Depreciation as Per Books of Accounts
Discuss about the Reducing Deductions for Amounts Paid.
In Australia, there are two different set of rules to define the profit of any organization, first is the accounting profit which is the profit arrived at after deducting expenses from the revenue as per the financial accounting rules containing financial accounting standards, concepts and principles, which are applied to measure the business profit of any organization for financial reporting purpose to the various stakeholders. (Investopedia, 2018)
The concept of taxable income or taxable profit is different from the accounting profit since the same includes the computation to be made as per the Australia Income tax act comprising of tax rules, legislations, various rulings and judicial cases and precedents.
Accounting profit details are available in the financial statement but the taxable profit data are secured and available only on database maintained by Australia Tax office and are strictly confidential and cannot be accessed by the public in large.
In the case of Timber Floors Pty. Ltd., which is an Australian resident private company for tax purpose, accounting profit computed as per accounting standard cannot be taken as the base for computing the tax liability and hence various adjustments are required to be done to the accounting profit in the form of allowances and disallowances as per the tax rules, rulings, legislations and judicial cases.
The various adjustments which have been done in accounting profit to arrive at the taxable income are shown as below:
Depreciation as per books of accounts is the amount which has been recorded in the financial statement as a charge for use of assets on the basis of matching principle of accounting, the life of the asset is based on management best estimate and the assets is charged of basis the matching principle on the estimated life of the assets, for example if an asset costing $50,000 is purchased with no salvage value and estimated life of 10 years then the book depreciation would be $5,000 per annum.
As per the Income tax act, there is a general set of rules which applies to the capital asset or depreciating assets, which states the assets to be depreciated over the effective life of the asset expressed in years. Depreciation deductions are usually available to the owner of the assets who is using it for the purpose of business and are allowed to be claimed only to the extent to which one uses the asset in the business to earn income, for example if an asset is used for 50% of the time for business purpose then one can claim only 50% of the depreciation in the current year.
Depreciation on Pool Assets
In the case of Timber Floors Pty. Ltd. the accounting depreciation as per note 4 of $150,000 which is based on director’s estimate of effective life of all assets being 5 years has got no relevance and hence has been added back to the accounting profit and an allowance for depreciating assets has been made as per the Income tax rules and acts.
Timber Floors Pty Ltd.’s final records show that on 1 July 2017 the opening balance of the company’s pooled depreciating assets was $18,000 and hence as per Section 328.185 (Australia, n.d.) “If you are a small business entity for an income year and you have chosen to use this Subdivision for that year, you deduct amounts for your depreciating assets (except assets for which you have deducted or can deduct an amount under section 328-180) through a pool, which allows you to deduct amounts for them as if they were a single asset, thereby simplifying your calculations. You use one rate for the pool” and the rate has been defined in Section 328.190 (Australia, n.d.) as the Opening pool balance X 30% and hence on the $18,000 a rate of 30% has been applied which calculates depreciation on pool assets to $5,400
Depreciation on Assets costing less than $1,000
Timber Floors Pty Ltd.’s also purchased a new Ipad at a cost of $990 (GST inclusive) which when GST excluded will come to $900 @ 10% GST since the same would be available for credit. As per Section 328.180 (Australia, n.d.) “You can also deduct, for an income year for which you are a small business entity and you choose to use this Subdivision, the taxable purpose proportion of an amount included in the second element of the cost of an asset for which you have deducted an amount under subsection (1) if:
- the amount so included is less than $1,000; and
- you started to use the asset, or have it installed ready for use, for a taxable purpose during an earlier income year”
So in tax computation as per the above section, we have deducted $900 from the accounting profit as deduction.
Depreciation on New Spray Equipment, new Truck and three further assets management
As per Section 376.185 (Australia, n.d.) “In determining an amount of expenditure for the purpose of this Division, the expenditure is taken to exclude GST” and hence for the purpose of computation of depreciation on new spray equipment and new truck, GST has to be excluded.
Capital cost of New Spray Equipment excluding GST @10% comes to $155,227 and that of new truck comes $157,484, since the further three assets were purchased at a exclusive GST price we have considered the acquisition price at $ 170,080.
Depreciation on Assets Costing Less than $1,000
As per Section 40.102 (Australia, n.d.) relating to capping life of certain depreciating assets, the effective life has been capped at 6 2/3 Years which comes to ~ 15% of the assets value since the asset has been used in primary production sector. Total value of assets in this category as mentioned above comes to $482,791 which when depreciated at 15% gives depreciation of $72,419 since all the assets have been purchased on the first day of financial year.
