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Question 1

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

300,000

Gross receipts from trading

Payments ($):

100,000

Purchases of trading stocks

30,000

Partners' salaries (each)

2,000

Interest on cash advance made to the partnership by Peter

60,000

Salaries for employees and rent paid

2,000

Legal expenses in recovering bad debts


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.

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.
  1. $78,562 was spent on hiring additional fire equipment to fight a fire at the mine site.
  1. $583,412 was spent on legal fees and advertising to represent the company and its directors at a Government enquiry into coal mining activities.
  2. 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.
  3. 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.

Question 1

Question 1:

Partnership is the concept were two of more parties joins together to commence business or a specific activity. In this case the profits are shared equally by both the partners. Usually it depends upon the mutual understanding and written partnership deed to share the profits among the partners (Woellner, et al., 2018). In the absence of any information it is assumed that the profits are to be shared equally whether the capital introduced by each of the partners are not equal.

Gross receipts from trading:  Under section 8-1 ITAA97 of Income Tax Act, 1994, this is the proceeds of the sales that take place during the year so it will be the main income that happens during the whole year it can also be termed as gross income (Australian Government, 2018). All the expenses and losses are deducted from this head for the calculation of the net income of the firm.

Payments: Under section 8-1 ITAA97, all the payments that are made for the various transactions are deducted from the incomes for the calculation of the net income so the various heads such as purchase of the trading stock, salaries of each of the partners, interest on cash advances from peter are to be deducted from the gross receipts (Woellner, et al., 2018).  The other deductions include salaries to the employees and rent paid and legal expenses. The amounts related to the partners and their salaries are deducted as they are treated as separate entity as per the company law (ATO, 2018).  Australian taxation office also considers a person as individual and the incomes are taxable under various heads such as salaries, income from business and profession, capital gains, other sources and professional income.

The taxable income refers to the income earned by the firm on which there is a need to calculate the tax that requires to be paid to the government. The main reason behind it is that taxes are considered as the revenues for the government.

Calculation of the taxable income of Peter

In this problem first of all it is needed to identify the total income of the partnership firm.

Particulars

Amount ($)

Particulars

Amount ($)

Trading stock at beginning 1July

10000

Sales

300000

Purchases

100000

closing stock 30 June

20000

Gross profit  (Balancing figure)

210000

Grand total

320000

Grand total

320000


From the above calculation it is identified that the total income of the partnership was $300000 and the remaining stock that is to be carried forward for the next year will be 20000. The gross profit for the partnership firm is $210000. This profit is also termed as gross income of the company. Thereafter, the various expenses related to the company are to be deducted from this income for the purpose of calculating net income for the purpose of tax (ATO, 2018). The various expenses incurred and paid by the company/partnership firm are as below:

Particulars

Amount in ($)

Gross profit

210000

Less: Interest in cash advances

(2000)

Less: Salaries for employees and rent

(60000)

Less: Legal expenses for recovering bad debts

(2000)

Net profit

146000

Question 2


The amount will be available for being distributed among the partners will be 86000 [($146000 - $60000 (salaries of both the partners 30000each)].   

As per the available information peter and Jill shares the profits equally.  So, the calculation of the taxable income will be as below:

Sharing of profits equally = 86000/2 = $43000

Calculation of the taxable income of Peter:

Particulars

Amount (in $)

Calculation of the total income of Peter

Share of partnership (net income share)

43000

Salary

30000

Interest on cash advances

2000

Winnings from gambling

2000

Net salary as a part time instructor

5000

Less: Deductions

        Subscription to professional journals

(500)

Total taxable income

81500

Question 2

Excel Mining Ltd

Excel Mining Ltd is a company that is engaged in the activity of the mining of the coal. Besides this, it is founded in the year 1998 and operates as a subsidiary of Alliance Coal LLC. This company operates in the industry named oil, gas and consumable fuels. For the calculation of the tax to be paid to the government on the income earned by the company, there is a need to calculate the taxable income for which there is a need to carry out the treatment of the different components related to different economic transactions carried out by the company as follows.

  1. Treatment of expenses of car purchased for tax purpose:

Law/Provision: 

According to Australian Taxation Office, if a company purchased a car and uses it in carrying out employment duties, the expenses of car can be claimed by the owner as deduction while calculating the taxable income. It also includes a car purchased on hire or lease. However, if the vehicle is used for the personal use, the expenses incurred on car cannot be claimed for deduction in income tax (Australian Taxation Office, 2018). Also, if a car is being used by the company for both personal as well as employment purposes, the expenses can be claimed as deduction only to the extent of work related use of the car.

