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LEGL300- Taxation Law For Racing Parts Pty Ltd

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Questions:

Question 1 
 
Racing Parts Pty. Ltd. is an Australian Resident Private Company for tax purposes and a small business entity for tax purposes. The company has provided the following information for the year ended 30 June 2018. It carries on the business of being a motor parts distributor in Brisbane.
 
The company's accounting net profit is $700,000. In calculating the accounting net profit the following items were taken into consideration:
1. The accounting net profit includes $100,000 of net exempt income and $50,000 of nonassessable non-exempt income.
2. The accounting depreciation deduction included in the net accounting profit was
$20,000. The company’s tax depreciation for the income year was $30,000.
3. On 2 July 2017, the company wrote-off a debt of $20,000 from a customer who had purchased trading stock on credit. The relevant customer was declared bankrupt on 26 June 2017. The accounting net profit had not included a deduction in respect this bad debt but had included a deduction of $40,000 as a provision for doubtful debts.
4. The accounting net profit also included a deduction for a Provision for Long Service Leave of $35,000. The provision included:
$25,000 in respect of employee, Sashi, who had completed the required 10 years of employment to qualify for long service leave. He had requested and been granted
approval to take long service leave in October 2018. The company arranged to pay Sashi when he took long service leave; and $10,000 that had been paid to employee Wei Fei, when she took long service leave on 30 June 2018.
5. A cash dividend of $50,000 (partially franked to 50%) was received from an Australian resident public company. The cash dividend was not included in the accounting net profit figure.
6. The accounting net profit included a deduction for borrowing costs of $5,000 incurred in relation to a bank loan of $100,000 that was used to purchase new items of plant. The loan is for a period of 6 years and commenced on 1 January 2018.
7. The company donated a $5,000 painting to a local University in Far North Queensland. The company had purchased the painting in 2016. The company also made a gift of $1,000 to the Brisbane Roar Soccer Club. These gifts were claimed as expenses in the accounting profit and loss statement.
8. The accounting net profit included a capital gain of $30,000 made on shares sold on 30 June 2018 that had been purchased 13 months earlier. The company also made a capital loss of $10,000 from the sale of another parcel of shares it sold on 30 May 2018. The company also sold an antique vase for a capital loss of $10,000. The company had owned the shares and antique for 5 years. Neither the capital gain nor the capital losses, were included in the net accounting profit.
9. The accounting net profit included a deduction for the services of the Managing Director’s husband, Sebastian, who received $30,000 from the company for services rendered as a computer analyst over a 2 week period. Independent consultants had quoted $8,000 for the same task.
10. The accounting net profit included a deduction of $30,000 for the cost of goods sold based on the following information:
Cost of Goods Sold $
Opening Stock 50,000
Purchases 40,000
90,000
Closing Stock 60,000
Cost of Goods Sold 30,000
For accounting purposes, the closing stock above was based using the LIFO Method.The Opening stock value for tax purposes was $50,000. The FIFO Method however produces the following results for stock value at the end of the year:
$
Cost Price 45,100
Replacement Price 47,000
Market Selling Value 49,000
The company wishes to minimise its taxation.
11. The company has a prior year Division 36 Tax loss of $120,000 from the 2016-2017 income year.
12. The company bought a second-hand packing machine for $10,000 on 1 July 2017 for use in the business. Unfortunately, when staff tried to start the machine it failed to operate as two of its pistons were damaged and a steel shaft was broken into two pieces. They had the pistons repaired and replaced the steel shaft. The repair of $5,000 was claimed as an accounting expense in calculating the net accounting profit.
REQUIRED:
Demonstrate the calculation process to determine Racing Parts Pty Ltd’s taxable income and tax payable for the year ended 30 June 2018.
Note - You must give reasons for your inclusion or exclusion of any of the above listed items. If you fail to explain your inclusion or exclusion of any item, you will lose marks.
For example:
$1,000 Tax Agent’s Fees – s 25-5 and a brief discussion of the law in this context.
Question 2 
John is a self-employed architect. He purchased a house in the outer suburbs of Melbourne in July 2017 at a total cost of $1,250,000. He purchased the property because it had a room which he could modify and use to conduct his architectural business. The room made up 15% of the house area. He borrowed a large sum of money from the bank to help finance the purchase. He pays interest of $34,000 per annum on this loan to the bank. He specifically purchased the house because the room he uses for his architectural business faces the street. After purchasing the house, he had a builder install a new door, which enabled clients to enter the room without going through the main living area. Unfortunately, the local council fined him $1,000 in January 2018 for not obtaining a building permit before he installed the door. After moving into the house he replaced the old carpet in the room with better quality carpets at a cost of $6,000. He also furnished the room with an antique desk which cost $7,250, which he uses only for his work. He claims that the room is the sole base for his architectural business. He is also required to travel to building sites and visit clients to discuss designs and drawings. He uses his own motor vehicle a Honda HRV to carry this out. Based on his log book he uses the car 72% of the time for work purposes. He uses the rest of the house for private purposes. In May 2018 he sold the house for $1,855,000. At the same time, he also sold the antique desk for $3,850.
REQUIRED
Advise John on the tax consequences of the above facts, referring to appropriate legislation and case law. No calculation is required.

