Tax Implications Of Partnership Business In Australia

1.Peter and Jill are in a partnership as retailers of electrical goods. The partnership records, exclusive of GST, for this income year disclose:

Other details:

• Peter and Jill share partnership profits equally
• Trading stock on hand 1 July: $10,000
• Trading stock on hand 30 June: $20,000
• Peter's personal records disclose:
• Gambling winnings: $2,000
• Net salary as a part-time instructor (excluding PAYG tax instalments of $2,000): $5,000
• Subscription to professional journals: $500
• Peter is a member of a private health fund Calculate Peter's taxable income for the income year explaining your treatment of each item in this question.

2.Viktor is a director of Excel Mining Ltd a coal mining company in Victoria.

The company had the following transactions during the year ended 30 June 2018. He wishes to know how they are treated for income tax purposes by the company.

You can assume in this question that the numbers exclude GST unless otherwise stated.

1. Purchased a Mercedes Benz motor vehicle for a cost of $128,000 on 10 October 2017. The car is used by the managing director 72% of the time for work purposes. The effective life of the car is 6 years. On 16 May 2018 the car was crushed by a forklift. The insurance company wrote off the car and paid the company $87,000.
2. $78,562 was spent on hiring additional fire equipment to fight a fire at the mine site.
3. $583,412 was spent on legal fees and advertising to represent the company and its directors at a Government enquiry into coal mining activities.
4. The company also made a provision in the company accounts for $568,438 for future liabilities from claims by the townspeople against illnesses that may arise from the effects of the coal mine fire.
5. It also donated $55,000 to the local community SES Fire services. Viktor also advises you that he wants the company to maximise its tax deductions and minimise its taxable income.

Required

Explain to the company how each of the above items is treated. In your answer please carry out calculations where necessary

Determining Taxable Income of Partnership Business in Australia

The issue is to determine the taxable income of Peter from the information provided in the about detailing the receipts and payments from the partnership business of Peter and Jill. In determining the taxable income Peter, apart from the receipts and payments of partnership business other personal income of Peter shall also be considered.

In Australia, the income tax rules and regulations are enumerated in the Income Tax Assessment Act 1997, here in after to be mentioned as ITAA 1997. The provisions of appropriate sections of the ITAA 1997 along with the instructions of Australian Taxation Office (ATO) shall be considered.

The honourable court in the above case decided that the income of a partner from partnership business shall form part of the assessable income of the partner to determine the taxable income of partner in an income year. However, if certain conditions are met then the income from partnership will not be included in computing the taxable income of a tax payer in a particular income year.

Total assessable income lower than $20,000:

In case total assessable income of a partnership is less than $20,000 then, no distributions from partnership are allowed and in such case the income of the partnership is not label to be considered for computation of taxable income of an individual.      

All the partners must be individual and resident Australia:

In order to avail the benefit of exemption for calculation of taxable income, the partners in a partnership are all must be individuals and must be resident Australia. In case any of the partners are either a foreign resident or not an individual then even the smallest of distributions are to be included in computing taxable income of an individual.   

Thus, if the above two conditions are met then the income from partnership is not to be considered for computing the taxable income of an individual. The decision in Hope v Bathurst City Council (1980) 144 CLR 1 at 8; 12 ATR 231, also established that in case a partner has earned any other income from the partnership in excess of the distribution of profit to the partners, then such other income shall also liable to be included in computation of taxable income of the individual.  

The above section discusses the tax implications of different distributions received from a partnership. Often partners are paid salaries for participating in the day to day affairs of the partnership. Such salaries paid to the partners are considered as in calculating taxable income of the partners. The profit distributed by a partnership to the partners shall also be taken into consideration in determination of the taxable income of the partners in the year of distribution.

Exemptions for Taxable Income of Partnership Business in Australia

Peter along with Jill are in a partnership business. Apart from the profits distributed by the partnership business, Peter has also received salary from the partnership business. As already mentioned that the receipt of salary from partnership is assessable income to be considered in computation of taxable income of the individual. The profits from the partnership business liable to be taxed in the hands of Peter is calculated below:

Details	($)	($)
Receipts of gross amount from trading	300000
Add: Closing stock in excess of opening stock as per s70-35 ITAA1997	10000
		310000
Less: Purchase of trading stock (Working Note 1)	100000
Salaries paid to partners are not allowed as deduction	-
Interest on as per s8-1 ITAA 1997 (On case advance made to the partnership by Peter)	2000
Payment of salaries to the employees and rent as per s8-1 ITAA 1997	60000
Bad debt recovering expenses as per s8-1 ITAA 1997	2000
		164000
Net income of the partnership business		146000

Details	($)
Trading stock at the beginning	10000
Add: Purchases made during the year	100000
	110000
Less: Trading stock at the end of the year	20000
Trading stock expenses for the year	90000

As established in Hope v Bathurst City Council (1980) 144 CLR 1 at 8; 12 ATR 231, in case the net income of a partnership is above $20,000, then the amount can be distributed as profit to the partners. As can be seen from the above calculation, that the net income of the partnership is $146,000, i.e. excess of $20,000 hence, the profit can be distributed to the partners as per the partnership agreement. Thus, the amount of profit distributed to Peter and the other income including the interest on cash advance and salaries (As per s18A of the ITAA 1936) received from partnership shall be included in computation of taxable income of Peter for the income year.

Since the partnership agreement provides that the partners shall distribute profits and losses equally thus, the net profit of $146,000 shall be distributed as $73,000 each to Peter and Jill. In calculating the taxable income of Peter, the distributed profit of $73,000 along with salaries and interest received shall be included in computing the taxable income of Peter for the concerned income year.

