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Question 1

The Lotteries Commission conducts an instant lottery called ‘Set for Life’ under which a winner who scratches three ‘set for life’ panels wins $50,000 each year for 20 years. The first $50,000 is payable as soon as the winner is notified, and later amounts are payable on the first anniversary of the first payment. In the event of the death of the winner, the Commission may pay any outstanding amounts to the deceased’s estate.

Requirement:

Is the annual payment income? Give reasons for your decision

Question 2

Corner Pharmacy is a chemist shop. It provides no credit sales but accepts major credit cards. It sells items off the shelf and the proprietor fills prescriptions for cash and for payments made under the Pharmaceutical Benefits Scheme [PBS].

Three (03) assistants are employed. The following financial data is provided:

Cash sales $300,000

Credit card sales $150,000

Credit card reimbursements $160,000

PBS:

  • Openingbalance $25,000
  • Closingbalance $30,000

- Billings $200,000

- Receipts $195,000

Stock

  • Openingstock $150,000
  • Purchases $500,000
  • Closingstock $200,000

Salaries $60,000

Rent $50,000

Requirement:

On the assumptions that an accrual basis applies and the cost of sales and other outlays are allowable deductions for tax purposes, calculate the pharmacy’s taxable income.

Question 3

What principle was established in IRC v Duke of Westminster [1936] AC 1? How relevant is that principle today in Australia?

Question 4

Joseph (an accountant) and his wife Jane (a housewife) borrowed money to purchase a rental property as joint tenants. They entered into a written agreement which provided that Joseph is entitled to 20% of the profits from the property and Jane is entitled to 80% of the profits from the property. The agreement also provided that if the property generates a loss, Joseph is entitled to 100% of the loss. Last year a loss of $40,000 arose.

Requirement:

How is this loss allocated for tax purposes? If Joseph and Jane decide to sell the property, how would they be required to account for any capital gain or capital loss?

 

Answers:

1

Prizes and awards are referred by Australian Tax Office as other income mainly because they are not earned on regular basis as is seen in normal business operations. The tax office is likewise seen to explain the classification of awards and prizes for tax purpose on these gaming and winnings events as either tax exempt or taxable (Marshall and Armstrong, 2010. Pg.220.)

Australian Tax System and for this case Australian Tax Office classifies prize draws for tax purpose as those which upon conduction of draw there is a consideration or payment done to the winner. The award or prize done takes different forms, i.e., some are in cash while others are assets form like cars or even goodwill and at some point, winners are awarded holidays and air tickets adventure while others are also offered low-interest loan and discounted options on market costs. However, it is not all prizes or awards won are taxed or exempted, this is because it entirely depends on the parties that conducted that draw or sponsored that gaming or winning event (Perez and Humphreys, 2011. Pg.560.)

For instance, any lottery draws, prize draw or award draw that is conducted by any of investment company, i.e., financial institution, cooperative and building societies, large companies any winnings award or prize that is offered the winner is subjected to tax as an income for that case. The winner is expected to declare this prize won in his or her tax return for that year (Chen, Chie, Fan, and Yu 2009. Pg.35.) It is likewise supposed to see these firms that sponsor these events to declare this too on their return but this time around as a claim for the tax deduction, not income. Ideal they are seen to claim this as deduction similarly to what happens to corporate social responsibility events they are witnessed sponsoring. In case individuals who frequently contest for game show winnings are paid for appearance the law requires them to declare these appearance fees without fail as their income for tax purpose (Maroney, Jackson, Rupert and Zhang, 2012. Pg.130.)

 


This is however contrary to what happens to ordinary lottery awards that are won especially on those conducted by lottery companies in Australia. These awards that are deemed to be earned out of conduction of ordinary lottery lotto or raffle ticket are exempted from tax hence not declarable as part of the winner's income (Boyle, Heyworth, Landrigan, Mina, and Fritschi, 2012. Pg.130.) This award is exempted for tax purpose due to one sole reason which is that the prize won is not deemed to be won out of assurance hence it is believed to be as a result of an event whose outcome is unknown thus it is a game full of chances option.

Although lottery prizes are not taxable, there are instances when convertible asset disposal that result from these prizes are declared for tax purposes especially any capital gain that is earned. Thus, therefore, let it be known that in case the award won as either an asset or an asset acquired from cash prize won is disposed of any gain that is in capital form has to be declared for tax purpose.

This ‘’Set for Life’’ lottery draw that is conducted by the ordinary lottery commissioner is a good illustration of a regular lottery event whose prize is free from taxation. The $50000 win from the three scratches is therefore exempted from tax hence the winner, and the estate will enjoy this tax-free award for the next 20years. The Lottery Commission is consequently deemed ordinary by the law since its conducting the draw by the unknown outcome.