 

Answer:

To determine the taxable income for Racing Parts Pty Ltd certain assumptions are provided below regarding the exclusion and inclusion of income and expenses for tax purpose.

  1. Referring to “section 6-20 of the ITAA 1997”the exempted income of $100,000 has been considered as tax offset against the previous year loss figure of $120,000 incurred under “Division 36”. While the sum of $50,000 obtained as Non Assessable Non Exempted income is included for assessment because previous year tax loss incurred under Division 36 is deducted against the income.
  2. Referring to Division 40 the depreciation sum of $30,000 has been considered for deduction for taxation purpose.
  3. The bad debt of $20,000 has been written off for deduction under “section 25-35” while provision for doubtful debt amounting to $40,000 is not allowed for deductions.
  4. The amount of $35,000 relating to the provision of long service leave and annual leave is excluded from the deduction since it is an accounting liabilities and non-deductible for income tax purpose.
  5. The cash dividend received by Racing Parts Pty Ltd has been considered for assessment while the franking credits attached to the dividends is considered as tax offset under “section 67-25” which is equal to the amount of franking credits.
  6. With reference to “section 8-1 of the ITAA 1997” the borrowing expense of $5000 is treated as tax deductible expenditure because the expenses were occurred by Racing Parts Pty Ltd in derivation of assessable income.
  7. According to the judgement in “Arnold v FCT (2017)”value of gifts and contributions exceeding the amount of $2 given to the gift deductible recipient are treated as permissible deduction under “Division 30”. The donation and gift expenses incurred by Racing Parts Pty Ltd will be treated as tax deductible expenses under “Division 30”.
  8. The expenditure occurred for the service of Managing Director husband as the computer analyst is treated as tax deductible expenditure under the general provision of “section 8-1(1) of the ITAA 1997”. The outgoings were occurred in deriving the assessable income of the Racing Parts Pty Ltd.
  9. Closing has been considered based on LIFO method and the same is included in cost of goods for tax deductible in order to provide Racing Parts Pty Ltd with higher tax deductions.
  10. With respect to “Division 36”the tax loss of $120,000 reported by Racing Parts Pty Ltd during the income year is considered for offset against the NANE and Exempted Income.
  11. Expenses on repair incurred on plant constitutes deductible expenses under “section 25-10 of the ITAA 1997”because it was occurred in restoring the efficiency of the plant without changing its nature.
 

Issue:

The current issue is associated with the determination of the income tax consequences from the transactions incurred by the taxpayer in the relevant income year. The issue here would take into the account the capital gains tax consequences that arises from the sale of residential property and antique desk.

Rule:

According to the explanation given under the “Taxation Ruling of TR 93/30” where the home office is simply is used by the taxpayer for deriving assessable income but does not comprises the character of business place only the appropriate part of the running outgoings will be allowed for deductions. To support the argument the decision made by court in “Swinford v FC of T (1984)” held that the self-employed script writer was allowed deduction under the positive limbs of “section 8-1 of the ITAA 1997” relating to the portion of rent that was paid for house where a separate room was dedicated by the taxpayer for the purpose of study.

According to the “section 26-5 of the ITAA 1997” a taxpayer is not allowed to claim deduction for the expenses that are incurred in the form of fines or penalties for breaching the Australian law.

According to “Taxation Ruling of TR 97/23” outgoings occurred in replacing the exhaust fans and locks of a permanent fixtures installed in property that are employed for deriving assessable income are held as repairs of deductible nature under “section 25-10”. An exception to this rule is that repairs or replacement of damaged unit by a new unit would not be treated as repairs instead it constitute an improvement of capital nature. The explanation made in “Western Suburbs Cinemas v FC of T (1952)” stated that the replacing the old ceiling with an improved and new ceiling was treated as the improvement carrying capital nature and was held as non-allowable expenditure under “section 25-10”.

As defined under “section 40-25 (1) of the ITAA 1997” a taxpayer is allowed to deduction relating to the depreciating asset that is equivalent to the sum of decline in value during the income year.