In addition to this, as per section 53 of Fringe Benefits Tax Assessment Act 1986, there are 2 ways for estimating the assessable value of car fringe benefits. The formulae specified for this by the statue and the operating cost method are:

  • The statutory method is used when the assessable value of a car fringe benefit is determined through total kilometres. At the point, it may produce an inducement for the employees to travel more kilometres in order to minimize the overall taxable value of their car.
  • The operating cost method states that the actual operating costs of a car, like its expenses, registration, depreciation, and insurance should be divided between employment purpose and private purpose. The private use portion of the car's operating costs refers the value of the car fringe benefit. On the other hand, the operating cost method enables a more reliable assessment than the statutory formula. Also, it enforces a strict conformity burden for the individuals with low levels of employment use.

The Australian Taxation Office also states that if that car is sold, transferred or damaged wholly, the amount received on sale or from insurance (if any) would be deducted from the written down value of the car and the income tax would be imposed on the remaining amount.

In the presented case, Excel Mining Ltd has purchased a Mercedes Benz for $128000 on10th Oct 2017. The car is used for employment purpose up to 72% and 28% for private purpose. It means the company would be allowed deductions on the car expenses only to the extent the car used for employment purpose.

Partnership and Taxable Income

Thus, the allowed deduction amount = $128000*72% = $92160

The life cycle of car is 6 years. However, the car was destroyed on 18 May, 2018 (within 7 months). So, no depreciation would be applicable.

The insurance claim received by the company is $87000

Thus, the taxable amount would be = $92160- $87000

= $5160

  1. Treatment of hiring additional fire equipment for tax purpose:

Law/Provision:

According to the guidelines of Australia Taxation Office, capital assets are those that have long life (generally more than a year) and are useful to business either in enlarging or improving the structure, such as machinery, tools and fixtures, building or land. The expenses incurred on these capital assets are called capital expenditure (Australian Taxation Office, 2018).  If a company makes any expenditure on hiring any capital asset, it can claim this expenditure as deduction while estimating the annual taxable income in the year of purchase only.

Otherwise, the company has an option to claim the deduction for the decrease in asset value, i.e. depreciation on the asset every year over the expected life of that asset.  

Case Analysis:

Excel Mining Ltd spends $78,562 on hiring additional fire equipment to fight a fire at the mine site. Since this expenditure is made in order to safeguard the operations and mine site from any threat or hazard, it would be treated as a capital expenditure for the company for the tax purpose. As a result, the expense of $78,562 on additional fire equipment would be allowed 100% deduction to the company.

  1. Treatment of expenses on legal fees and advertising by company for tax purpose:

Law/Provision:

Under the section 113 of the Tax Administration Act 1994 of Australia, legal costs and advertisement expenses are those which are incurred by an entity with respect to the business purposes.  These expenses must be treated as either revenue or capital expenditure, depending on the amount. The general principle laid under section 113(1) is that the initial incurring of such expenses would be treated as capital, and therefore the costs associated with that cannot be claimed as deduction unless there is a any transfer or sale of the asset in which situation, the amount would form part of the computations for capital gains. The Act also states that an entity can claim the deduction on such expenses it incurs in running the business in order to minimize the taxable income. As a general rule, the entity can also claim the everyday business operating costs in 100%, in the year of incurring. However, the costs of capital assets like land, machinery and tools can be claimed for deduction over a number of years.

Company and Taxable Income

In addition to this, According to the guidelines of Australia Taxation Office, operating expenses refer to those which are spent by a company in its day to day functioning related to business. For example, renting office site, office stationary, wages and salaries of employees. These costs are also known as revenue or working expenditures (Australian Taxation Office, 2018). A company can avail 100% deduction on such expenditure made in the same year when it was incurred. The common examples of such expenses in business include:

  • advertising and funding costs
  • insurance premiums, together with disability or accident or fire, professional indemnity, burglary, public risk, loss of profits insurance, motor vehicle or workers’ reimbursement
  • bad debts
  • interest on money rented for
    • employer super contributions, income tax debts, or delayed imbursement or accumulation of tax
    • producing measurable income or purchasing income-generating assets
  • lease expenses on luxury car
  • bank bills and charges
  • stationery expenses

Case Analysis:

In the presented case, $583,412 was spent by Excel Mining Ltd on legal fees and advertising to represent the company and its directors at a Government enquiry into coal mining. Since this expense was incurred by the company for the purpose of carrying out usual business activities, according to general principle under Australia’s tax laws for businesses this expense must be allowed as 100% deduction to the company while computing its taxable income (Australian Taxation Office, 2018).

