Advance Payment Of Fees And Its Taxation Treatment

Why Do Small Business Taxpayers Stay With Their Practitioners?

The Case of Arthur Murray (NSW) Pty Ltd v FCT (1965)

The facts of this case is that taxpayer carried on the business of giving dancing tuitions and charged fees from those that took lessons from the tax payers based on hourly basis. As evident from the case the basic tuition courses which was available to those that learned dancing was in varied hours of 5, 15 and 30. The tuitions was provided following the appointment with the taxpayer inside one year time (Barkoczy 2014). Individuals that took tuitions from the taxpayer was required to make an advance payment of the course fees in two ways namely in lump sum and or in instalment and variable sum of discounts were provided by the taxpayer on immediate payment of tuition fees.

The taxpayer upon the receipt of fees of recorded in the company account books by crediting the receipt in the Unearned Deposits of Untaught Lesson Accents. The sum that was credited to the account stood correspondingly with the dancing lessons that was taught and intermittently shifted the sum by crediting the “Earned Tuition Account” (Brokelind 2014). The company filed the income tax returns on the basis of the footings that the fees that was obtained in advanced from the pupils were not regarded as the assessable income at the time of receipt. The taxation commissioner on conducting the appropriate evaluation stated that the fees derived from the dancing tuition was held as income in the receivers hand during the year in which such fees were received.

The prepaid sum of tuition fees was treated as the income for the taxpayer and the tuition fees was entered into the books of the accounts on completing the dancing lesson when it was imparted by the taxpayer to those that took lessons (Coleman and Sadiq 2013). Additionally there was hardly insertion of the advance tuition fees in the taxpayer’s assessable income. Whereas at the time of performing the computations of assessable income it was found that the fees was included in the taxable income of the taxpayer in which the taxpayer derived the income. The court of law in its verdict stated that the taxable earning was derived by the taxpayer as advance tuition fees in the year when such dancing tuition was provided by the taxpayer (Eliot 2016). Under “section 25 (1) of the ITAA 1997” the advance sum of tuition fees that was received by the taxpayer constituted ordinary income.  

Earnings and Receipt Methods for Income Calculation

The present issue that is involved in the case of “Arthur Murray (NSW) Pty Ltd v FCT (1965)” is that whether or not the advance sum of prepaid fees that was received by the taxpayer was held as income? The current issue that is involved here is to determine whether the advance fees that was received by the taxpayer was regarded as the taxable income?

The case can be concluded by stating that the purpose was to gain an understanding whether the advance payment of tuition fees that comes home had the characteristics of income and the same may or may not be regarded for assessment purpose (Grange et al. 2014). The verdict passed by the taxation commissioner explained that the tuition fees that was received by the taxpayer as prepaid relating to the service which is yet to be rendered. However, the advance payment of fees cannot be regarded for assessment purpose.

In the decision made by the law court stated that there may be an management between the taxpayer and the student that the prepaid amount of fees was not refundable (James 2014). But in the actual scenarios the taxpayer refunded the advance payment that was received on the event when dancing tuitions was not provided. The decision of the court stated that the no such inclusion of tuition fees was made by the taxpayer in the year when such tuition fees was received since there was a clearly possibility that the tuition fees may be refunded on the event of no lessons rendered to the pupils. The taxation commissioner in its decision held that taxpayer obtained the tuition fees as the advance payment hold no such characteristics of income unless the tuition is imparted to the students.

According to “section 6-5 of the ITAA 1997” most of the income that is received by the taxpayer or in their behalf or any amount that is received will be classified as income (Kenny 2013). In addition to this, receipt of income under this section is held taxable based on the ordinary concepts of the “section 6-5 of the ITAA 1997”.

 Usually there are two procedure that are involved in calculating the income for taxation purpose namely the earnings and the receipt methods. An individual taxpayer in terms of the suitability may opt for either of the method. Accordingly the “taxation ruling of TR 98/1” is concerned with the determination of income under the two concepts namely the earnings method or the receipt income (Krever 2013). However, an individual taxpayer under the “subsection 6-5 (2) of the ITAA 1997” is under obligation of including the gross sum in their assessable income.

