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BULAW3731 Income Tax Law And Practice

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  • Course Code: BULAW3731
  • University: Federation University
  • Country: Australia

Question:

During the year (2016/17) Frank submitted a design as part of a national competition for

‘The Citadel’, the centrepiece of an ambitious urban redevelopment. His visionary design and revolutionary use of local materials left the judging panel speechless with admiration and, to national acclaim, he was awarded the prize and commissioned to build the structure. Immediately he borrowed $1 million, rented premises in Main Terrace, acquired state of the art equipment and employed six draughtsmen and two administrative staff. During 2017/18 his billings were $2.5 million.

You must refer to appropriate case law. Your answer must include (but should not be limited to) a discussion of the following:

  • What factors affect the choice of a cash or accrual basis?
  • Does Frank have a choice of the basis he adopts?
  • Does the Commissioner of Taxation have a right to insist on a particular basis?
  • Should Frank’s basis be the same in both years?
  • Given the present availability of accounting software packages, in your view, is the traditional criteria for the cash/accrual distinction still relevant?
 

Answer:

Introduction

According to section 6-5 of ITAA 1997, the assessable income of an Australian resident should be regarded as taxable in accordance with the ordinary concepts which can be derived from either direct or indirect sources. The sources of ordinary income can be divided into certain categories; such as income from rendering personal services, income from property and the income generated from any business (Gitman et al., 2015). The case law also stated other formations of income which can also be regarded as taxable, which are, the earned income, expected income, reliable income, or a regular or periodic income. But it is a matter of argument for the taxpayers that if the expected or reliable payments can be considered as confirmed income in accordance with the section 6-5 of ITAA 1997 or not.

Section 6-10 of ITAA 1997 provides the list of incomes that are not included in ordinary income. These incomes can also be regarded as assessable income with regards to several provisions. These incomes are considered as statutory income so recognized as a part of assessable income (Aldridge et al., 2015).

 

Factors to choose the accounting methods

In order to prepare an accounting statement for taxation, there are two methods that can be observed in accordance with the guideline of ATO. These methods are stated in the paragraph 8 and 9 of Taxation Ruling 98/1. The first one is the cash basis methods in which only the income or payments that have been already received in hand can be included in the taxation statement (Ciconte et al., 2016). The payments which are due in the concurrent financial year cannot be included as assessable income and thus, cannot be listed in the taxation file. On the other hand, all the payment that have been received or yet to be receive must be included in the taxation documentation of a company. Despite some payment can be outstanding for the firm, but the taxation will also be implemented upon the outstanding payments too.

The method of accounting mostly depends on the size and area of operation of any firm. Large business firms (making an annual turnover of $10 million or above) must have to use accrual methods for accounting as per the legislation of Australia stated. But for smaller firms whose annual turnover is less than $10 million can consider the cash basis accounting for taxation (McGregor-Lowndes & Crittall, 2017). For obtaining the possession of choice for the individual or entity to choose from any one of the accounting methods, the individual or entity must fulfil any one of the following criteria:

  • Small business structure- whose annual turnover is less than $10 million.
  • Non profit organisations like government school, charitable institution or trustee or any such funds.
  • A gift-deductible entity.
 

The available choice of accounting for Frank

In the given case, as Frank is running a medium scale business in which the turnover is limited to below $10 million, Frank certainly has the freedom to choose any one of the following accounting methods. According to the paragraph 27 of TR 98/1 the taxpayers determines the arrival of the income by adopting an accounting method. These accounting methods have been discussed in the paragraph 8 and 9 of TR 98/1 namely receipts method (cash method) and earnings methods (accrual method). In the paragraph 17 of TR 98/1, it is stated that the taxpayer should adapt the particular method which is most suitable with the circumstances with the case and can provide an accurate reflexion of the income. As stated in paragraph 18 and 20 of the same legislation, the receipts method is suitable for the income derived by an employee, non profit organisation or the business where the income is derived from various provisions. In paragraph 20, it is stated that the earning method is suitable for trading and manufacturing business firms. From the above analysis, it can be stated that the accrual method of accounting should be most appropriate for Frank (Robinson et al., 2015).