As long as the $50000 Set for Life win will not be converted to the asset for disposal purpose the winner and the estate in case of death will enjoy this prize for the 20years free from any tax charges or levies. However, if the winner converts this prize to asset and disposes of, he is expected to declare any gain disposal of that asset he or she is arranging, and if it is a capital loss, he is allowed by the same law to carry forward the capital for future net off in case of alternative gain. In summary form, I wish to state that the Set for Life $50000 lottery award prize is exempted by the law from Australian Tax Law for the next 20years as long as it will be enjoyed in this cash form means (Barnes, Welte, Tidwell, and Hoffman, 2011.Pg.580.)

2

Australian Tax Office defines accrual method as that method in which revenues and expenses are recognized in the books as soon as invoices are generated and expenses are debited in the ledgers respectively (Woellner, Barkoczy, Murphy, Evans and Pinto, 2010. Pg.37.) It is further defined to be that transaction whose revenue option is not mandatory recognized when only cash receipt or payment is done in the case of an expense no; it happens as soon as a ledger is passed to account for that revenue or cost.

It is argued that accrual method of business take place only when revenue and expense are deemed to provide future benefit with most of it being on credit basis. This method is however understood to cause tax argument since most Australian Taxpayers have argued that the payment of tax for credit sales should only apply when the credit sales are paid hence regardless of when the fee is to be done. This sounded awkward to the tax man since to ATO this were signs of pushing profits declaration for tax purpose forward an aspect that indeed would cause tax evasion or rather minimize collection of taxes in this case (Saez, Slemrod and Giertz, 2012. Pg.47.)

 


Some arguments of paying tax on invoices whose values would later be considered lousy debt is likewise raised. However, this has been factored in by the tax man that in case a debt whose tax payment has been done is written off as bad the written off amount is considered as an allowable expense for tax purpose (Rutledge, 2012. Pg.36.) Therefore, it is now certain that any post-tax event that happens to revenue or a cost of a company that applies accrual basis is factored in as the allowable deduction in the next year of tax.

In this question I wish to state that Corner Pharmacy is deemed to be a small business enterprise whose owner probably could be a sole proprietor hence the calculation of taxable income of Corner Pharmacy will be calculated on accrual basis, therefore, it is estimated bearing in mind that revenue and expense are recognized and reported as soon as they are transacted. For instance, all though there are cash sales for this venture that are deemed by default identified as quickly as they are receipted it should likewise be known that both credit card sales and sales done on pharmaceutical benefit scheme their receipts are actualized on a later date however it should be recognized that these sales have to factor in when it comes to calculation of taxable income for Corner Pharmacy.

It is possible to calculate Corner Pharmacy taxable income now that we have all the items that form part of the statement. This payable income statement constitutes sales that are indeed in three forms, i.e., cash sales, credit card sales and sales on pharmaceutical benefits scheme. This is considered as part of the deals with an assumption that Corners Pharmacy stocks were given to this scheme so as they can have them sold on their behalf hence the stock movement is what is seen to define what was sold. However, it is in this scenario of sales that accrual basis is seen to dominate, just because the amount that will be considered as sales is not the receipts that were made no, it is the billing amount or rather the amount invoiced.

The other item of this statement is the cost of sales which indeed, in a nutshell, is deemed to be the overall cost of the materials that are sold to generate the three forms of sales highlighted above (Rosenberg and Center, 2013. Pg.81.) It is deemed to be an allowable item for the tax deduction that is seen to calculate gross profit. Finally, we have expenses that in business operation are considered to be inevitable. Corners Pharmacy shop has two significant losses, i.e., the rent which indeed is fixed cost that has to be honored whether there is the profit of not and staff expense for the three officials that has to cater for to have them sale Corners Pharmacy products.

 


Assuming Corners Pharmacy year of tax ends on 31St December 2017 its taxable income is therefore calculated as follows;

           Corners Pharmacy Chemist Shop

Taxable Income Statement

For Year End 31st Dec 2017

                                                                                     $                                                         $                    

Sales Revenue;

                    Corners Pharmacy Cash Sales                                                                           300000

                    Corners Pharmacy Credit Card Sales                                                                 150000

                    Corners PBS Sales (Billed amount)                                                                    200000    

Total Sales Revenue                                                                                                             650000         

Less;

         Cost of Sales; Opening Stock                                  150000

                     Add;      Purchases                                     500000

                     Less;      Closing Stock                              (200000)                                      (450000)

Gross Profit                                                                                                                        200000

Less Other Expenses;

                      Salaries                                                      60000        

                      Rent                                                           50000                                          (110000)

Net Taxable Income/Profit                                                                                                     90000

The 90000 Australia dollars is what is to be declared as taxable income for tax purpose by Corner Pharmacy hence in his other income if the owner is a professional doctor he has to add this as other income, and in case he only operates this he has likewise expected to declare this amount as per the small medium enterprises regulation of the land.

