Assessable Income
Discuss about the Taxation Law for Facts, Issues, and Conclusion.
RIP Pty Ltd is a private corporation that is a resident of Australia and its primary business is being a funeral director. In addition to the funeral premises, the company has office facilities, a chapel, an assembly area, professional rooms and motor vehicles to be able to complete the operations successfully. On June 2016, RIP Pty Ltd reported a net profit of $2.45m which came from fees payable after thirty days, under insurance contracts, those received from RIP Finance Pty Ltd and any amounts paid under a funeral plan which the clients are required to make periodic contributions in order to be able to meet any funeral costs in the future. The company has an ‘Easy Funeral Plan’ where the price is fixed and as soon as the money is paid, the client is guaranteed a comfortable funeral arrangement upon his or her death. However, if the price is not fully paid by the time the person passes away, the fees of the deceased would be payable under a ‘net 30 days’ invoice or under an insurance contract with the amount being non-refundable. By the end of the financial year ended 30th June, RIP’s Easy Funeral Plan had a credit balance of $225,000. Additionally, it is expected that the clients may die abroad, no funeral services may be provided or their remains may not be recovered, thus amounts paid to the Easy Funeral Plan may not be drawn upon which may cause refund issues.
The issue here is that by the end of 30th June, the firm transfers any amount from the Easy Funeral Plan in connection with defaulting members. As at that date, the Forfeited Payments Account had a credit balance of $16,200. The issue, here, is how the amount in the Forfeited Payments Account should be treated for the purposes of taxation
For this case study, the decision of Arthur Murray(NS) Pty Ltd V FCT (1965) 114 CLR 314 can be used. In this case study, Arthur Murray sold dancing lessons which were to be paid for in the future. On assessing the taxpayer to determine whether this constituted assessable income, the commissioner concluded that the amount was received in advance for services not yet earned and thus it would not be liable to tax (Barkoczy, 2010, n.d.).
This case of Arthur Murray can be used to form a decision in this case study since the company was providing funeral services after death and thus it applies to the accounting treatment of amounts in the ‘Easy Funeral Plan’. However, there are some instances where the client could contribute to an ‘Easy Funeral Plan’ to pay in advance for their funeral costs in future. Ideally, by the financial year ended 30th June, the ‘Easy Funeral Plan’ had a credit balance of $225,000. As seen in the decision made in Arthur Murray’s case, this amount received in respect to the provision of funeral services has not yet been earned until future obligations for the funeral has been discharged and therefore it is not liable to taxes (Barkoczy, 2010, n.d.). This means that the amount of the ‘Easy Funeral Plan’ should not liable to taxes.
Forfeited Payments Account
When RIP Pty Ltd derives its income generally other than funeral business, it would be seen that the company is not carrying on its ordinary business activities and therefore any amount realized from this would not be included in the taxable income. However, if the corporation derives its income from its funeral services and related activities, this amount would be considered to be from ordinary business activities, thus it would be included and thus liable to taxes due to the fact that it is allowable for tax purposes (Barkoczy, 2010, n.d.). The commissioner or any taxpayer does not have a choice in the method of accounting for tax since the respective law must be followed when preparing the statement of taxable income of RIP Pty Ltd. Another scenario may occur when the client dies abroad. In such a scenario, the amount in the ‘Easy Funeral Plan’ of $225,000 should be included in the assessable income since it is evident that the obligations for the funeral arrangements will be discharged (Barkoczy, 2010, n.d.).
According to section 104-150 of the ITAA 1997, when a deposit is forfeited and a taxpayer makes a capital gain, the capital gain would be the deposit less the deposit less any expenses in relation to the sale. However, when the taxpayer makes a capital loss, the capital loss would be computed as the expenditure in relation to the sale less the deposit forfeited. According to taxation ruling 97/19 Para 7, a CGT provision applies to the effect that a forfeited deposit may be considered as a capital gain in certain circumstances. In this case study, RIP Pty Ltd had $16,200 in the ‘Forfeitures Payments Account’. This amount of $16200 that was paid by defaulting members would be considered as a capital gain and thus it should be included in the assessable income under sec 104 -150 of ITAA 1997and TR 97/19. Therefore, the capital gain attributable to RIP Pty Ltd would be computed as the deposit by the members who defaulted payment less any expenditure associated with the sale, that is, the funeral services. However, since RIP Pty Ltd is not incurring any expenses for this amount, the capital gain would just be the deposit by the defaulted members, that is, $16,200.
According to ITAA 1997 section 70-10(1), a trading stock is anything that has been produced or acquired or the purpose of exchange, manufacture or sale in the ordinary course of business. Section 70-10(2) of the ITAA 1997 states that a trading stock does not include CGT asset or division 230 financial arrangement. RIP Pty Ltd had three types of caskets which the company had prepaid for $25,000 in June 2016 that had to be delivered in August 2016. The caskets and accessories would be considered to be trading stock since the items were acquired for the purpose of sale. The $25,000 would be considered an expense from ordinary activities and therefore it would be liable to taxes. Ideally, the accrual concept applies that is expenses would be recorded when incurred and not when paid and therefore the $25,000 would be incorporated when computing the taxable income of June 2016 (Handley and Maheswaran, 2008, p.83). This is because has not yet been incurred since it has been paid in advance.