Franked dividend is an Australian method or arrangement to eliminate the double taxation of dividends. The shareholders who receive dividends are able to reduce the tax paid on the dividend by an equal amount of tax credits for franked dividends. Franked dividends helps shareholders reduce the tax burden on them because they are responsible for a smaller amount of tax on those dividends depending on the shareholder’s tax rate, if the shareholder’s tax rate is below the company’s tax rate the shareholder will be entitled to refund of the difference from the Australian Tax office (ATO). Fully Franked dividends includes a credit of 30% which represents tax paid by the Company issuing dividend and partially franked represents the partial credit of the 30% tax amount.
On 30 November 2017, the company received a cash dividend of $100,000 (franked to 80%), As per Section 207.5 (Australia, n.d.) this means 80% of the 30% tax has been credited to Timber Floors Pty Ltd., we need to gross up the dividend received and add the same to accounting profit since the same has not been accounted for while computing accounting profit which comes to $134,826 (($100,000*100/70*30%*80%) + $100,000) and a tax credit of $34,826 has also been given for franked dividend tax paid by company.
On 31 August 2017, the company also received a cash dividend of $120,000 from a US company. Withholding tax of $20,000 had been withheld in the US. Australia has a double tax agreement with the US. Since Australia has a double tax treaty, it reduces double taxation of the dividend income and hence the dividend income of $140,000 has been added to the accounting profit and a $20,000 tax offset has also been given for the tax withheld in US.
Timber Floors Pty. Ltd. has incurred repair cost of $30,000 consisting of painting the company premises for $10,000 and replacing the old rotting wooden office window frames with new steel window frames for $20,000. As per Section 25.10 (Austrlia, n.d.) “You can deduct expenditure you incur for repairs to premises (or part of premises) or a depreciating asset that you held or used solely for the purpose of producing assessable income” and also mentions that “You cannot deduct capital expenditure under this section”, since painting of walls has been for the purpose of repairs to premises it is an allowance deduction and should be allowed, replacing the old rotten wooden office window with new steel window frame is considered a capital expenditure and will not be allowed as deduction. The effect of the disallowance has been shown as disallowing the whole $30,000 repair expenditure and then allowing $10,000 of painting expenses incurred.
Depreciation on New Spray Equipment, New Truck and Three Further Assets
As per Section 26.35 (Australia, n.d.)relating to reducing deduction for amounts paid to related entities “If, under another provision of this Act, you can deduct an amount for a payment you make, or for a liability you incur, to a related entity, then you can only deduct so much of the amount as the Commissioner considers reasonable” and hence in case of wages of $50,000 paid for marketing services provided by director’s service, the allowance has been made only for $20,000 which has been considered reasonable for the services provided.
As per Section 70.45 (Australia, n.d.) relating to Value of trading stock at end of income year “You must elect to value each item of trading stock on hand at the end of an income year at:
In case of Timber Floors Pty Ltd, we should value the closing stock at cost to maximize the deduction for excess of opening trading stock over closing stock and hence the closing stock will be valued at $133,567 and the deduction allowed would be $46,433
It is generally accepted that a payment in consideration for agreeing to a restraint of trade is a receipt of a capital nature (see Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337) and hence the same has been disallowed.
Certain expenditure are allowed when payment for the same has been made like provision for unreported claims, provision for long service leave and hence has been disallowed.
Pay as you go (PAYG) installments are a system for making regular payments towards expected annual income tax liability. It only applies only if one earns business and/or investment income over a certain amount. (Australia, n.d.)
In this case, the company paid a total of $255,000 in PAYG Installments during the financial year and hence allowed to offset the same against the tax liability ascertained.
References
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 205.20. [Online] Available at: https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s205.20.html[Accessed 4 June 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 207.5 Overview. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s207.5.html[Accessed 4 June 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 26.35 Reducing deductions for amounts paid to related entities. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s26.35.html[Accessed 4 June 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 328.180 Assets costing less than $1,000. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s328.180.html[Accessed 4 June 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 328.185 Pooling. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s328.185.html[Accessed 4 June 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 328.190 Calculation. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s328.190.html[Accessed 4 6 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 40.102 Capped life of certain depreciating assets. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s40.102.html[Accessed 4 June 2018].
Australia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 70.45 Value of trading stock at end of income year. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s70.45.html[Accessed 4 June 2018].
Austrlia, P. o., n.d. INCOME TAX ASSESSMENT ACT 1997 – SECT 25.10 Repairs. [Online] Available at: https://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_act/itaa1997240/s25.10.html[Accessed 4 June 2018].
Investopedia, L., 2018. Accounting Profit. [Online] Available at: https://www.investopedia.com/terms/a/accountingprofit.asp[Accessed 4 June 2018].
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