Advance Payment of Fees in RIP Pty Ltd Case Study

According to the “Taxation ruling of TR 98/1” the receipt methods of recording income is regarded as the best method relating to the income that is derived from any investment. Apart from this there prevails an exceptions (Morgan, Mortimer and Pinto 2013). The exception states that the earnings method is regarded as the correct process of ascertaining business income that is derived from the business of trading or manufacturing. However, the general rule for assessment purpose states that the taxpayer must follow the earnings method of recording their income. 

As evident from the situation of RIP Pty Ltd the company is involved in giving funeral related service and recorded a net profit of $2.45 million. RIP Pty Ltd also generated income by providing their customers with the facilities of paying their invoice in inside the 30 days period. Referring to the “Taxation ruling of TR 98/1” and “subsection 6-5 (2) of the ITAA 1997” the earnings derived by the RIP Pty Ltd from its business should be treated under the earnings method (Sadiq et al. 2014). For RIP Pty Ltd earnings method is the most suitable method of keeping track of the income made during the accounting year.

Evidences obtained from the case study suggest that the business obtained earnings as prepaid fees. Therefore, under the easy plans of the RIP Pty Ltd the company received prepaid fees which was regarded as the non-refundable (Woellner 2013). As a general rule the prepaid fees that is received by the company is forfeited into and transported in the Forfeited Payment Account. As a consequence of this the forfeited fees that is received is held as income and no additional obligations arises to provide the funeral service given the operations are withdrawn under the easy future plan.

The principles that are laid down in the case of “Arthur Murray (NSW) Pty Ltd v FCT (1965)”  states that any form of advance payment that is received by the taxpayer is regarded as income in the year in which such income is received relating to the services provided (Woellner et al. 2014). Citing the reference of the case in RIP Pty Ltd, fees that were derived by the business from the easy funeral plans were regarded as the fees that is received by the business as prepaid with the funeral services to be provided in future. As stated in the “taxation ruling of TR 98/1” adequate weight must be placed in the event of taxpayer and sufficient methods of accounting should be employed in providing the correct reflections of the income that is derived during the year.

Treatment of Forfeited Payment and Trading Stock

Similarly in the taxation commissioner in “Dunn v FCT (1989)” stated that it is necessary to determine the state of occupations and how the business is performed together with how the accounting books should be kept (Pinto 2013). The fees that is derived by the RIP Pty Ltd are recorded in the company books and it is held as income in the year in which it is received. The situation of Arthur Murray (NSW) Pty Ltd v FCT (1965)” is implemented in the case study of RIP Pty Ltd relating to the accounting treatment (Basu 2016). Additionally the RIP Pty Ltd is under obligations of keeping track of the fees received in advance in the accounts book and consider those advance fees as the income for the services of funeral provided by the company.

According to the “Taxation ruling of TR 98/1” an explanations is provided relating to the applications of the rulings for both the individuals taxpayers and business entities for taxation purpose. The ruling requires them to make use of either the receipts or the earnings methods of accounting to determine the assessable income (Tan, Braithwaite and Reinhart 2016). According to the “subsection 6-5 (4) of the ITAA 1997” under the receipts methods of accounting income obtained by the taxpayer are either constructively or on actual basis. Under the earnings method income is obtained only when it is earned by the taxpayer. The rulings allows the taxpayers to select from any of the two methods so that they can calculate their taxable income for taxation purpose.

Referring to the case study of RIP Pty Ltd on noticing that a customer has failed in paying the advances in instalments then the partial sum of fees received by the customers is forfeited and it would shifted to the Forfeited Payment Account (Cao et al. 2015). Evidently in the situation of RIP Pty Ltd the company receives non-refundable fees and it can be stated that the forfeited sum of $16,200 shall be regarded as income.

As defined under the “section 70-10 of the ITAA 1997” trading stock can be defined as the items that a produced in business, purchased with the objective of selling in the market (Robin and Barkoczy 2017). On the other hand “section 70-25 of the ITAA 1997” explains that expenditure that are incurred during the business of trading stock should be in the nature of capital.

