Describe about the Taxation and Law Practice for Accruals Accounting.
Facts
The taxpayer received prepaid tuition for providing dancing lessons. The taxpayer encouraged the prepaid tuition fees by providing the students discount for advance payment of fees. The advance tuition fees were recorded in suspense account and the name of the account was “unearned deposit- untaught lessons account”. The fees were transferred from the suspense account to revenue account after the taxpayer has provided the tuition. There was an agreement between the taxpayer and student that no refund is available for advance tuition fees paid. The prepaid tuition fees were not included in the assessable income, as the taxpayer did not consider it as income derived. The taxpayer only included those fees in assessable income for which dancing lessons have been provided during the year (Brody et al., 2014). The commissioner of tax calculated the assessable income of the taxpayer on receipt basis. The commisioner in the assessable income included the fees in the year it is received and not in the year the service was provided.
The court is required to determine the treatment of the prepaid tuition fees for the purpose of tax. The question before the court was whether the advance fees are to include in the assessable income in the year the service is provided or in the year, the fees are received in advance.
Conclusion
It was decided by the court that the taxpayer derived income in the year the service is provided so advance fees should be included in the income in the year the service is provided. The general rule that if the service for which the advance fees are received has not been provided then the advanced fees should not be included in the assessable income (Saad, 2014). The fee that was received in advance is not required to be refunded by the taxpayer as per the agreement. If the students did not take the lessons, then the taxpayer in general practice refunded the advance fees received from the student (Dunne et al., 2016). The court therefore held that the taxpayer could not include the prepaid fees received, as income as there exists a possibility that the fees received in advance could be refunded.
According to section, 6-5 of the ITA Act 1997 the income derived during the year should be included in the assessable income of the taxpayer. The section 6-5(4) further provides that it is considered as income derived if the income is actually received by the taxpayer or anyone else on behalf of the taxpayer (Robson, 2014). The income is recognized under two methods for the purpose of tax these are earning method and receipt method. The method that correctly reflects the income of the taxpayer during the income year should be chosen for computing income for the purpose of tax. The taxation ruling 98/1 in Para 19 provides that receipt method is appropriate when the income is received from investment, income received by employees and other non-business income. In Para 20 of the ruling it is provided that earning method is considered appropriate in case of income is derived from trading and manufacturing business (Dzhumashev, 2014). The earning method is considered as the most suitable method for determining income for the purpose of tax.
The RIP Pty Ltd is a company that is engaged providing funeral and other associated services. The company in the year 30 June 2016 made a profit of $2.45 million. The company earned revenue by providing funeral and associated services. It received payment from customers under different schemes and method and this are:
Under a net 30 days involve from the customers
Under a net 30 days invoice from external insurance companies
From RIP Finance under installment repayment scheme
In advance as installments under Easy future Plan
As per the general rule, earning method represents the business in most appropriate way. The income of RIP Pty Ltd should be recognized, as revenue as the service is provided as per the earning method and the company should not wait for actual receipt of money for recognizing it as income. The company received fees in advance under easy future plan for providing the required service in future (French, 2013). The fees under this scheme are received as advance installments and this fees are non-refundable. If a member fails to clear all the installments then the advance fees are forfeited and transferred is to a separate account. The forfeited fees should be recognized as revenue as the company does not have any liability to provide service in the future. Based on the above analysis it is concluded that the income of the RIP Pty Ltd is derived in the year the actual service is provided.
In the case of Arthur Murray, the income is derived in the year the service is actually provided was held by the court. A general rule was also stated in the case that in the year the service is provided the income should be actually recognized in that year (Gaal, 2013). The company took advance fees from the customers for providing funeral services in the future under the scheme in the name of easy future plan. The company treated the advance fees received as income in the year the advance is received. The situation of the Arthur Murray and the case of RIP Pty Ltd is similar so the principle of accounting treatment that was held in the case of Arthur Murray is applicable in the case of RIP Pty Ltd (Paturot et al., 2013). Therefore based on the Arthur Murray case the advance fees received by the company should be treated as income in the year the funeral service is provided and not in the year the advance is received.
The ordinary income under section 6-5 of the ITA Act 1997 can be determined under two methods for the purpose of tax. The two methods that are mentioned in the Taxation Ruling 98/1 are the receipt method and the earning method. According to the receipt method, income is derived in the year the income is received (Kenny, 2013). There cash basis or cash received basis are the other names of the receipt methods. The subsection 4 of section 6-5 of the ITA Act 1997 it is stated that it will be considered as income derived for the purpose of tax though it is not received by the taxpayer but is received someone other than the taxpayer on his behalf. There is another method of accounting for income received mentioned in the Taxation ruling 98/1 that is the earning method. Under earning method, the income is derived when a recoverable debt is created. A recoverable debt is created when the service as per the agreement has been provided and the debt can be legally recovered. The earning method is also known as cash and credit method or accrual method (Long et al., 2016). Therefore, it can be concluded that the taxpayer and the commissioner has two methods of accounting and the method that best reflects the income derived during the year should be preferred.