Trading Stock
According to the Income Tax Assessment Act 1936 section 44-1, a shareholder’s assessable income includes dividends derived out of profits and paid out to the shareholder and any non-shared dividends that have been paid to the shareholder (resident); dividends paid to shareholder by the firm from only the profits derived from Australia and non-shared dividends derived from sources in Australia (non-resident); and those paid to the shareholder and they are from a permanent establishment out of which profits are derived from sources outside Australia and non-shared dividends attributable to a permanent establishment whose profits are derived from sources outside Australia (shareholder is a non-resident that is carrying on a business within Australia or through a permanent establishment in Australia. RIP Pty Ltd had fully franked cash dividends amounting to $21,000 which was received from RIP Finance Pty Ltd (Handley and Maheswaran, 2008, p.84). Since the fully franked dividends were received from a firm that is a resident of Australia, from the sources derived in Australia and from a permanent establishment in Australia, the fully franked dividends of $21,000 would be liable to taxation which means that they would be liable to taxes.
RIP Pty Ltd paid an amount of $57,000 on 1st March 2016 for two-years rental space whose lease was to expire on 28th February 2018. Out of this, $9,500 was expensed to the account while the remaining $47,500 was capitalized in the statement of financial position. The question is what amount can be included in the statement of taxable income in order to determine the assessable income. To answer this, one can look at the case of FC of T v. Krakos Investments Pty Ltd. In this case, Krakos bought land to build a hotel and leased the hotel premises to another party (lessee) after several years for $420,000 which was paid for goodwill as agreed by the two parties. The Federal Court on basing their decision on whether this amount is liable to taxation had to assess whether this amount was a premium payable or paid for the grant of the lease. Ideally, a sum can be considered a premium if the amount paid is for the grant of the lease whereas an amount would be considered rent if the consideration was paid for occupation and the right of use (Kluwer, 1997, n.d.).
In this case study, a lease occurred between RIP Pty Ltd and another company. Here, RIP Pty Ltd was the lessee while the other company was the lessor since the other corporation transferred the right of use of the rented space to RIP Pty Ltd at a consideration to be paid at a specific period. RIP Pty Ltd paid $57,000 for a rental space for a period of 2-years. This amount was paid in advance for the whole period that RIP Pty Ltd was to use the rented space. However, for that financial period, that is, from 1st June 2015 to 30th June 2016, the expense relating to the rented space amounted to $9,500 while the remainder of $47,500 was capitalized to the balance sheet in the fixed assets section (Kluwer, 1996, n.d.). When computing the assessable income of RIP Pty Ltd, the amount of $9,500 was the expense for the year with respect to this rented space and this, therefore, would be the only amount to be included in the statement of taxable income for the company when ascertaining the assessable income for the year since it was the only expense relating to the lease for that period. The other amount of $47,500 has been paid by RIP Pty Ltd but it has not yet been incurred and therefore it is a prepayment. For this reason, it would not be liable to taxes.
Dividends
According to the Income Tax Assessment Act 1997 section 26-10(1), a long service leave cannot be deducted from the assessable income except if it was paid in the year of income to the person going on leave or if it was an accrued leave transfer payment is made in the year of income. Additionally, section 26-10(2) of the ITAA 1997 states that this accrued payment is any amount made by a corporation to a person’s leave and when the company is no longer required to give that person leave pay and to another business when the other business has begun to be required to make the payments in relation to that leave under the Australian Law (Woellner et al., 2012, n.d.). According to section 15-5 of the ITAA 1997, the accrued leave transfer payment must be liable to taxes.
The managing director of RIP Pty Ltd went on a long service leave for three months where he was to be paid $22,000 in advance. This amount was debited in the accounts of the business and a contra entry performed on the Provision for Long Service Leave Account. Since this amount was paid in advance, it is prepaid and therefore it cannot be considered as an accrued leave transfer payment which is liable to taxes as seen in section 15-5 in the Income Tax Assessable Act 1997 (Handley and Maheswaran, 2008, p.85). Ideally, an accrual is something that has been incurred continuously and has not yet been paid while a prepayment or something paid in advance is an amount that has been paid but has not yet been incurred by the business. Section 26-10(1) states that any long service leave cannot be deducted from the assessable income except if it was paid to whom the leave relates to in the year of income or if it was an accrued leave transfer payment. However, since this amount was paid in advance, then it does not relate to the year of income and it cannot be considered as an accrued leave transfer payment. This, therefore, means that the amount of $22,000 paid to the managing director for his or her long service leave of three months shall be exempt from taxes. Thereby, the amount of $22,000 paid to the managing director for the long service leave is not liable to taxes and therefore it shall not be liable to taxes and thus it shall not be included in the statement of taxable loss or income.
