Discuss about the Taxation Law and Practice for RIP Pty Ltd.
Fact of the case states that the tax payer was engaged in the providing the lessons on dancing by accepting the fees in advance. The taxpayer used to accept the advance fees payment for the dancing lesson services to be provided in future. As per the contention of commissioner, the amount received in advance was required to be considered as income under taxation law. However, the taxpayer denied the contention of commissioner because the service of dance lesson was still due. Moreover, according to the judgment of the high court, it was contended that any amount received in advance in lieu of providing service shall qualify for income received only if the service has been released. Until the taxpayer has actually performed the service, the advance received shall not be considered as taxable income for the assessee (Grubert, 2015). Since the given situation of RIP Pty Ltd is similar to the case of Arthur Murray, with respect to the fees of funeral services received in advance, it can be co-related to it.
In case the income of RIP Pty’s income is derived generally, then such income shall be considered as income generated during the accounting or financial year. It would be considered as the taxable income under the taxation system. Therefore, the company should include such amount of income while determining the tax liability on income. On the contrary, if the amount received from the income of funeral and related services, it would be considered in the statement of financial position of the business and not as an income (DeBacker, Heim & Tran 2015). This is because the service of funeral is rendered after the receipt of service fees. As and when such service is provided, the same shall be transferred and converted to the financial statements of the company and same shall be taxable as per section 6 ITAA 97.
“Easy Funeral Plan” of the organization is a fixed price contract where clients make periodic payments against the funeral services to be provided in future. Under the first plan, consumers are ensured to receive deluxe service in future one the payment is done. Similarly, in case of second plan of the contract, the company used to receive the amount in part payment scheme until the death of a person occurs. Hence, it can be said that the principle of Arthur Murray applies to the accounting treatment for the amounts received in the contract plan (Ciconte et al., 2016). In case of Arthur Murray, the fees received in advance were not included in the income statement until the dancing lessons actually provided. Likewise, in case of RIP Pty Ltd, fees received under the contract shall be treated as income after the funeral services are provided by the company after the death of the client.
The method of accounting for tax is on accrual basis, which means that the transactions related to the current accounting year would be considered for ascertaining the business performance and income tax liability. On the other hand, the accounting for tax can also be prepared by using the cash basis especially is the business enterprise is small or conducted by sole practitioner. In view of the decided case law of Carden, it was contented that the business organizations are required to use the method of accounting for tax that discloses the correct and fair income of the taxpayer. Hence, it can be said that the commissioner or assessee has the choice in using method of accounting for tax. Further, in case of “Firstenberg vs. Federal Commissioner of Taxation”, since the taxpayer was single individual to conduct the business it would be appropriate to follow cash basis for tax accounting method (Robinson, Stomberg & Towery, 2015). Moreover, in case the business is large or operates using credit services, then accrual basis should be conducted for tax accounting that reveals the correct and transparent income of the taxpayer.
Forfeiture of any prepaid receipts is considered as capital receipts as per the taxation ruling (TR) 1999/19 of Income Tax Assessment Tax (ITAA) 97. This ruling is relevant to the business organizations who conduct the business activities by receiving advance payments for the services to be provided in future. However, in case the future service is not taken by the clients, then the advance payment is forfeited by the organizations instead of refunding the same that is recorded by the companies in a separate ‘forfeited payment account’. In many organizations, future service contract demands advance payment, which is not subjected to the clause of forfeiture. Therefore, in case the service is not provided then receipt of such amount is considered as capital receipts (Choudhary, Koester & Shevlin, 2016).
In the provided situation of RIP Pty Ltd, the company conducts the business to provide the services of directing funeral activities as well as dealer of fixed contract under “Easy Funeral Plan”. The company provides services to the clients by receiving advance payments for the funeral services to be provided in future under the fixed contract. However, certain clients could not avail the service hence, the payment received as advance was transferred to the forfeiture account. The account of forfeiture reflected the balance of $16,200 at the end of the accounting year 30th June.
According to the rulings of taxation system, the amount of $16,200 in the forfeited payment account shall be considered as capital receipts that would be valued as assessable income at year-end. As the company’s fixed contract was not subjected to the forfeiture clause therefore, the waiving of services by the clients does not call for refunding the amount already paid by them. Additionally, as per the decided case of Guy v. Federal Commissioner of Taxation 96 ATC 4520; (1996) 32 ATR 590, the amount transferred to the forfeiture account by the taxpayer had been treated as capital receipts and not as revenue receipt. With respect to the nature of service and contract terms and conditions, forfeited amount is considered as a part of “continuum of events” and at the end of the accounting year, the total balance of the forfeited account would be treated under taxable income of the assessee (Jakstonyte & Boguslauskas, 2015). Accordingly, in case of RIP Pty Ltd the balance in forfeited payment account amounted to $16,200 would be treated as assessable income at the end of the accounting year.
