Describe about the Taxation Law and Practice for Business Taxpayer.
Facts
The taxpayer was carrying on a business of teaching dancing lessons. The taxpayer offered a discount to student in order to encourage them for providing prepayment of tuition fees. This prepaid tuition fees received by the taxpayers are placed in the “suspense account”. This suspense account was described as “unearned deposit- untaught lessons account” by the taxpayer. Then after providing the dance classes, the taxpayer transferred the appropriate amount of relevant fees for tuition provided from suspense account to revenue account. The agreement between the taxpayer and the students expressly provided that no refund would be provided for the prepaid of tuition fees. However, the general practice is that taxpayer would refund fees of the student if not all the lessons are provided (French, 2013).
The taxpayer did not treat the prepaid tuition fees as “income derived” until the tuition is completely provided to the student. Though the fees were received in advance, the taxpayer did not include it in the assessable income. Therefore the assessable income of the taxpayer only included tuition fees for which dancing lessons have been provided during the relevant year. The commissioner of Income tax calculated the assessable income on receipt basis (Kenny, 2013). The commissioner of Tax included the prepaid fees in the taxpayer’s assessable income as per section 25(1) of the ITA Act 1936 in the year in which the fees are received and not based on actual year of providing the tuition.
The issue in this case before the court was to determine whether the assessable income of the taxpayer should include the tuition fees received in advance in the year in which the tuition was provided or in the year the fees were received (Barnett & Harder, 2014).
Conclusion
The high court held that the taxpayer derived the fees from the tuition in the year the tuition was provided and not in the year in which the fees were received. The general rule is that if the fees are received in advance for services that are not yet provided then such receipt should not be regarded as the income of the taxpayer in the year of receipt (Gaal, 2013). There was an agreement between the taxpayer and the student that the fees received in advance will not be refunded. In normal practice, however the taxpayer refunded the fees where the student did not take all the lessons. Therefore, it was further held by the court that the taxpayer could not include this receipt in advance as income because there is a possibility that the fees can be refunded by the tax payer if the tuitions is not provided (Lynch 2016).
The ITA Act 1997 in section 6-5 states that the assessable income of the taxpayer should include income derived during the income year. The section 6-5(4) of the act further states that it is considered as income derived when the amount is received by the taxpayer or is received by anyone on behalf of the taxpayer. There are generally two commonly used methods for recognizing income in tax accounting this are “receipts methods” and “earning methods”. The taxpayer should choose the method that is appropriate for recognizing the particular kind of income in that income year (Ferran & Ho, 2014). That method is considered as appropriate if the method reflects substantially the correct income in that income year. In Para 19 of the Taxation Ruing 98/1, the general rule is that a receipt method is considered appropriate if the income is derived from investments, income derived by employee and other non business income (Courtney 2014). The general rule is that earning methods is considered appropriate when the incomes are derived from the trading or manufacturing business as per Para 20 of the TR 98/1. In most cases, earning method is considered as the most appropriate method of determining income for the purpose of tax.
In the given case, RIP Pty Ltd is a private company carrying on the business of funeral director. The company for the year ended 30 June 2016 reported a profit of $2.45 million. It mainly earned its revenue from funeral services and it collected fees from customer under different options (Carter 2013). The different sources and methods through which company collected its fees are given below:
The general rule is that business income derived is most appropriately reflected in earning method. In case of PIP Pty Ltd, the income is derived as soon as service is provided and should be immediately recognized as revenue. It is the general procedure of the company that after providing the service it raises a net 30 days invoice. It would be inappropriate on the part of the company to actually wait for receiving the fees before recognizing it as revenue. This is because as per the earning method income is derived as the service is provided therefore revenue should be immediately recognized (Matthews & Malek, 2012).
The company also receives fees from a scheme of easy future plan. Under this scheme, the company receives fees in advance and undertakes to provide funeral service in future. The fees are non-refundable and in case of defaulting members, these fees are transferred Forfeited payment accounts. As the fees are forfeited for discontinuing members so the company does not have any liability for providing the services so this should be immediately recognized as income. Therefore based on the overall analysis it can be concluded that in case of RIP Pty Ltd income is derived as the funeral service is provided (Thwaites, 2014).
In the case of Arthur Murray, it was held by the court that the taxpayer derives income in the year the service is provided. The case also that as per the general rule the fees received in advance for providing a service is recognized as income in the year the service is actually provided. The RIP Pty Ltd in the easy future plan receives fees in advance and undertakes to perform the funeral service in future (Beverwijk, 2015). The company treats in its accounts the fees received in advance under the easy future plan as income in the year in which the advance is received. As the circumstances in the case of Arthur Murray and the situation of RIP limited in easy future plan is almost similar so the principles of Arthur Murray applies in the accounting treatment of amounts in easy future plan. According to the principle of Arthur Murray the company should not include the advance fees received under the plan as income in the year the advance is received but should be treated as income in the year the funeral service are provided (Shetreet & Turenne, 2013).
The Taxation Ruling 98/1 states that for the purpose of section 6-5 of the ITAA 1997 there are two methods of accounting for tax for items of income. These two methods of tax accounting are Receipts method and earning method. The receipts method is also referred to as the cash basis or cash received basis. In the receipt method, income is derived in the year in which either the constructive or the actual income is received (Ramlogan, 2013). The section 6-5(4) of the ITA Act 1997 also provides that the income will be taken as derived although it is not actually paid over to the taxpayer but is dealt by someone else on the behalf of the tax payer. Another method for accounting for tax is earning method, which is also referred to as accrual method or cash and credit method. In this method, income is derived when it is earned and a recoverable debt is created. The recoverable debt refers to the time in which the taxpayer can legally ascertain the amount as the task that was required to be performed under the agreement has been performed completely (Woellner et al. 2016). Therefore based on above discussion it can be said that the taxpayer and the commissioner has two choices in the method of accounting for tax and they can chose the method that appropriately reflects the income for the purpose of tax.