3

A case law ruling is mostly seen to develop principles and facts that are deemed unchangeable and unchallengeable over the years. However, in this case of IRC V Duke Westminster, it is a case whose ruling indeed afterward has been challenged due to the nature of the matter especially when it involves states means of revenue collection.

The fact that Duke stopped paying his gardener the substantial amount he used to pay him for the gardening work he used to do and instead opted to pay the equivalent amount at the end of agreed specified period within covenant agreement document decided upon Duke's tax burden and surtax was reduced evenly due to allocation of the gardener expense as tax allowable at that specified end period. The land tax man, i.e., Inland Revenue Commission differed with this arrangement and instead filled a case against Duke on the basis that he was engaging himself in an agreement that was suggesting tax evasion (Desai and Dharmapala, 2009. Pg.540.)

Upon consideration of this charges on both parties ground judge Lord Tomlin ruled in favor of Duke with the sentiments governing that as long as a man of the land is able to arrange his financial affairs accordingly so as to see him reduce his tax burden within the peripherals of the law no one at all can compel him to pay extra tax even if it is the IRC since his local arrangement are made in line with the law (Kleven and Schultz, 2014. Pg.300.)

 


It is this ruling that saw into the introduction of tax avoidance principle across the globe. This principle is simple terms entails legal tax arrangement plan and system that sees into minimization of the tax burden. It is one of the tenets that indeed have affected the bodies involved in tax collection globally to a point where the authorities have gone to court to challenge its operation. The filled cases challenging tax avoidance ideally has affected and weakened the process of this principle (Gravelle, 2009. Pg.750.)

Australia is one state that indeed had felt the wrath of application of this principle this is because all along the years until 2016 when they introduced agencies to curb this monster they have been losing the substantial amount of tax in the name of tax avoidance. It is not that tax avoidance is terrible not really what it has a led is a creation of the proxy event that is non-tax compliance hence leading to tax fraud and evasion at the same time (Pagone,2010. Pg.33.)

The tax office has ideally lost tax collection due to this principle and since they had no authority to bar it from existing the only option they had was to introduce agencies that would fight tax avoidance hence eradicate tax fraud and evasion. This indeed led to the introduction of Tax Avoidance Task Force and Multinational Anti-Tax Avoidance agencies whose work was to ensure that all tax that is deemed payable are declared and paid by the right people and the proper. These agencies core purpose was to provide that there is tax compliance, especially on the large multinational entities.

Tax compliance by the Australian citizens due to the introduction of these agencies has revived back the tax collection position of the taxman since the citizens have been made aware of the need to pay tax and hence why they are expected to meet their obligation, (Xynas, 2011. Pg.2.)

Tax compliance by the Australian citizens due to the introduction of these agencies has

I wish to say that the successful application of these tax avoidance agencies in Australia was made able due to the introduction of multinational anti-avoidance tax legislation as well as profit diversion regulation. It is therefore evident that these legislations introduced to be implemented by the tax avoidance agencies is what indeed has saved Australia from the shackles of tax fraud and evasion that led to low tax revenue collection (Fuest and Riedel,2009. Pg.70.) This principle of tax avoidance has therefore not done Australian Tax Office and tax agencies any good at all.

4

Joseph and Jane have invested in rental property as joint partners however Joseph is an accountant and Jane is deemed to be a housewife. This means that there is nobody at all among the two who are involved in the day to day operations of the rental property since Joseph is an accountant and Jane a housewife indicating that they partly manage the rental property operation. Joseph and Jane are likewise brilliant when it comes to tax application issues this is because of the profit and loss ratios allocation which is seen to favor Joseph’s income both on loss basis and profit.

Since Joseph is an accountant and has an income on it to minimize the amount of taxable income he is given less portion of the profit as Jane pockets the other part now that she has no other income that is added on it. Similarly, to loss, it is allocated to Joseph at 100% share to net off his accountancy taxable income if any Dai, Maydew, Shackelford and Zhang.2008. Pg.710.)

Australian Tax Office on rental losses is evident since most rental owners have failed to manage the rentals hence out of malice they report the failure to have their other income reduced for tax purpose. The regulation is therefore very satisfied on daily operations of the rental property in the sense that if Joseph though partly is very concern with the day to day operation of the rental property he is entitled to the 20% of 40000 profit share while his wife gets the 80% of 40000 shares and in case of a rental loss as it is in this case he is entitled to the full 100% of 40000waiver on his accountancy salary. Thus his taxable income reduces with 40000 (Altshuler, Auerbach, Cooper and Knittel, 2009.Pg.80.)

