The Fact Situation
Discuss about the Taxation Law for Arthur Murray (NSW) Pty Ltd v FCT.
Arthur Murry (N.S.W) Pty Ltd who is the taxpayer in the current situation was under licence from the United States Company, carried out the business of providing lessons in dancing in Sydney and Melbourne. Contract were signed by the pupils that came to take lessons generally for five, ten or fifteen hours that was spread over the period of a year. Payments were made either in the form of full upon the signing of the contract or in the form of substantial deposits followed by the payment of instalment in the course of lesson (Hora 2014). The contract provision included that the contract was entire and not separable and the students were held responsible for the entire amount of tuition that was set forth in the contract. The contract was non-refundable and non-cancellable.
The agreement of the licence contained that any request for refund would be entertained if the provision of request is justified (Kiprotich 2016). In spite of the terms contained in the contracts the taxpayer during the year of income made certain refunds on circumstances when the students failed to take the agreed number of dancing lessons and provided a satisfactory explanations for discontinuation of the contract.
The taxpayer undertook the method of accounting that was considered as the “accrual” or the “earnings method” where the entire sum of money that is received in advance in form of advance payment for dancing lessons provided were not credited immediately to the general revenue (Jones and Rhoades-Catanach 2013). Rather, these amounts were credited to the account named as “Unearned deposits”-“Untaught Lessons Account”. As soon as the each lessons were given the instructor used to enter the amount on the record sheet that was maintained by him with the name of students.
Following the end of the every month a corresponding sum of amount that earned from the lessons were transferred to the account known as “Earned Tuition Account”. Therefore, the amount of money that was received by the taxpayer were not held as income by the taxpayer as having been earned till the lesson is provided (Hart et al. 2017). Following the year of income the consequences of the amount that was standing as the “Unearned Deposits-Untaught Lesson Account” was to be carried forward to the next year.
The taxation commissioner issued an assessment of the amount in relation to the years of income along with the taxable income, the sum that was eventually received by the taxpayer in each of those income year instead of the amount that was presenting the taxpayers bookkeeping scheme as having been received. The taxpayer raised the objection for assessment that was not allowed by the commissioner and requested that the matter be referred to the Board of review (Coleman et al. 2014). From the board review it was found that the receipt of cash constituted gross proceeds in the business of the taxpayer and was regarded as the part of the taxable income in the year in which the amount was received and thus, upholding the assessments. The taxpayer however raised an appeal in the Australian High Court.
Issue
Had the taxpayer actually derived the prepaid amount of tuition fees during the year in which it was the tuition was provided or the year in which the fees were received?
Conclusion:
The court of law relied on the principles of “Federal Commissioner of Taxation v Flood (1953)” where the court of law declined to follow the accounting and the commercial practice based on the question of what established an appropriate deduction from the income (Graetz et al. 2015). In deciding the verdict in Arthur Murray, it was held that the amount that was received in advance for dancing lesion were not regarded as derived until the lesson were actually provided. The court of law found the circumstances of the receipt made is necessarily in respect of good business sense which the taxpayer must treat the fees received but yet to be held as earned. The decision states that as a subject of contingency the entire amount or a portion of the amount may have to be repaid even though it only accounted as damages given the taxpayer failed to provide the agreed services (Hayek 2014). The court of law held that no income had been derived by the taxpayer until the taxpayer rendered the service.
As defined under “section 6-5 of the ITAA 1997” majority of the income which is obtained by an individual taxpayer is held as income (Jones and Rhoades-Catanach 2013). According to “section 6-5 of the ITAA 1997” income that are derived by the taxpayer in this section is regarded as taxable based on the ordinary concepts.
There are two methods of calculating the assessable income. This comprises of earnings and the receipts method. Based on the suitability of the taxpayer it may choose any of the method. The “taxation ruling of TR 98/1” provides guidelines in ascertaining income based on two methods which is earnings and the receipts method (Rohatgi 2015). As stated under “subsection 6-5 (2) of the ITAA 1997” a taxpayers should include the gross earnings in their taxable income.