Law/Provision:

Accounting Standard 137 of The Australian Accounting Standards Board, the Provisions, Contingent Liabilities and Contingent Assets apply to both entities and non-entities. Section 334 of the Australian Corporations Act 2001 defines provisions as those liabilities that have uncertain amount or timing. In Australia, the term ‘provision’ is applied in context of those items whose payable amounts or time period is not known. Such items include tearing of assets, depreciation, and uncertain debts. According to general principle under Australia’s tax laws, the expenses estimated by a company to be incurred in future are need to be debited in the statement of profit and loss for the purpose of accounting, in the form of provision. However, this provision for future expense are permitted to be deducted for the taxation purpose in the succeeding year (Australian Taxation Office, 2018).

For example, expenditures made by business such as duties, taxes, cess, fee must be debited as per accrual basis of accounting but they are allowable on payment basis only for calculating the taxable income, when the liability actually arises.

Case Analysis:

In the presented case, the Excel Mining Ltd has also made a provision for $568,438 in the company accounts for the future liabilities from claims by the townspeople against illnesses that has the probability to occur from the effects of the coal mine fire. Since the loss has not actually occurred, the amount must be debited to the statement of profit and loss account by the company. However, the company can claim 100% deduction on it only in the year when it would actually occur.

Capital Assets and Tax Deductions

Law/Provision:

Section 6(1)(b) of Charities Act of Australia states that when an individual or an entity gives a gift or donates to a local community, the amount can be claimed for a tax deduction while computing the total chargeable amount under the provisions of The Taxation Administration Act 1953 of Australia. However, the amount that can be allowed largely depends on the kind of gift or donation made by the entity. Apart from this, According to the guidelines issued by the Australian Taxation Office, when a company donates money to an official charity (registered under "ATO"), the entire amount can be claimed for 100% deduction while computing the taxable income for the year. If an organization is registered by the ATO as a “Deductible Gift Recipient institution”, then such donations made to them must be tax deductible(Australian Taxation Office, 2018). On the other hand, if such donation is made in kind or other than cash, the company cannot claim for 100% deduction on the amount. Moreover, if the institution to which the donation is made, is not registered under ATO, no deduction must be allowed to the donor.

In addition to this, given that the amount of donation is $2 or more, and the company makes it to a deductible gift recipient charity, the company can claim the 100% amount of money donated on the your tax return. As per the rule of Section D9 of Australian Tax Laws on your tax return (Gifts and Donations) deals particularly with charitable donations, guiding donors on how to record their donations in tax return.

Case Analysis:

In the presented case, the Excel Mining Limited donated $55,000 to the local community SES Fire services. A fire and emergency services fund is a public fund established by Australian government and maintained by Australian government agency to provide volunteer based emergency services (Australian Taxation Office, 2018). Since SES is registered under ATO, the amount donated to it is allowed as 100% deduction to the company.

References

ATO, (2018) Individuals: 24 Other income 2018. [Online]. Available at:   https://www.ato.gov.au/Individuals/Tax-return/2018/Supplementary-tax-return/Income-questions-13-24/24-Other-income-2018/ (Accessed: 24 September 2018).

ATO, (2018) Partnerships. [Online]. Available at:  https://www.ato.gov.au/tax-professionals/prepare-and-lodge/tax-agent-lodgment-program/tax-returns-by-client-type/partnerships/ (Accessed: 24 September 2018).

Australian Government, (2018) Partnerships. [Online]. Available at: https://www.ato.gov.au/business/non-commercial-losses/partnerships/ (Accessed: 24 September 2018).

Australian Taxation Office (2018) Tax Deductions. Australian Government, [Online]. Available at https://www.cancercouncil.com.au/ways-to-donate/tax-deductible-donations/ (Accessed: 24th September, 2018)

Australian Taxation Office (2018) Tax Deductions. Australian Government, [Online]. Available at https:/ https://www.ato.gov.au/business/income-and-deductions-for-business/reconciliation-activities/depreciating-assets-and-capital-expenses// (Accessed: 24th September, 2018)

Australian Taxation Office (2018) Tax Deductions. Australian Government, [Online]. Available at https://www.ato.gov.au/individuals/income-and-deductions/deductions-you-can-claim/vehicle-and-travel-expenses/car-expenses/ (Accessed: 24th September, 2018)

Woellner, R. Barkoczy, S. Murphy, S. Pinto, D. and Evans, C. (2018) Australian Taxation Law 2018. Australia: Oxford University Press.

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