However if the two partners are noticed that none of them has operational concern of the rental property and by mistake the rental property makes loss, Joseph is barred by the law from claiming the 40000 loss incurred since there is no assurance that there was no action that would see into it that no rental property loss occurred. If Joseph and Jane decide to sell the (Evans, 2004.Pg.30) property the disposal by itself is termed as capital hence if a gain on disposal of this rental property is earned the capital gain is likewise to be declared on the agreed ratios of 20:80 thus Joseph accountancy income is added 20% portion while Jane claims the 80% of the gain as income (Benson, 2016.Pg.8.) In case of loss, the regulation is precise that any capital loss resulting from the disposal of an asset which in this case is a rental property with Joseph as the loss bearer the law allows Joseph to claim this capital loss for an allowable deduction on any capital gain that will be earned in future.

 

References

Altshuler, R., Auerbach, A.J., Cooper, M. and Knittel, M., 2009. 3 Understanding US Corporate Tax Losses. Tax Policy and the Economy, 23(1), pp.73-122.

Barnes, G.M., Welte, J.W., Tidwell, M.C.O. and Hoffman, J.H., 2011. Gambling on the lottery: Sociodemographic correlates across the lifespan. Journal of Gambling Studies, 27(4), pp.575-586.

Benson, J., 2016. The Islamic law on land tax and rent: the peasants' loss of property rights as interpreted in the Hanafite legal literature of the Mamluk and Ottoman periods. Routledge.

Boyle, T., Heyworth, J., Landrigan, J., Mina, R. and Fritschi, L., 2012. The effect of lottery scratch tickets and donation offers on response fraction: A study and meta-analysis. Field Methods, 24(1), pp.112-132.

Chen, S.H., Chie, B.T., Fan, H.F. and Yu, T., 2009. Income distribution and lottery expenditures in Taiwan: An analysis based on agent-based simulation. In Natural Computing in Computational Finance (pp. 207-223). Springer, Berlin, Heidelberg.

Dai, Z., Maydew, E., Shackelford, D.A. and Zhang, H.H., 2008. Capital gains taxes and asset prices: capitalization or lock?in?.The Journal of Finance, 63(2), pp.709-742.

Desai, M.A. and Dharmapala, D., 2009. Corporate tax avoidance and firm value. The review of Economics and Statistics, 91(3), pp.537-546.

Evans, C., 2004. Taxing Personal Capital Gains in Australia: Causes of Complexity and Proposals for Reform. Austl. Tax F., 19, p.371

Fuest, C. and Riedel, N., 2009. Tax evasion, tax avoidance and tax expenditures in developing countries: A review of the literature. Report prepared for the UK Department for International Development (DFID), pp.1-69.

Gravelle, J.G., 2009. Tax havens: International tax avoidance and evasion. National Tax Journal, pp.727-753.

Kleven, H.J. and Schultz, E.A., 2014. Estimating taxable income responses using Danish tax reforms. American Economic Journal: Economic Policy, 6(4), pp.271-301.

Maroney, J.J., Jackson, C.M., Rupert, T.J. and Zhang, Y., 2012. The Effect of Accounting Information on Taxpayers' Acceptance of Tax Reform. Journal of the American Taxation Association, 34(1), pp.113-135.

Marshall, R., Smith, M. and Armstrong, R., 2010. Ethical issues facing tax professionals: A comparative survey of tax agents and practitioners in Australia. Asian Review of Accounting, 18(3), pp.197-220.

Pagone, G.T., 2010. Tax avoidance in Australia. Federation Press.

Perez, L. and Humphreys, B.R., 2011. The income elasticity of lottery: New evidence from micro data. Public Finance Review, 39(4), pp.551-570.

Rosenberg, J. and Center, U.B.T.P., 2013. Measuring Income for Distributional Analysis. Washington, DC.: Urban-Brookings Tax Policy Center. July, 25.

Rutledge, T.E., 2012. State Law & State Taxation Corner. J. Passthrough Entities, 15, p.37.

Saez, E., Slemrod, J. and Giertz, S.H., 2012. The elasticity of taxable income with respect to marginal tax rates: A critical review. Journal of economic literature, 50(1), pp.3-50.

Woellner, R.H., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2010. Australian taxation law. CCH Australia.

Xynas, L., 2011. Tax Planning, Avoidance and Evasion in Australia 1970-2010: The Regulatory Responses and Taxpayer Compliance. Revenue Law Journal, 20(1), p.2.

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