Apart from the income derived from partnership, other incomes derived by him are also to be considered while determining the taxable income of Peter for the concerned income year. During the year Peter has also derived income of $2,000 from gambling. Australian Taxation Office (ATO) has provided that winnings from gambling is assessable income and shall be classified under other income at the time of computing the taxable income and resultant tax liability of an individual. Thus, $2,000 winning from gambling shall also be added with the income derived from partnership to compete taxable income of Peter. The amount of $7,000 received as salary by Peter for providing part time instruction is assessable income in computing taxable income of Peter. Thus, it is also to be included in computing taxable income of Peter. The deductible expenditures shall be allowed in computing taxable income thus, $500 shall be deducted in the form of subscription of journal. Taking into consideration the above discussion, the taxable income of Peter is calculated below:

Details	($)
Share of income from partnership as per s92 ITAA 1936	73000
Income derived from salary as per s92 ITAA 1936, and Tax Ruling TR2005/7	30000
Winnings from gambling	2000
Income from Interest on cash advance as per s6-5 ITAA 1997	2000
Part time instructor’s salary as per s6-5 ITAA 1997	7000
Less: Allowable deductions:
Payment for subscription of journal	500
Taxable income of Peter	113500

Calculating Taxable Income of an Individual Partner in Australia

Conclusion:

Taking into consideration the various provisions of ITAA 1936 and ITAA 1997 and the instructions of ATO, the taxable income of Peter is calculated at $113,500. On the above taxable income Peter shall be tax as per the applicable rate of tax that applies on his taxable income for the concerned income year.      

The issue is to discuss the tax treatments for different expenditures of Excel Mining Limited to minimize its tax liability. Thus, as per the applicable income tax provisions appropriate tax treatments for different expenditures of Excel Mining Limited shall be recommended to Victor, one of the director of the company, with the objective of minimizing the tax liability of the company. 

Income Tax Assessment Act 1997 (ITAA 1997) provides that revenue derived from business activities of an entity are subjected to income tax along with capital gain of such entity made from sale of capital assets. Australian Taxation Office (ATO) also provides, that unlike an individual an entity, i.e. a corporation, is not allowed to use capital gain discount (CGT) method to calculate the taxable income from capital gain.

Sub section 1 of section 136 of ITAA 1997 contains the provision in relation to liability of an employer in respect of Fringe benefits tax (FBT). Employers are liable to FBT at a statutory rate of 20%. However, there are certain exemptions to the FBT liability to an employer. The following case discusses the exemption in respect of FBT to an employer:

In case certain services and facilities have been provided to the employers that were driven to a large extent for the work purpose and objective of the entity then such facilities and services are not considered as fringe benefits and no FBT is required to be paid by the employer for such services and facilities. It is important to keep in mind that the FBT to be paid on taxable value of fringe benefits shall be considered as allowable expenditure in calculating the taxable profit of the employer for income tax purposes.

Expenditures in connection with the security of the factory or premises in which the entity has its place of operations shall be allowed as expenditures to calculate the taxable profit from business. Such expenses are considered operational expenditure of business and accordingly, allowed as deduction from revenue of the business to calculate the taxable profit of such business.                     

The ruling in Casimaty v FCT (1997) 37 ATR 358, established that in case acquisition of certain assets for securing the mining area or place of mining, the entire cost of such acquisition shall be considered as ordinary expenditure of business and will be allowed to be deducted in computation of taxable profit from mining business. 

Minimizing Tax Liabilities of Excel Mining Limited in Australia

As per ATO, legal expenses of an entity for defending law suits against the entity is allowed as ordinary expenditure. However, in case legal expenses are in connection with capital assets then such expenditures are capitalized and not to be deducted as expenditures for computing taxable profit of an entity.  Similarly, the advertisement and promotional expenditures incurred by an entity is considered as ordinary expenditures and to be deducted for computation of taxable profit from business of the entity. ATO provides, that in computation of taxable income from business, an entity is not allowed to deduct provision made for anticipated losses in the books of accounts. Anticipated losses are not allowed as deduction, such expenses are allowed only when these are incurred by an entity.

The car provided to one of the directors of Excel Mining Limited and used for both official and private purposes, i.e. 72% for official and 28% for private. Thus, capital fringe benefit shall be recorded for 28% of private use. Written down value of the car is $115200 and depreciation shall be provided under straight line method for computing taxable value of benefit.

The entire cost of $78562 for acquisition of fire equipment for fighting fire in the mining site will be fully allowed as deduction as such purchases are considered ordinary business expenditures in mining business.       

The legal expenditures incurred by Excel Mining Limited is ordinary business expenditures to be deducted in computing taxable profit of the business on which tax liability of the company is to be calculated. The advertisement and promotional expenditures incurred to increase sale is revenue expenditures incurred by the business is allowed fully as deduction for computing taxable profit from business of the company. 

Provision made in the books of accounts of  $568438 for expected future losses due to fire in the mining sites are not allowed as deductions as such provisions are not allowable expenditure in computing business income of an entity.     

Since, the donation made to SES Fire Services is not a specific donation as per the ITAA 1997 hence, the donation of $55000 to SES Fie Services is not allowed as deduction for computing taxable profit from mining business of the company.   

Conclusion:

Taking into consideration the above discussion, it is quite clear that all items of expenditures are to be considered separately as per the provisions of Income Tax Assessment Act 1997 to consider the deductions applicable to these expenditures in order to minimize the tax liability of an entity in Australia. 

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