Taxation Law - Decision in Arthur Murray Pty Ltd v FCT and Other Cases - Assignment Example

Taxation Law Part A i) Decision in Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314 The facts in the case are that the taxpayer had received a grant from a grantor (Government Agency) intended to provide business assistance and the terms of the grant were stipulated in a deed. However, the taxpayer (grantee) used some part of the grant to make share acquisition in the businesses they provided assistance and later sold the shares before the grant period ended. The financial reports from the grantee showed the grant fund as unearned income although there was no indication as to whether the payment was considered as a loan. After the funds were expended, the taxpayer’s accounts treated it as income. The issue in the case was whether the grant funds can be used in asset acquisition bearing in mind that it is derived by the taxpayer in pursuit of “section 6-5 of Income Tax Assessment Act” in the income year of asset acquisition. It was held that a prepaid service income should not be derived till the services have been provided; however, it can be derived if the payment is non-refundable for both contractually and in practice. ii) a) According to general principles, accrual based income recognition occurs when the taxpayer has accomplished all necessities to be entitled to payment unless it is contingent. An income received in advance cannot be accounted for income generated in that financial year since the company has not incurred the corresponding expenses with respect to that income and hence it is regarded as an unearned income. Income should be derived when it is realized and earned. Income is realized when goods or services or other assets are exchanged for cash or claims to cash. RIP Pty Ltd will derive Income from funeral services when it has substantially accomplished what it must do to be entitled to the benefits represented by the income (Woellner, et.al, 2011). b) Arthur Murray principle does not apply to funeral plan No 1 since the amount paid is not refundable. In case of non-refundable contract, an income is considered derived in the year the receipt is made even if no services have been provided (Nethercott & Devos, 2011). In funeral plan No 2, Arthur Murray principle applies since only income from funeral services offered are derived. There is also refund for a membership that is cancelled and this income is considered not derived as the funeral services have no been offered in such a case. c) The commissioner or any taxpayers have a choice in the method of accounting for tax. The choice will arise depending on the basis employed whether accrual or cash basis. However, the accounting method used should reflect correctly the true income of the taxpayer. Many accounting measurement do not have a single correct answer. Therefore, a choice must be made among alternative assumptions under conditions of uncertainty. The concept of conservatism hold that when reasonable support exist for alternative accounting method and for different measurement techniques, commissioner or taxpayer should select the method of techniques with the least favorable effect on net income and financial position in the current accounting period. The accrual basis will consider expenses that were incurred last financial year but whose corresponding revenue has been realized in the current year while excluding those expenses paid in advance. The cash basis considers the actual amount of expenses incurred in the current accounting period (Barkoczy, 2011). The commissioner will also have to establish the residency of the taxpayer. In a case “FCT V Jenkins (1982)”, the three years that the taxpayer had spent outside Australia was considered significant and the court held that the taxpayer resided permanently outside Australia. iii) The amount in funeral plan No 1 should be recognized as income and treated as such for tax purposes. This is because it is a contract which is non-refundable and therefore income is derived whether the funeral services have been provided or not. In the case of amount in funeral plan No 2, the RIP Pty Ltd will derive income according to the “rule of thumb” only after it has done everything considered necessary to have payment entitlement. The company has not provided funeral services, that is, it has not accomplished its obligation and therefore this income is not derived (Krever, 2011). This amount should therefore not be treated as income for tax purposes. iv) The amounts in respect to members who have ceased making scheduled payments and who are not expected to make up arrears (defaulting members) do not form part of derived income. This is so because RIP Pty Ltd has not offered funeral services in their regard hence not earned. Any prepayment for a service income its corresponding income is not considered derived until provision of the service in question has been effected. Since RIP Pty Ltd has not accomplished its side of bargain it does not become entitled to this income. However, since these amounts are generally non-refundable they will be treated as derived income (Gibson, and Fraser, 