Conclusion
According to the ITAA 1997 division 43, a building can deduct construction costs in relation to a building, extensions, improvements to the building, structural improvements, improvements to the structural improvements and earthworks in relation to environmental protection. According to section 43-70(1) of the ITAA 1997, a construction expenditure is any capital expenditure in relation to the construction of capital works. Section 43-70(2) further states that a construction expenditure does not include cost of acquiring the land on which the structure is being built on, any expenses incurred in demolishing the existing structures, costs on landscaping and plant, and expenditure for a property whose deduction is allowable such as depreciating assets (subdivision 40-F), primary producers (subdivision 40-G) and expenditure deductible over time since it has been capitalized (subdivision 40-I).
In this case study, the Board of Directors paid $250,000 for preliminary architectural designs, they acquired land amounting to $1.25m and they incurred $50,000 to demolish an existing structure in 2013. In this year, only the amount of $250,000 incurred on the preliminary architectural designs is allowable for tax purposes while the cost of land of $1.25 million and the amount incurred to demolish an existing structure of $50,000 are disallowable. On September 2014, RIP Pty Ltd constructed the new premises at $2.5 million. This amount is allowable since it consists capital expenditure in relation to the construction of the capital works. on 1st June 2015, the company installed fitting and equipment and began their operations in August 2015. Furthermore, by September, an on-site car parking was completed at a cost of $125,000. The fitting and equipment are excluded from taxes since they are grouped under depreciating assets (subdivision 40-F). The on-site car parking, on the other hand, is liable to taxes since it is considered as an extension to the building and therefore it must be included in the assessable income. Lastly, by January 2016, RIP Pty Ltd had completed landscaping of the site at a cost of $40,000. This amount is disallowable as seen in section 43-70(2) of the Income Tax Assessment Act 1997. However, only the income for the year beginning 1st June 2015 to 30 June 2016 will be included in the statement of taxable income since it is expected by the Australian standard that a company computes the taxable income for the income year. For this part, all other amounts relate to the prior income tax periods except the cost of landscaping of $40,000, fittings and equipment purchased during the year and the on-site car parking cost of $125,000. Despite this, only the cost of on-site car parking would be included in the statement of taxable income or loss when determining the assessable income since the other expenditures are disallowable as seen in section 43-70(2) of the ITAA 1997. Below is the computation of the assessable income of RIP Pty Ltd.
References
Barkoczy, S., 2010. Australian tax casebook. CCH Australia Limited. [Accessed on 29th May 2018].
Handley, J. C., and Maheswaran, K., 2008, A measure of the efficacy of the Australian imputation tax system. Economic Record, 84(264), 82-94. [Accessed on 29th May 2018].
Income Tax Assessment Act 1997-Sect 104-150: Summary of the CGT Events. Commonwealth Consolidation Acts. [Online]. Available at https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s104.5.html [Accessed on 29th May 2018].
Income Tax Assessment Act 1997-Sec 70-10: Meaning of Trading Stock. Commonwealth Consolidation Acts. [Online]. Available at https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s70.10.html [Accessed on 29th May 2018].
Income Tax Assessment Act 1936-Sect 44-1: Dividends. Commonwealth Consolidation Acts. [Online]. Available at https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s44.html [Accessed on 29th May 2018].
Income Tax Assessment Act 1997-Sect 26-10: Leave Payments. Commonwealth Consolidation Acts. [Online]. Available at https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s26.10.html [Accessed on 29th May 2018].
Income Tax Assessment Act 1997-Sect 43.20: Capital Works to Division 43. Commonwealth Consolidation Acts. [Online]. Available at https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s43.20.html [Accessed on 29th May 2018].
Income Tax Assessment Act 1997-Sect 15-5: General Interest Charge. Commonwealth Consolidation Acts. [Online]. Available at https://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s5.15.html [Accessed on 29th May 2018].
Kluwer, W., 1996, FC of T v. Krakos Investments Pty Ltd 96 ATC 4063; (1995) 133 ALR 545. CCH iKnow. [Online]. Available at https://iknow.cch.com.au/document/atagUio540142sl16721306/fc-of-t-v-krakos-investments-pty-ltd-federal-court-of-australia-full-court-19-december-1995 [Accessed on 29th May 2018].
Kluwer, W., 1997, Income Tax Assessment Act 1997-Sect 43-70: Construction Expenditure. CCH iKnow. [Online]. Available at https://iknow.cch.com.au/document/atagUio695356sl24359645/income-tax-assessment-act-1997-section-43-70-what-is-construction-expenditure [Accessed on 29th May 2018].
TR 97/19, 1997, Income Tax: Taxation Ruling, para 7. [Online]. Available at https://law.ato.gov.au/atolaw/view.htm?locid=%27TXR/TR9719/NAT/ATO%27 [Accessed on 29th May 2018].
Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2012. Australian taxation law. CCH Australia. [Accessed on 29th May 2018].
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