The Court Case – Prepaid Tuition Fees
The taxpayer under this case held the licensed from United States as the company that performed the business of the giving lessons in dancing to the pupils in Sydney and Melbourne. The taxpayer provided the students with the contact that enrolled under the taxpayer for taking dancing lessons. The period of lessons generally consisted of the fifteen hours which was spread over one year period (Sadiq et al. 2014). The pupils were enrolled under the taxpayer who were required to sign the contract. The provision that was stated in the contract was completely non-refundable and the pupils that enrolled under the taxpayer were completely held responsible for the full sum that was paid for lessons as enumerated in the contract. The contract clause contained that the amount paid cannot be refunded and cannot be cancelled as well.
The clause of the contract stated that any form of request relating to refund can be only considered if the request made by the students is on justified grounds (Woellner 2013). Even though the terms that were provided in the contract the taxpayer in the income year made certain kind of refunds based on the situations when the pupils were failure in taking the fixed amount of dancing classes and gave the students the suitable explanations for termination of contract.
The accrual” method of accounting was adopted by the taxpayer where the full amount of money that is obtained in advance as prepaid dancing tuition given, were immediately not recorded or credited in the company revenue account books (Woellner et al. 2014). The taxpayer instead credited the prepaid amount in “Unearned deposits”-“Untaught Lessons Account”. As and when the lessons were provided by the taxpayer to the students the instructor was required to record the amount in the sheet that was kept together with the names of the pupils.
At the end of the each month an equivalent sum which was earned upon imparting the dancing lesson was transmitted in to an account called “Earned Tuition Account”. Consequently, the sum that was received by the taxpayer were not treated in the form of income that has been earned until and unless the tuition is provided (Pinto 2013). After the income year the sum that was standing in the “Unearned Deposits-Untaught Lesson Account” was carried forward to the following year.
As a result the taxation commissioner issued an assessment of the sum that was in respect of the years of income together with the assessable income where the sum was ultimately received by Arthur Murray in every year of income rather than the sum that was presented into the books of accounts of taxpayer as received. The taxpayer objected against the assessment that was turned by the commissioner and requested to refer the subject to the Board of Review (Basu 2016). The review conducted by the board stated that the cash that was received from the dancing lesson were regarded as the gross receipts of the business process for the taxpayer and was regarded as the portion the taxpayer assessable earnings during the year in which the amount was obtained and eventually upholding the assessment. This led the taxpayer to eventually raise an appeal in the High Court of Australia.
Assessing Business Income
The issue revolves around whether the taxpayer has originally obtained the advance payment of the tuition fees that was received during the year where dancing lessons were provided?
The Australian high court remain dependent on the principles stated in “Federal Commissioner of Taxation v Flood (1953)” where the law court did not follow the commercial and the accounting practice in respect of the question that would constitute the deduction of income (Tan, Braithwaite and Reinhart 2016). The court of law on arriving at the decision in the case of “Arthur Murray” stated that the amount received by the taxpayer as the prepaid amount of tuition fees could be held as derived until and unless the tuitions were initially imparted. The findings of the court suggest that the receipts that was actually made is necessarily in relation to the business and the taxpayer should consider the fees that is received but yet to be considered as netted. The decision passed by the high court of Australia explains that as a matter of contingency the taxpayer was also required to repay the amount in part or in full despite it only held as damaged if the failure on the part of the taxpayer to provide the tuition (Cao et al. 2015). The decision of the court stated that the taxpayer did not derived the income unless the service was rendered by the taxpayer.
As stated under “section 6-5 of the ITAA 1997” when the taxpayer receives any income then the amount that is derived by the taxpayer would be considered for assessment. The income that is obtained by taxpayer should be considered for assessment under “section 6-5 of the ITAA 1997”. To calculate the business income there are two well-known method. The method includes the earnings method and the receipt method (Robin and Barkoczy 2018). The taxpayer are required to follow the method since it helps in reflecting the income in an efficient manner. Taking into the account the receipt method as one of the most appropriate method of determining assessing income. According to the provision stated in paragraph 19 of the “Taxation Ruling 98/1” it explains that if the income derived is obtained from any other manufacturing activities then such income should be recorded based on the earnings method. Hence, earnings method should be considered as the suitable method determining the appropriate amount of tax.
Taking into the consideration the case of RIP Pty Ltd which is a funeral service proving company and makes around $2.45 million as net profit. The company derived majority of the revenues by providing its customers with the service of funeral. The customers were provided with the facilities of paying the fees and some of them are listed below;
- An invoice of thirty day was issued by the RIP Pty Ltd from the outside insurance company in order to obtain their fees,
- The company issued the invoice of thirty days to its customers so that the customers can pay within the stipulated time period.
- The company officers its customers with the credit facilities and allowed them to repay in instalments as they can obtain the fees from such credit facilities.
- Under the easy future funeral plan RIP Pty Ltd was able to derived fees as an advance from the customers.
Implications for Small Business Taxpayers
Denoting the circumstances of the RIP Pty Ltd the principles of Arthur Murray can be implemented in the year in which the company obtained the fees from the customers. In accordance with the common law where any form of money that is received in advance will be considered as income (Robin 2017). Evidences suggest from instances collected from the case study of RIP Pty Ltd that the company follows the practice where the fees is received in advance and the same is recorded only when the amount is received by the company. The instances obtained from the case study suggest that the principles adopted is similar to the case of Arthur. It is advised that RIP Pty Ltd should not record the fees in the year when it is received, rather the company is advised to record the fees when the funeral service is actually rendered by RIP Pty Ltd to its clients.
