In Australia, Income Tax Assessment Act, 1997 (ITAA 1997) contains all the provisions and regulations to be followed by corporations and individuals to determine their taxable income and resultant tax liability. As per the appropriate provisions of the ITAA 1997 applicable in the facts of the two different cases provide in the document, a detailed explanation is given below.
The explanations for the treatments made to each of the items of revenue and expenditures in calculating the income liable to be taxed and tax liability of Bloomingdale Florists Pty Ltd are given at the end of the computation table.
Income reconciliation statement of Bloomingdale Florists Pty Ltd as per the provisions of ITAA 1997 and subsequent income tax liability of the company are calculated in the table below:
Income reconciliation statement of Bloomingdale Florists Pty Ltd as on June 30, 2018 |
||
Particulars |
($) |
($) |
Net profit as per accounting records |
126,000.00 |
|
Add: Expenditures and assessable income |
||
Accounting depreciation is not allowed as expenditures |
12,000.00 |
|
Misleading advertisement penalty is disallowed for computing taxable income |
5,000.00 |
|
Provision for long services leave is not an expenditure to be deducted from revenue, hence disallowed |
20,000.00 |
|
Provision for doubtful debt is not an expenditure, hence, disallowed |
17,000.00 |
|
Capital expenditure disallowed for income tax purpose (Window replacement) |
10,000.00 |
|
Painting of office and factory premises is revenue expenditure allowed for tax purposes |
– |
|
Paramatta Eels League club gift expenditure is not allowed |
10,000.00 |
|
Cost of borrowing is a capital expenditure to be amortized over the period of loan, hence, disallowed. |
3,000.00 |
|
Foreign resident company’s dividend receipt is ordinary taxable income |
1,000.00 |
|
Franked dividend is exempt from tax however, not franked portion is taxable (9000 x 20%) |
1,800.00 |
|
Director’s salary which is above the reasonable limit as set by Tax Commissioner is disallowed for computing taxable income |
10,000.00 |
|
Total addition |
|
89,800.00 |
Profit after additions |
|
215,800.00 |
Less: Expenditures allowed but not recorded and income recorded but not assessable |
||
Long term service leave payment is an item of expenditure allowed for tax purposes |
10,000.00 |
|
Bad debt is an expenditure for tax purposes |
15,000.00 |
|
Tax allowed capital allowances is considered |
10,000.00 |
|
Closing stock is overvalued due to use of LIFO method is reversed now (60000 -52000) |
8,000.00 |
|
Borrowing cost amortized (3000/3) |
1,000.00 |
|
Income exempt |
10,000.00 |
|
Total subtraction |
|
54,000.00 |
Assessable business income for tax purposes |
161,800.00 |
|
Less: Previous year’s unabsorbed losses |
20,000.00 |
|
Income liable to be taxed for the year ending on June 30, 2018 |
141,800.00 |
In Australia, corporates are taxed @30%, accordingly, the tax liability on the taxable income of Bloomingdale Florists Pty Ltd is calculated below.
Taxable income of Bloomingdale Florists Pty Ltd for the year ending on June 30, 2018 is $141,800. Since the company belongs to 30% tax rate, thus, tax liability of the company is (141,800 x 30%) = $42,540 for the income year 2017-18.
Notes to explain the tax treatments:
Issue:
There are two issues in this case, these are as following:
Rules:
Division 6 of ITAA 1997 explains the concept of Eligible Termination Payments (ETPs) and its implication on taxable income and tax liability of a tax payer in the country. ETPs are ordinary income taxable as per div. 6 of ITAA 1997. It is important to consider the circumstances of each case while determining whether the compensation is to compensate loss of revenue and profit or for capital purpose. In case the compensation is to compensate for loss of revenue then it is taxable as ordinary income of the recipient as per s6-5 of ITAA 1997.
Capital gain is recognized on profit realized from sale of capital assets. It is important to remember that if capital assets is depreciated and the depreciation has been allowed as expenditure for computing taxable income of an entity then such assets shall not be eligible for capital gain purpose. In such case profit on sale from such assets is taxable as ordinary income as per s6-5 of ITAA 1997. Land is a capital asset on which depreciation is not allowed for tax purposes and hence, in case of profit realized from sale of land by an individual or by an entity then, such profit is taxed as capital gain and tax is imposed on such gain as per the appropriate tax rate applicable for capital gain in the country.
Application:
Subsequent to the termination of a contract by Strike a Light Pty Ltd, the most major customer of Matchsticks Limited responsible for 80% sales of the company, an amount of $1,000,000 has been paid to Matchsticks Limited as compensation. It is clear that the compensation of $1,000,000 paid by the customer to Matchsticks Limited is to compensate for the loss of revenue due to the termination of contract. Hence, it is an ETP as per div. 6 of ITAA 1997. Thus, the entire compensation is assessable as ordinary income under section 6-5 of ITAA 1997.
Matchsticks Limited has realized a profit of $10,000,000 from sale of land. The realized profit is a capital gain of the company and shall be taxed accordingly. The land is a capital asset which is not allowed to be depreciated thus, the realized profit from sale of land to Matchsticks Limited is not to be considered as ordinary income as per s6-5 of ITAA 1997 even if the objective of acquiring the land was not to dispose it off in the future. Thus, the entire gain on sale of the land to the company, i.e. $10,000,000 is taxable as capital gain of the company.
Conclusion:
Matchsticks Limited shall include the amount of compensation of $1,000,000 received from its customer for termination of contract as ordinary income under section 6-5 of ITAA 1997. Tax payable on business income of the company shall be calculated after including the compensation of $1,000,000 in calculating its taxable income from business. The profit of $10,000,000 realized from sale of land is a capital gain of Matchsticks Limited and to be taxed as per applicable rate of tax for long term capital gain.
References:
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Bowler-Smith, Mark. “Corporate Income Tax: What Is It Good for.” Austl. Tax F. 30 (2015): 865.
Dixon, J. M., and Jason Nassios. Modelling the impacts of a cut to company tax in Australia. Centre for Policy Studies, Victoria University, 2016.
Edvardson, Hannes. “Risk assessment.” U.S. Patent 9,959,574, issued May 1, 2018.
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