The easy future plan was a scheme run by RIP Pty Ltd. Under this scheme, the customers are required to pay in installments the fees in advance and the company undertakes to provide funeral service in future. If the fees are not fully paid by the customer then such fees were forfeited by the company and were transferred to a separate account called forfeited payment account. The company is not liable to provide funeral service for incomplete fees received. It is advised that the company should include the forfeited amount in the assessable income because the fees are non-refundable and there is no liability of the company to provide service in the future. Therefore, for the purpose of tax the balance of $16200.00 in the forfeited account should be treated as income (MacDonald, 2012).
The trading stock is defined under section 70-10 of the ITA Act 1997. The section states that anything that is manufactured, produced or acquired and is used in the ordinary course of business for the purpose sale, manufacture or exchange is included within the meaning of trading stock. The CGT assets and financial agreements are not included within the meaning of trading stock (Bray, 2014). The section 70-25 of the ITA Act states that an amount of capital nature should not be included in the stock. The caskets and accessories purchased by the RIP Pty Ltd are used for providing the services in the ordinary course of business. Therefore, for the purpose of tax the caskets and accessories should be treated as trading stock.
The section 8-1 of the ITA Act 1997 states that the amount that is incurred for the purpose of trading stock is allowed as allowed as general deduction. The amount incurred for the purchase of trading stock is allowed as deduction in the year it becomes part of the stock in hand as per section 70-15 of the ITA Act 1997. The RIP paid advance in June 2016 for stock that is to be delivered in August 2016. The amount incurred can be claimed as general deduction under section 8-1 of the ITA Act 1997 to the extent the expenses were necessary for generating an assessable income during the year. The RIP Pty Ltd made a payment for the purchase of trading stock that is to be delivered in the next income year and the amount incurred has not contributed in producing the assessable income so it is advised that the prepayment for stock should be treated as advance as on 30 June 2016.
The income received from any source outside or within Australia should be should be included with the assessable income of a resident taxpayer as per section 6-5 of the ITA Act 1997. The dividend amount that is received by the company is taxable based on the provision mentioned above. The dividends that are received are fully franked so the company is allowed to take franking credits. The definition and a list of CGT assets are included in the section of 100-25 of the ITA Act 1997. The list in the section does not include advance paid for rental storage as capital assets. The rent amount for two years that is paid should be treated as advance rent and the rent for four months should be treated as expenses in the current income year and is allowed as general deduction under section 8 of the ITA Act 1997. The unused long service leave received by a taxpayer is included in the assessable income as per section 83-80 of the ITA Act 1997. The RIP Pty Ltd has paid an advance of three-month long service leave. The amount that is paid in advance for long service leave should be treated as expenses and not as an advance (Berger, 2016).
The amount that is incurred for producing assessable income can be claimed as expenses for general deduction under section 8-1 of the ITA Act 1997. The ITA Act in section 100-25 provides a list of CGT assets and the list includes land and building as CGT assets (Athanasiou, 2014). The expenses that are incurred for the purpose of land and building are of capital nature and should not be allowed as general deduction under section 8 of the ITA Act 1997. The expenses that are incurred for construction of Onsite Park, equipments and landscaping should be included as capital expenditure and not as general deductions.
References
Athanasiou, A. (2014). Changing from cash to accruals accounting. Taxation in Australia, 48(8), 459.
Berger, L. L. (2016). Bitcoin exchange transactions: income tax implications to consider within the South African environment (Doctoral dissertation).
Bray, J. R. (2014). 18. Changes in Inequality in Australia and the Redistributional Impacts of Taxes and Government Benefits. Measuring and promoting wellbeing: how important is, 423.
Brody, E., Breen, O. B., McGregor-Lowndes, M., & Turnour, M. (2014). 5 An Unrelated Income Tax for Australia?. Performance Management in Nonprofit Organizations: Global Perspectives, 17, 87.
Dunne, J., Taylor, H., Batten, N., & Krapivensky, N. (2016). 2015 case review: High ATO success rate continues. Taxation in Australia, 50(10), 609.
Dzhumashev, R. (2014). Corruption and growth: The role of governance, public spending, and economic development. Economic Modelling, 37, 202-215.
French, R. (2013). Law-complexity and moral clarity. Brief, 40(6), 25.
Gaal, J. (2013). CGT Small Business Reliefs: The Comprehensive Practitioner’s Handbook. CGT Small Business Reliefs: The Comprehensive Practitioner’s Handbook, xxviii.
Kenny, P. L. (2013). Aligning Income Tax Laws with Accounting Rules: A Simplified Tax System Case Study. Available at SSRN 2340888.
Long, B., Campbell, J., & Kelshaw, C. (2016). The justice lens on taxation policy in Australia. St Mark’s Review, (235), 94.
MacDonald, A. (2012). Introduction to taxing of trusts. Concise Collection of Tax Fundamentals, A, 51.
Paturot, D., Mellbye, K., & Brys, B. (2013). Average personal income tax rate and tax wedge progression in OECD countries.
Robson, A. (2014). Australia’s carbon tax: An economic evaluation.Economic Affairs, 34(1), 35-45.
Saad, N. (2014). Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, 1069-1075.
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