Right of the Commissioner of Taxation

As far as the taxation guideline is concerned, the Commissioner of Taxation cannot insist on a particular basis unless the individual or the entity. The legislation clearly states that a person can choose any of the accounting method until the entity or the individual maintains the criteria stated in the legislation (Towery, 2017). Thus it can be said that if a person or entity does not have the annual turnover of over $10 million, it has full right to choose any of the accounting methods which is more suitable in accordance with the need of the business firm. If there are any conflicts between the Commissioner of Taxation and the taxpayer, specific provisions of the legislation will apply to specific transactions. But still, the Commissioner of Taxation cannot influence a legal taxpayer for choosing a specific accounting method.

Planning of accounting for upcoming year

In accordance with the financial condition of Frank, he should also continue with accrual accounting for the next year as the accounting will be more suitable for his business. As there is more outstanding payments that needs to be added in the taxation report in order to evaluate the business properly (Enste, 2018). Thus it is recommended for Frank to carry on the accrual accounting in the next year also.

Relevance of traditional criteria in accounting

The traditional criteria are still relevant for the cash/accrual distinction because the current available accounting software cannot distinct between the cash/accrual methods. In order to maintain a standard distinction between the cash/accrual methods, the traditional criteria of accounting should be followed by the companies. Otherwise the software could not distinct between the two methods of accounting (Gale & Samwick, 2014).

As far as the accounting method and its legislation are concerned, all the legal procedure and its criteria should be followed in order to maintain the taxation guideline. Frank has recently gained some decent contract and trying to increase his business. So it is very important to maintain proper guideline for taxation so that the further disputes regarding the taxation process can be avoided and the rate of taxation can be reduced as far as possible.

The Income Tax Assessment Act 1997 states under section 8-1 that the expenses that are incurred for generating assessable income are allowed as deduction for calculating the tax payable. The difference between the assessable income and exempt income has been distinguished in section 6 of the same act. It should be noted that only expenses that are incurred for assessable income are allowed as deduction (Timmons-Brown & Hess 2018). That means the expenses that have been incurred for generating the exempted income cannot be claimed as deduction under the act.  The GST is regarded as the consumption tax, which is stated under section 17 of Income tax assessment act 1997. The brief explanation of deductable and non-deductable taxes has been stated in section 25-26 of the same assessment. The method of tax deduction is stated in the section 28 of this act (Machogu & Amayi, 2016).

 

Discussion

In the given case study, it is needed to suggest the probable tax deductions to the directors of Ruby Pty Ltd. As far as the given transactions of Ruby Pty Ltd are concerned, following suggestions can be made:

  1. As far as the guideline of section 8 of the Income Tax Assessment Act 1997 is stated, the management and maintenance cost will be deducted from the taxable income. The deduction from the assessable income is needed to be made against the income of the current year (Christians, 2016). In the present context, the annual income of Ruby Pty Ltd is $35,000. But the expenses spent in the maintenance of the kitchen are being calculated as $8,500. Thus the maintenance expense of worth $8,500 will be deducted from the annual income from the rental of the company. The net rent for Ruby Pty Ltd will be 26,500 for the concurrent year. This will be considered as the taxable income of the organisation under the section 25-10 (repairs) of the income tax assessment act 1997.
  2. In order to claim the deduction, the entity or the individual has to only claim the expenses which are related to the rental income. In the given context, a visitor to the tenant slipped from the steps and injured herself. She suited an legal proceedings against the company stated that the injury was duly caused by the manufacturing defects of the company (Hoynes et al., 2015). Thus the company was forced to incur an expense of $7,000. But as the expense was duly for the compensation of the manufacturing defect, it cannot be included in the deductable income tax. Apart from this, the payment was not made till the year ending date of the company. The income tax deduction cannot be done on penalty charges as it is stated in the section 26.5 of the income tax assessment act 1997.
  3. For the next instance, the company has to accept the defective goods from its clients as a return and thus the client is asking for the return of the payment paid to the company. The car manufacturing company suited a law charge in the federal court. The case was settled in November 2017 and the decision was against the company. Thus the company accepted this claim and paid to the client of a sum worth $750,000. This payment made by the company will be regarded as a cash penalty for the defective goods (McCluskey & Franzsen, 2017). That’s why; the payment made by the company will not be deducted in the taxation of the company according to the section 26.5 of the income tax assessment act of the company.
  4. After the claim of the car manufacturing company, Ruby Pty Ltd decided to make a small provision in case of such claims occurs in future. The compensation given to the car manufacturing company had a severe effect on the profit report of the company and thus the company decided to set aside a provision of $100,000 just for any further claims made by the clients regarding the disputes of the product or services (Zidar, 2015). But with the perspective of the provision, it cannot be regarded as assessable income which is states in the section 15 of income tax assessment act 1997. Thus, this amount cannot be regarded as deductable tax.
  5. For the last instance, it is stated that the company wanted to re-enter the car parts manufacturing industry. The key plan of the company was to use a new kind of alloy which was supposed to be profitable for the company. The company paid an amount of $220,000 to the consultants for further investigation regarding the matter. The research work was done by the consultant for some time, but after noticing the unstable condition of the motor vehicle industry, the company decided to not to proceed further and stopped the project (Devos & Zackrisson, 2015). This case lies under the legislation of section 25.40 of the income tax assessment act 1997 where it is stated that an entity can enlist the deduction of tax over the amount which is lost from profit-making undertaking or plan. Thus, in this case, the whole amount can be deductable from the income tax report (Ashworth & Perera, 2018).
 