As stated under the “Taxation ruling of TR 98/1” one of the best method of keeping track of income is the receipt method. There is also an exception which explains that earnings method is held as right method determining business receipts obtained from manufacturing or trading (Basu 2016). The common rule states that to record income a taxpayer is required to follow the earnings method.
Conclusion
Denoting the circumstances of RIP Pty Ltd the company provided its clients with the funeral service and earned a net profit of $2.45 million. The funeral service company provided its clients with the credit facilities of paying their invoices within the span of thirty days. Denoting the guidelines of “Taxation ruling of TR 98/1” and “subsection 6-5 (2) of the ITAA 1997” the receipt of income from the funeral service business should be recorded under the earnings method (Sadiq et al. 2013). A recommendations can be provided in this respect is that earnings method of recording revenues is the appropriate method of recording the taxable income derived by the RIP Pty Ltd during the accounting year.
In the later part of the case study RIP Pty Ltd received prepaid fees from its “Easy Funeral Plan” which was non-refundable. Usually the prepaid amount that was received by RIP Pty ltd was usually forfeited and moved to the “Forfeited Payment Account”. Likewise, the fees that was forfeited was regarded as income with no further obligations of giving funeral service if the services are discontinued under the easy future plan.
The principles of “Arthur Murray” is only applicable if the prepaid payments are kept in the suspense or the unearned income account by the taxpayer (Freeland, Lind and Stephens 2014). These payments are not treated as income till the amount is earned if not the balance day adjustment is made to the gross revenue account to exclude the unearned income from the profit and loss account. An argument can be bought forward by stating that the principles of the Arthur Murray is only applicable where there are probability that the unearned income might have to be repaid because of the specific term of contract.
In the current situation of RIP Pty Ltd receipt of fees made under the “Easy Funeral Plan” is held as income which is received by the company as the part of the prepaid funeral service to be rendered in future. According to the “taxation ruling of TR 98/1” there is a need for placing a sufficient amount of weightage in the taxpayer’s circumstances and appropriate accounting method should be used to correctly reflect the income made in the year (Woellner et al. 2013).
The high court of Australia in “Dunn v FCT (1989)” explained that it is obligatory to understand the business state and methods of record keeping procedure. In the current case, the receipt of fees by the RIP Pty Ltd is preserved in the company’s accounting books and it should be treated as income during the year in which the fees is derived. The principles of “Arthur Murray (NSW) Pty Ltd v FCT (1965)” is applied in the current case of RIP Pty Ltd for accounting treatment of accounting receipts (Miller and Oats 2016). In addition to this, RIP Pty Ltd is required to maintain a record books of fees that is received as prepaid into the company account books. Furthoremore, the company is required to treat the receipt of prepaid fees in the form of income that is made from the easy funeral plans that is offered by the company to its clients.
The taxation ruling of “Taxation ruling of TR 98/1” applies for taxation purpose to the individual taxpayers as well as the business. The taxation ruling of “Taxation ruling of TR 98/1” requires each of the taxpayers to account for their revenues based on the concepts of receipts method or the earnings methods so that they can ascertain their taxable income (Barkoczy 2016). Denoting the explanations made under the “subsection 6-5 (4) of the ITAA 1997” the receipts of accounting income based on the receipts method is either made constructively or made on real base. The earning method states that a taxpayer derives income when the amount of earned by them. The taxation ruling of “Taxation ruling of TR 98/1” provides the taxpayers with the options of selecting from any of the two method in order to determine their taxable income.
As evident in the current case study of RIP Pty Ltd, if it is noticed that a failure on the part of the customer in paying their advances in instalment then the part of the amount is forfeited that is received by the company from its customers. Additionally the forfeited amount is shifted to the account name as “Forfeited Payment Account”. The case study highlights that the fees that is received by the RIP Pty Ltd is held as non-refundable and the forfeited amount of $16,200 would be classified as income.