Correspondingly, travel from and to the place of work is not allowed for deductions since it is treated as the private expenditure of domestic nature. However, travel in the course of employment will be held as permissible deductions. Evidently the decision made in the case of “Weiner v FCT (1978)” held that the teacher was permitted deductions for the travelling expenditure because the travel from one place of employment to another place was travel during the course of work.

As per the ATO when a taxpayer uses their own car for carrying out business activities then the expenses incurred for the business purpose would be treated as the allowable deduction. The expenses are viewed as car expenditure. By using the log book method, the business proportion of the car expenses used by the taxpayer during business will be allowed for deductions.

The main residence of an individual taxpayer is generally held exempted from the provision of capital gains tax. Nevertheless, the taxpayer can obtain the partial main residence exemption if any part of the property is used by the taxpayer for deriving assessable income. As per the ATO a taxpayer under the interest deductibility test can claim an allowable deduction relating to the amount of money borrowed for purchasing the residential property and interest occurred from such borrowed funds.

“Section 108-10 (1)” explains that the taxpayer must separate any amount of capital loss and under “section 108-10 (4) of the ITAA 1997” the net amount of capital loss can be carried forward in the relevant income year.

Application:

The case study provides that John is a self-employed architect and purchased a residential property in the outskirts of Melbourne. John used a portion of house for his architect business where his clients could visit him. An expenses in the form of interest on loan was occurred by John during the income year. Referring to the “Swinford v FC of T (1984)” a deduction is allowed to John for loan interest of house. John can claim deduction under “section 8-1 of the ITAA 1997” up to the part of house that is exclusively used from where he carried is business activities. Later John reports a payment of fine for installing door without obtaining permission. The fines imposed will be non-deductible under section 26-5 since it is a breach of Australian law.

John reports expenses on his house where the old carpet in his room was replaced by the new carpet of improved quality and incurred a cost of $6000. Referring to “Western Suburbs Cinemas v FC of T (1952)” replacing the old carpet with new on is a capital improvement and not allowed for deduction under “section 25-10 of the ITAA 1997”.

An antique desk was bought by John for the purpose of work. Citing “section 40-25 (1) of the ITAA 1997” a deduction is allowable to John for an equivalent amount that is related to the decline in the value of antique desk. John later reports traveling to visit clients regarding the building designs and simultaneously travelled to the building sites. Referring to “Weiner v FCT (1978)” the travel by John is the travel during the course of work and any expenses arising thereof is deductible. John later reports car expenses that was used for business purpose. With the help of log book only the business proportion will be permitted for deduction while the private part of car expenses is non-deductible.

The house bought by John during July 2018 was eventually sold. Since John used the house for generating income he can claim partial main residence exemption. The interest expenses on borrowed funds meets the interest deductibility test and hence will be allowed for deduction. Furthermore, the sale of antique desk resulted loss and hence under “section 108-10 (4) of the ITAA 1997” the net amount of capital loss can be carried forward by John in the relevant income year.  

Conclusion:

On a conclusive note, a deduction will be allowed to John incurred for home office purpose but john cannot claim any deduction for capital expenses. Similarly a partial main residence exemption can be claimed by John as the property was partially used for generating income.

 

References:

Bankman, Joseph, et al. Federal Income Taxation. Wolters Kluwer Law & Business, 2017.

Finkelstein, Maurice. "Cases on Federal Taxation (Book Review)." (2014): 22.

Fleurbaey, Marc, and François Maniquet. Optimal taxation theory and principles of fairness. No. 2015005. Université catholique de Louvain, Center for Operations Research and Econometrics (CORE), 2015.

James, Simon Robert, and Christopher Nobes. Economics of Taxation: Principles, Policy and Practice. Fiscal Publications, 2016.

Kabinga, M. "Established principles of taxation." Tax justice & poverty (2015).

Miller, Angharad, and Lynne Oats. Principles of international taxation. Bloomsbury Publishing, 2016.

Murphy, Kevin E., and Mark Higgins. Concepts in Federal Taxation 2017. Cengage Learning, 2016.

Schenk, Deborah H. Federal Taxation of S Corporations. Law Journal Press, 2017.

Schmalbeck, Richard, Lawrence Zelenak, and Sarah B. Lawsky. Federal Income Taxation. Wolters Kluwer Law & Business, 2015.

Seto, Theodore. Federal Income Taxation: Cases, Problems, and Materials. West Academic Publishing, 2015.

Sikka, Prem. "Accounting and taxation: Conjoined twins or separate siblings?." Accounting forum. Vol. 41. No. 4. Elsevier, 2017.

Simmons, Daniel L., et al. Federal Income Taxation. Foundation Press, 2017.

OR

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