According to “section 275-105 of the ITAA 1997” trading stock does not takes account of the CGT assets since it is not covered in this section (Robin 2017). Evidently in the situation of RIP Pty Ltd the purchase of accessories and the caskets that were used during the ordinary business course were regarded as the trading stock and did not accounted as capital assets.

As defined under “section 8-1 of the ITAA 1997” expenditure that a person or business incurs in the purchase of the trading stock is regarded as the allowable deductions (Blakelock and King 2017). Evidently in the situation of RIP Pty Ltd the caskets and the accessories that were purchased in the ordinary business course would be regarded as the permissible deductions. In addition to this, RIP Pty Ltd is also entitled to claim deductions for the items of the trading stock that is bought during the course of business as well as the stock that is held as closing stock in hand.

The positive limbs of “section 8-1 of the ITAA 1997” allows a person from their assessable to claim for deductions relating to the sum that is incurred in producing the taxable income of the taxpayer’s (Roe 2017). Evidently in the situation of RIP Pty Ltd the amount of prepaid expenditure that was incurred in the purchase of the trading stock will be allowed as the allowable deductions under “section 8-1 of the ITAA 1997” since it was related to the derivation of the taxable income. The prepaid amount will be regarded as the advance during the year ended 2016.

As defined under the “section 6-5 of the ITAA 1997” an individual that derives income from the ordinary sources will be regarded for assessment based on the ordinary conceptions (Blakelock and King 2017). According to the Australian taxation office an Australian resident company that earns dividend from the Australian sources is under obligation of declaring the same at the time filing tax return.

Gauging into the circumstances of RIP Pty Ltd a dividend income was earned that also included the franking credits attached to it. Evidently in the situation of RIP Pty Ltd the dividend income that is received by the company must separate the franking credits from the dividends as the dividends are fully franked.

As stated under “section 100-25 of the ITAA 1997” the advance payment derived for the rental storage cannot be regarded as the capital assets (Cao et al. 2015). Evidently in the state of the RIP Pty Ltd, reference to “section 100-25 of the ITAA 1997” can be made to explain that the rental storage sum that is received is not held as the capital asset.

In addition to this, the advance payment that is received by the RIP Pty Ltd is regarded as the element of the current income based on the four months period and the rent can be considered for general deductions under “section 8-1 of the ITAA 1997”.

Payments relating to the long service leave or payments relating to the employment termination is subjected to PAYG tax withholding (Pinto 2013). As stated by the Australian taxation law office an employee is generally regarded as the entitlement for the long service leave till when the employee rendered service. In addition to this, the long service leave is later accrued in respect of the terms of the services rendered by the employee. According to the “section 83-80 of the ITAA 1997” the unused sum of long service leave would not be regarded as the portion of the assessable income.

As defined under “subsection 83-85 of the ITAA 1997” A person that is entitled to claim tax deductions relating to the  unused sum of the long service leave is required to assure that the sum of income tax that is paid on the long service is not greater than 30 per cent (Krever 2013). As understood in the case of the RIP Pty Ltd three month long service leave was paid by the company in prepaid and these payment will be considered as the expenditure for the income year ended June 2016. 

According to the “section 8-1 of the ITAA 1997” an individual taxpayer is permitted to claim deductions relating to any losses or outgoings from their taxable income up to the extent that these expenses are incurred in the positive limbs and in gaining the taxpayers assessable income. “Section 100-25 of the ITAA 1997” is associated with the CGT assets namely the land and building (Sadiq et al. 2014).

Denoting from the state of affairs of the RIP Pty Ltd the expenses that were occurred for the land and building is regarded as the capital expenditure forming the part of the capital asset. Such expenditure is not allowed for deductions because it relates to the cost base of the assets. The expenses that is occurred by RIP Pty Ltd for onsite car parking together with the expenses on the building and equipment is regarded as the capital expenditure and no allowable deductions can be claimed under “section 8-1 of the ITAA 1997”.  

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