Denoting the explanation made in “section 70-10 of the ITAA 1997” trading stock refers to an items that a business produces or it is purchased for selling it in market (Bankman et al. 2017). Alternatively “section 70-25 of the ITAA 1997” provides that expenses sustained in purchased of trading stock should be in nature of capital.
Referring to “section 275-105 of the ITAA 1997” trading stock is viewed as CGT assets since it does not forms the part of the section (McDaniel 2017). Likewise for RIP Pty Ltd it bought accessories and caskets which is used for ordinary business course. Therefore, it would be classified as trading stock and not capital assets.
An important declaration of “section 8-1 of the ITAA 1997” is that expenditure occurred at the time of purchasing the trading stock should be held as permissible deductions (Murphy and Higgins 2016). Taking into the consideration the circumstances of RIP Pty Ltd the purchase of caskets and accessories constituted trading stock expenditure which is allowed as deductions under “section 8-1 of the ITAA 1997”. The company can further claim deductions for items purchased in ordinary business course and stocks that are regarded as closing stock in hand.
Denoting the explanations of “section 8-1 of the ITAA 1997” an individual taxpayer is permitted to claim deductions for any losses or outgoings sustained in making taxable income. Denoting the circumstances of RIP Pty Ltd the company reported a prepaid expenses that forms the part of the purchase of trading stock (Schmalbeck, Zelenak and Lawsky 2015). With respect to “section 8-1 of the ITAA 1997” the company would be allowed for claiming deductions from the assessable income since the expenses were incurred in producing the taxable income of business.
Referring to the “section 6-5 of the ITAA 1997” majority of the income which is obtained by the taxpayers from all the sources is regarded as the taxable income on the basis of ordinary concepts (Burke 2016). As stated by the ATO dividends that are earned by the company of Australian resident is required to include into the taxable income.
As understood from the state of affairs of RIP Pty Ltd income that is derived through dividend should take away the franking credits which attached to the dividend. The company is required to detach the franking credits in order to make the dividend completely franked.
Signifying the explanations of “section 100-25 of the ITAA 1997” any form of advance payment received for the rental storage does not constitute a capital assets. With regard to the “section 100-25 of the ITAA 1997” receipt of rental storage is not believed as the capital asset (McDaniel 2017). Furthermore, it is worth mentioning that the receipt of prepaid sum of payment which is obtained by the RIP is regarded as the present income based on the period of four months and with respect to “section 100-25 of the ITAA 1997” the rent obtained would be held in the form of general deductions.
Payments that are made by the taxpayer for an employee long service leave or payments that is made by the employer for the termination of employment shall be liable for PAYG Withholding. According to the ATO an employer is required to contribute into the employees long service leave entitlement in respect of the services that are rendered by employee. Denoting the explanations of “section 83-80 of the ITAA 1997” the unused amount of the long service leave is not considered as the element of the taxable income.
Taking into the consideration of the “subsection 83-85 of the ITAA 1997” an individual taxpayer is required to claim an allowable deductions for the unused amount of long service leave (Bankman et al. 2017). However, it is vital that the amount of the long service leave paid that is paid should not be higher than thirty percent of the assessable income. Similarly for the RIP Pty Ltd the company paid the long service leave to its employees for three months and such payment is held as expenses for the year ended 2016.
As defined under the positive limbs of the “section 8-1 of the ITAA 1997” a taxpayer can claim an allowable deductions given the outlay and the outgoings that is sustained was in the direction of deriving the assessable income (Barkoczy 2016). According to the “Section 100-25 of the ITAA 1997” CGT assets generally classified as the land and buildings.
Taking into the consideration the circumstances of the RIP Pty Ltd, expenses reported by the company relating to the payment of the preliminary architectural designs is regarded as the capital expenditure. Under “Section 100-25 of the ITAA 1997” such expenditure forms the part of the cost base which is not allowed as deductions. Additionally the expenses reported by the company for the onsite car parking and the expenses on the building and equipment is classified as the capital expenditure with no allowable deductions is allowable under “section 8-1 of the ITAA 1997”.
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