2011). They will be considered for tax purposes since they have been derived during the year. This amount will be assessable for income as it is in the hands of RIP Pty Ltd. Part B: i) Trading is the exchange of goods and or services with cash or for other goods and or services with the chief intention of realizing a positive return from the undertaking (Tulsian, 2000). According to Nelson (2006), “trading stock for tax purposes” refers to anything whether produced, acquired or manufactured for trading purposes. The loss or profit of a trading stock is determined by considering the difference between the closing valuation and the opening valuation. The caskets and accessories would be trading stock for tax purposes since they are acquired for the normal use in the ordinary course of the business of the company. These costs relate directly to the assessable income generated by the company which should be subjected to taxation. The amount of $25,000 is a prepaid expense and therefore cannot be accounted for income tax for the year June 2011 even if it is an allowable expense for tax purpose since it does not relate to that year- it relates to financial year ending June 2012. The matching principle requires that after the revenue (accomplishment) for an accounting period has been determined the cost (effort) associated with their revenue must be deducted from revenue to measure the net income (Davis, et al., 2009). Therefore, this amount will be expensed in June 2012 to reflect a deduction from the revenue of that accounting period and thus derive the corresponding tax. ii) A fully franked cash dividend of $21,000 received from Ripper Finance Pty Ltd, represents other sources of income for the company. This should also be disclosed and considered for tax purposes. This should be added to income before tax so as to reflect the correct figure of income of the company for tax purposes. The prepayment of $22,000 with respect to the long service leave of the managing director of RIP should be deducted from the income before tax of the company since it does not relate to the year ended June 2011. The only amount which should be expensed in this accounting period is $ 7,333 and not the whole of $22,000 since the fiscal year ends on 31 June 2011. Therefore, $14,666 should be deducted from the income before tax. In a case “FCT V Applegate (1979)”, it was observed that since imposition of tax was on annual basis, the residency was determined on annual basis. iii) Depreciation of the building will be an allowable deduction since it relates to the business of the company in the production of assessable income (Donald, et al., 2009). The depreciation expense is based on the initial cost of the building which is then distributed throughout the life span of the building. The cost of the building will also include $250,000 paid for preliminary architectural designs in addition to the $2.5m incurred in the construction of the new premises. Therefore, the total cost of the building is $2.75m. Taking that the premises will have a useful life of 20 years and that the residual value of the premises will be insignificant we apply the straight line method to account for its depreciation per year. The depreciation expense per year will be $2.75m/20 = $137,500. Therefore, the company will have a tax deduction of $137,500 per year with respect to the premises. This depreciation expense is matched with the revenue corresponding to that accounting period. Since by June 2011 the premises have been in operation for 11 months a prorata basis will be applied to account for the exact depreciation expense. Therefore, the amount allowable for tax purposes will be $(137,500/12)*11 = $126,041. iv) Schedule for the company’s taxable income and tax liability Reported net profit $2,450,000 Add: materials prepaid $25,000 Cash dividend $21,000 Prepaid long service leave $14,666 Total $60,666 Less: credit balance in funeral plan No 2 $4,125 Amount with respect to defaulting members $16,200 Depreciation on new premises $126,041 Total ($146,366) Taxable income for the company $2,364,300 Income tax liability $47,100 + 45%(2,364,300-150,000) $ 1,043,535 References Barkoczy, (2011). Core Tax Legislation and Study Guide, (14th ed.). Australia: CCH Australia. Barkoczy, (2011). Foundations of Taxation Law, (3rd ed.). Australia: CCH Australia. Davis, D. et al., (2009). Companies and other business structures: commercial law. Oxford: Oxford University Press. Donald, E. et al., (2009). Intermediate Accounting. New Jersey: John Wiley and Sons. Gibson, A. and Fraser, D. (2011). Business Law. (5th ed.). Australia: Pearson Education. Krever, (2011). Australian Taxation Law Cases. (6th ed.). Sydney: ATP Publisher. Nelson, B. L., (2006). Law and ethics in global business: how to integrate law and ethics into corporate governance around the world. Sydney: Taylor & Francis. Nethercott, R. & Devos, A. (2011). Australian Taxation Study Manual. (20th ed.). Australia: CCH Australia. Tulsian, P. C. (2000). Business law. Tata: McGraw-Hill Education. Woellner, B., Murphy, E. & Pinto (2011). Australian Taxation Law (21st ed.). Australia: CCH Australia. Read More