Conclusion

In the stated case study, the reference is being taken from the division 25 and 26 in order to evaluate the deductable and non-deductable transactions in the tax return. Among the five situations, three of them were non-deductable and the rest was deductable expenses. The directors of the company while making the taxation report in order to get the deduction over the payable tax should keep the legislations and the circumstances of the cases in mind.

 

Reference

Aldridge, R., Callahan, R. A., Chen, Y., & Wade, S. R. (2015). Income tax preparation assistance service learning program: A multidimensional assessment. Journal of Education for Business, 90(6), 287-295.

Ashworth, A., & Perera, S. (2018). Contractual procedures in the construction industry. Routledge.

Christians, A. (2016). BEPS and the new international tax order. BYU L. Rev., 1603.

Ciconte, W., Donohoe, M., Lisowsky, P., & Mayberry, M. (2016). Predictable uncertainty: The relation between unrecognized tax benefits and future income tax cash outflows.

Devos, K., & Zackrisson, M. (2015). Tax compliance and the public disclosure of tax information: An Australia/Norway comparison. eJournal of Tax Research, 13(1).

Enste, D. H. (2018). The shadow economy in OECD and EU accession countries–empirical evidence for the influence of institutions, liberalization, taxation and regulation. In Size, Causes and Consequences of the Underground Economy (pp. 135-150). Routledge.

Gale, W. G., & Samwick, A. A. (2014). Effects of income tax changes on economic growth. Economic Studies, https://www. brookings. edu/wpcontent/uploads/2016/06/09_Effects_Income_Tax_Changes_Economic_Growth_Gale_Sa mwick. pdf.

Gitman, L. J., Juchau, R., & Flanagan, J. (2015). Principles of managerial finance. Pearson Higher Education AU.

Hoynes, H., Miller, D., & Simon, D. (2015). Income, the earned income tax credit, and infant health. American Economic Journal: Economic Policy, 7(1), 172-211.

Machogu, C., & Amayi, J. (2016). The Effect Of Taxpayer Education On Voluntary Tax Compliance, Among SMEs in Mwanza City-Tanzania.

McCluskey, W. J., & Franzsen, R. C. (2017). Land value taxation: An applied analysis. Routledge.

McGregor-Lowndes, M., & Crittall, M. (2017). An examination of tax-deductible donations made by individual Australian taxpayers in 2014-15. Australian Centre for Philanthropy and Nonprofit Studies, Queensland University of Technology.

Robinson, L. A., Stomberg, B., & Towery, E. M. (2015). One size does not fit all: How the uniform rules of FIN 48 affect the relevance of income tax accounting. The Accounting Review, 91(4), 1195-1217.

Timmons-Brown, S., & Hess, F. (2018). Why Arizona embarked on school reform (and Nevada did not). In School choice in the real world (pp. 115-128). Routledge.

Towery, E. M. (2017). Unintended consequences of linking tax return disclosures to financial reporting for income taxes: Evidence from Schedule UTP. The Accounting Review, 92(5), 201-226.

Zidar, O. M. (2015). Tax cuts for whom? Heterogeneous effects of income tax changes on growth and employment(No. w21035). National Bureau of Economic Research.

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