-Financial-Statements.pdf

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