Provisions of Income Tax Assessment Act (ITAA) 97 section 70-10 states that the trading stock of the business enterprise are the materials held for sale in the ordinary course of business. A stock or material is regarded as trading stock if such material is competent for trading in as a finished or progressive work structure while operating the business activities (Dumiter et al., 2016). Considering the rules of taxation system treatment of trading stock is done in the following manner:
The stock valuation also includes physical verification and valuation is done by considering the each stock on the basis of cost method, market value method and replacement value method by excluding Goods and Service Tax (GST). In case the assessee is eligible to claim GST credit, then only the taxpayer can exclude the tax on Goods and Service for the purpose of stock valuation (Altshuler, Shay & Toder, 2015).
In the given situation of RIP Pty Ltd, prepayment of $25,000 in June 2016 for the delivery to be made in August 2016 can be claimed as deduction by the taxpayer. According to the TR 93/23 if RIP Pty follows the cash basis accounting method such amount can be treated as an expense and claim as deduction. If the taxpayer applies the accrual method in accounting, the payment shall be included in the balance sheet and can be claimed as deduction in the next accounting year in which the delivery is made. Further, according the case of v St. Huberts Island Pty. Ltd. vs. FC of Taxation, (1978) 138 CLR 210 treatment of caskets and accessories would be valued at cost price.
In case of fully franked dividend received by the company $21,000 it shall be included in the assessable income of the company’s net profit. Fully franked dividends are considered after the tax payment, which is required to be included in the assessable income by the receiver as per ITAA 97. In order to avoid the double taxation system the Australian Taxation system works through the “imputation system” which enable the shareholders to take back the taxes paid by the company. The imputation system allows the companies to distribute dividends with franked credits as taxes paid on earnings (Chang, Chen & Chen, 2016). Since, the dividend received by the RIP Pty is fully franked, the company shall include such amount in determining the net profit therefore, $21,000 would be included in computation of income for the current accounting year.
The company paid $57,000 in March 2016 as storage rental, which was acquired on two years lease expiring on February 2018. The payment for current tax year for four months has been recorded as expenditure in the income statement whereas rest of the amount has been capitalized. As per the provision under division 40 ITAA 97 operating lease payment are treated as expenses incurred by the taxpayer and therefore to be included in the income statement. In case there are advance payments or outstanding payments, it would be recognized in the balance sheet statement of the company (Amberger, Eberhartinger & Kasper, 2016). Therefore, the accounting record by RIP Pty Ltd for storage rental expense was correct as the lease obtained by the company was operating lease hence the payment for current tax year would be recorded as expense. Similarly, amount paid related to the next accounting year should be capitalized in the current accounting year.
Last case involves advance payment of “Long Service Leave” to the company’s managing director, which means the payment to the employees as paid leave. The companies pay it if the employees serve the employment for a longer period. ITAA 97 section 83-70, subdivision 83- D states that if the leave payment made by the companies before 16 August 1978, then the amount will not be considered as assessable or exemption. In case the payment is made between the period 16 August 1978 and 17 August 1993, it will be taxed at 31.5% including the Medicare Levy 1.5% (Schneider, 2015). Therefore, the amount of $22,000 under “Long Service Leave” paid by RIP Pty Ltd to the managing director would be subjected to the withholding tax of 31.5%. Out of the total payment, the company is eligible to recognize the payment $15,070 as expenses and the withholding tax $6,930 would be adjusted with the amount of tax liability.
According to the division 43 under Taxation Ruling 97/25 of ITAA 97 deduction of expenses for capital works is based on the actual amount incurred for construction process. In case the company conducts structural improvements on earthworks or capital expenditure on land for landscaping, demolishing or clearing then such expenses shall not be allowed as deduction to the taxpayer under section 43-70 ITAA 97 (Saltzman, Eibner & Enthoven, 2015). Hence, following expenses borne by RIP Pty Ltd are available for deduction in Australian Taxation System:
Reference List
Altshuler, R., Shay, S. E., & Toder, E. J. (2015). Lessons the United States can learn from other countries’ territorial systems for taxing income of multinational corporations. Available at SSRN 2557190.
Amberger, H., Eberhartinger, E., & Kasper, M. (2016). Tax Rate Biases in Tax Planning Decisions: Experimental Evidence. WU International Taxation Research Paper Series, (2016-29).
Chang, C. W., Chen, M. C., & Chen, V. Y. (2016). Are Corporate Tax Reductions Real Benefits under Imputation Systems?. European Accounting Review, 1-23.
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