According to the provision that is provided in the “Taxation Ruling 98/1” there are primarily two methods of accounting for the business profits and the same is implied in determination of the taxation (Chapman, Plummer and Tonts 2015). There are usually two methods that is take into the considerations namely the earnings method and the receipt methods. In respect of this method it can be stated that the income derived is actually the amount received or income has to be considered as the constructive receipts.
As defined under the “section 6-5(4) of the ITAA 1997” income is considered to be derived when the income is actually received by the taxpayer (Fry 2017). The alternative method that is employed in calculating the accounting profit and determining the assessable income is regarded as earnings method. In accordance with the given provision it can be stated that the income that is derived is treated similar to the income that is received as the recoverable debt. It is necessary on the part of the taxpayer to undertake the certain actions as it is helpful in claiming the amount which is based on the agreement and on the performance of the taxpayer. Hence, it is worth mentioning that the commissioner as well as the taxpayer can select either of the two methods for determining the tax liability.
RIP Pty Ltd commenced the business of easy funeral scheme where the customers were required to pay a certain amounts of instalments and in turn RIP Pty Ltd provided the customers with the service of providing funeral in near future. The fees that was received by the company was entirely held as non-refundable. The entire amount that as received by the company was forfeited and these forfeited amount was transmitted in the separate accounts books that was known as the Forfeited Payment Account given that there was any customer that failed to pay RIP Pty Ltd in advance. RIP Pty Ltd shall not be held liable to provide any further service if a failure was noticed on the part of customers to pay the entire amount (McGregor-Lowndes and Williamson 2018). The forfeited amount of $16200 would be considered as the income during the year in which such forfeiture occurred.
Conclusion
Trading stock stated under the “Section 70-10 of the ITAA 1997” can be viewed as anything that business acquires or manufactures so that it can perform the activities of selling the same into the market as well as exchange of goods and service during the year of income (McLaren 2015). Taking into the considerations that the provision that is mentioned in the “section 70-10 of the ITAA 1997” CGT assets along with the financial instruments is required to be included in the trading stock of assets. Furthermore, as stated under the “section 70-25 of the ITAA 1997” a taxpayer is not allowed to include any amount of capital in nature in the definition of the trading stock. However, as evident in the current case study it is noticed that RIP Pty Ltd incurred expenditure on the components of its trading stock namely the caskets and accessories as these can be used in the business by treating the same as the trading stock rather considering the same as the capital assets.
As understood from the evidences gained suggest that RIP Pty Ltd bought trading stock and the purchase of trading stock can be considered as the item that can be availed for deductions under “section 8-1 of the ITAA 1997” (Graetz et al. 2015). As evident from the situation of RIP Pty Ltd the company has in advance paid the amount of trading stock where it was required to deliver for a worth of $25,000. As understood from the discussion made it can be stated that the prepaid amount that was paid by the company should be treated as advance for the services rendered during the year ended 30th June 2016.
According to the “section 6-5 of the ITAA 1997” majority of the income that is derived by the tax payer is required to be considered as the ordinary income based on the ordinary concepts. Additionally “section 6-5 of the ITAA 1997” also provides that any form of income that is received by the Australian resident is held liable for assessment (Hart et al. 2017). The dividend income that is received by the RIP Pty Ltd will be considered as the assessable income. The primary reason for being the divided held assessable because the dividends were fully franked where the business would be able to take the franking credits.
As stated under the “Section 100-25 of the ITAA 1997” it states that any form of advance payment that is made by the business could not be included in as the capital asset by the business (Hayek 2014). Nevertheless the expenses are held as the advance payment of rent and the amount is not held as capital asset. It is worth mentioning that advance is required to be paid by the company over the period of four months in advance under the rules of general deductions based under the provision stated under the “section 8-1 of the ITAA 1997”.
As stated by the Australian taxation office an employer is under the obligation making a contribution in the long service leave entitlement of the employee relating the employment or the services that is performed by the employee (Hora 2014). An important consideration of the Australian Taxation Office any form of long service leave entitlement that is made by the employer for the employee would be subjected to PAYG withholding. Taking into the consideration the explanations that is made in the “section 83-80 of the ITAA 1997” the taxable income does not take into the consideration the unused amount of long service leave since it is a non-taxable element.
In agreement with the considerations that is provided under the “subsection 83-85 of the ITAA 1997” the provision allows the taxpayer to make a claim for the allowable deductions relating to the unused sum of the long service leave (Jones and Rhoades-Catanach 2013). An important consideration of the “subsection 83-85 of the ITAA 1997” is that any form of long service leave that is paid to the employee should not be greater than the thirty per cent of the taxable earnings of the employees. As evident in the current situation of the RIP Pty Ltd the company has contributed into the long service leave of the employee for a period of three months and such payment should be treated as expenditure and not an advance for the income year ended 30th June 2016.
According to the explanations provided under the “section 8-1 of the ITAA 1997” where it is noticed that the taxpayer held eligible for claiming an allowable deductions from their taxable earnings to determine the tax liability (Kiprotich 2016). Additionally, the items of expenditure that is reported under this section does not takes into the consideration the capital expenditure made on the land and building.
As understood from the situation of the RIP Pty Ltd, the expenditure that is occurred by the company associated to the payment of the architectural designs is treated as the capital expenditure. With respect to the provision of the “Section 100-25 of the ITAA 1997” these expenses are treated as the assets costs base. Furthermore, RIP Pty Ltd reported expenses on the onsite car parking therefore these expenses are capital expense and it non-deductible under “section 8-1 of the ITAA 1997”.
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