The RIP Pty Ltd receives fees in advance under easy future plan. If a customer fails to continue the fees until it is completely paid then the company forfeits the partial fees received. The forfeited fees are transferred to a separate account called Forfeited payment account. As the fees are not completely paid so, the company does not have any liability to provide services (Tiley & Loutzenhiser, 2012). Therefore, as the fees are non-refundable and the company does not have any liability to provide services in case of incomplete fees based on this circumstances it is advised that the company should treat the forfeited amount as income in the year the amount is actually forfeited. The company for tax treatment should treat the balance of $16200.00 in forfeited payment account as income.
As per section, 70-10 of the ITA Act 1997 trading stock means anything that is acquired, produced or manufactured and it is used for the purpose of sale, manufacture or exchange in the ordinary course of business. In order to understand the nature of trading stock it is important to note that trading stock does not include a financial agreement or a CGT asset. In section, 70-25 of the ITA act 1997 it is further provided that the amount incurred should not be of capital nature. In the given case, the RIP purchased caskets and accessories, which are used by the company in its ordinary course of business so it should be treated as trading stock for the tax purpose.
The amount incurred for purchase of trading stock is deductible under general deduction as per section 8-1 of the ITA Act 1997. The section 70-15 of the ITA Act 1997 states that amount incurred for the purchase of trading stock should be deducted under general expense in the year in which the item of trading stock becomes part of the stock on hand of the company. In the given case, RIP paid in advance in June 2016 for stock to be delivered in August 2016 that is next income year. In section, 8-1 of the ITA Act 1997 it is stated that the taxpayer can obtain general deduction for outgoing incurred to the extent it is necessary to carry on a business for producing assessable income (Burkhauser et al., 2015). The prepayment payment made by RIP for purchase of trading stock should be treated as advance and not as expense because the item of stock will be delivered in next income and the outgoing incurred does not produce as an assessable income as on 30 June 2016. Therefore, it can be concluded that the amount of $25000.00 should be treated as advance for the purpose of tax in the income year 30 June 2016.
The section 6-5 of the ITA Act 1997 states that assessable income of a resident taxpayer will include ordinary income received from any source within or outside Australia. The dividend received is therefore taxable in the hands of the RIP. As the dividends are fully franked so the company will receive franking credit. The section 100-25 of the ITA Act 1997 provides a general definition and list of CGT assets but the advance payment made for rental of storage space is not a capital asset. Therefore prepaid amount of rent should be treated as advance payment and the rent for four months should be treated as a general expense under section 8 of the ITAA Act 1997. The section 83-80 of the ITA Act 1997 states that if the taxpayer receives unused long service leave then it should be included in the assessable income of the taxpayer. In the given case as RIP paid a three months advance for long service leave it should deducted it as expense on 30 June 2016 and not treat it as advance as the expense will increase the company’s profit for tax purpose will decrease (Harris, 2013).
The section 8-1 of the ITA Act 1997 provides that a taxpayer can claim general deductions for amount for producing assessable income. The section 100-25 provides a list of CGT assets that includes land and building. Therefore, expenses paid in relation to land and buildings are not allowed as general deduction but should be included as capital expenditure. The expenses incurred for equipments, for constructing onsite parking, for landscaping should be included in the capital expenditure, and are not allowed as general deduction under section 8-1 of the act (McKerchar et al., 2013).
Reference
Barnett, K., & Harder, S. (2014). Remedies in Australian Private Law. Cambridge University Press.
Beverwijk, J. (2015). Power, To a Point: Is the Power to Add and Remove Discretionary Beneficiaries of a Trust Fiduciary?.
Burkhauser, R. V., Hahn, M. H., & Wilkins, R. (2015). Measuring top incomes using tax record data: A cautionary tale from Australia. The Journal of Economic Inequality, 13(2), 181-205.
Carter, J. W. (2013). The construction of commercial contracts. Bloomsbury Publishing.
Courtney, W. (2014). Contractual Indemnities. Bloomsbury Publishing.
Ferran, E., & Ho, L. C. (2014). Principles of corporate finance law. Oxford University Press.
French, R. (2013). Law-complexity and moral clarity. Brief, 40(6), 25.
Gaal, J. (2013). Small business entity test. CGT Small Business Reliefs: The Comprehensive Practitioner’s Handbook, 77.
Harris, P. (2013). Corporate tax law: Structure, policy and practice. Cambridge University Press.
Kenny, P. L. (2013). Aligning Income Tax Laws with Accounting Rules: A Simplified Tax System Case Study. Available at SSRN 2340888.
Lynch, A. (2016). Great Australian Dissents. Cambridge University Press.
Matthews, P., & Malek, H. M. (2012). Disclosure. Sweet & Maxwell.
McKerchar, M., Bloomquist, K., & Pope, J. (2013). Indicators of tax morale: an exploratory study. eJournal of Tax Research, 11(1), 5.
Ramlogan, R. (2013). Judicial review in the Commonwealth Caribbean. Routledge.
Shetreet, S., & Turenne, S. (2013). Judges on Trial: The Independence and Accountability of the English Judiciary (Vol. 8). Cambridge University Press.
Thwaites, R. (2014). The Liberty of Non-citizens: Indefinite Detention in Commonwealth Countries. Bloomsbury Publishing.
Tiley, J., & Loutzenhiser, G. (2012). Revenue Law: Introduction to UK Tax Law; Income Tax; Capital Gains Tax; Inheritance Tax. Bloomsbury Publishing.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2016).Australian Taxation Law 2016. Oxford University Press.
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