PART A Answer to Question i Arthur Murray (NSW) Pty Ltd V FCT (1965) 114 CLR 314
Case Facts
The person paying tax was associated with providing lessons for dancing to students and also allowed discount to those who make early payment of fees. This practice was used so that the students gets encouraged in paying the fees early. In the agreement between the student and the taxpayer it was clearly mentioned that no refund will be allowed of the fees paid in advance. The fees received in advance was transferred to the “suspense account” by the taxpayer, which he named it as “unearned deposit-untaught lessons account”. Advance fees was transferred in the revenue account after the lessons were provided to the students. Nevertheless, as per the contract, it was not necessary for the taxpayer to refund the advance fees but in reality, the taxpayer used to make refund of the fees of the students with uncompleted lessons (Burkhauser et al. 2015).
Only after the students avails the complete dance lessons, the prepaid tuition fees were accounted as “income derived” by the taxpayer. Hence, the advance fees was not included in the taxpayer’s assessable income. However, under section 25(1) of the ITAA 1997, the tax commissioner included the advance fees as ordinary income and the assessable income was computed on the basis of receipt.
Issue of the Case
The assessable income of the taxpayer was not tallying with that of the commissioner as they treated the prepaid tuition fees differently. The primary issue of the court was to declare whether the prepaid tuition fees to be included in the taxpayer’s assessable income or not (Lederman 2015).
Conclusion to the Case
The High Court stated that any such income that is received for any service which has not been served cannot be included under assessable income. The court also stated that despite it was stated in the contract that no refund of the advance fees would be made, but in practice it was not adhered. Fees of those students were refunded by the taxpayer to whom complete lesson were not provided. Hence, this practice did not allowed the taxpayer to add the advance fees as receipt in the year as because, there might arise such circumstances where the taxpayer might need to refund the tuition fees to the student (Becker et al. 2015). Moreover, the High Court added to its statement that the income derived by the taxpayer are accounted as per the number of lessons provided and not in the year. Hence, the court stated that the process of computation of its own assessable income of the taxpayer is correct and appropriate.
a)(i)
As per ITAA 1997, it is stated under section 6-5(4) that if any amount is received by the taxpayer or on his behalf, by anyone, then that amount shall be treated as income derived as per the act. Under section 6-5 of the ITAA 1997, it is mentioned that any income received in a year would be considered as the assessable income for that year. As per the law there exists two primary methods of computing the assessable income for taxation purpose, “Earning Method” and “Receipt Method” (Braithwaite 2017). It is the responsibility of the taxpayer to select that method of tax computation which best describes his income.
It is also mention under Taxation Ruling 98/1, Para 19 that only such income to be calculated as per receipt method where the income is generated from any investment or where the income is generated from any other sources other than business or any income generated by an employee or worker. It is also clearly mentioned under the TR 98/1 in Para 20, that income arising out of manufacturing or trade should be computed as per the earning method. The earning method is regarded as the most suitable and appropriate method for the purpose of calculation of income and to compute for taxation (Lawrence and Bennett 2017).
(ii)
The company RIP Pty Ltd is associated with offering services related to funeral and funeral related other services. For the year ended June 2016, the company’s profit that was reported was $2.45 million. Under several options, the company earned income and revenue by providing funeral services to its clients (James et al. 2015). Below mentioned are the various methods used by the company to collect the fees from its clients.
The most suitable and appropriate method for computation of income derived from business is earning method as per the general rule. As the funeral services are offered by RIP Ltd and income is generated, thus such should be acknowledged as revenue. The process that was used by the company was such that, a net 30 days invoice is being raised by the company after it provides the funeral services to its customers. The company must not wait till the actual receipt of such income/ revenue but consider the income derived as revenue immediately after the services related to funeral are provided to its customers and raising of the net 30 days invoice.
An easy future plan scheme is offered by the company where the company assures to provide funeral services in future to its customers by accepting its fees in advance. The fees that are received under the easy future plan cannot be refunded (Dootson and Suzor 2015). If any such situation occurs where a customer becomes a defaulter in paying any of the instalments under the easy future plan, then the fees that has been already paid by the customer will be forfeited and will not be refunded. Then such amount will be transferred to a separate account called “Forfeited Payment Account”.
Thus it is the responsibility of the company to treat the amount in such account as revenue as RIP will no longer be liable to provide any funeral services to those members or customers who have already discontinued to pay the instalments (Ferraro 2016). Thus on the basis of the above assumption and practice carried out by RIP Ltd, it can be said that income by RIP ltd is generated as the funeral services are offered to the customers.
(b)
It was considered in case of Arthur Murray that the income was derived in the year when the company offers services to its clients. Moreover, it is also mentioned in the case that according to the general ruling, it should be treated as income in the year when the services are actually offered in case of fees received in advance. The services related to funeral are provided by the company in future and the fees are charges in advance in case of the easy future plan. When the fees are received actually, then RIP Ltd recognises the fees received in advance as income for the year. It is similar to the circumstances that happened in case of Arthur Murray to that of the RIP Pty Ltd. Therefore the principle of Arthur Murray is valid in terms of accounting treatments of RIP Ltd and hence, it is not suitable for the company to account for the fees that are collected in advance as income for the year (Evans et al. 2016).
(c )
According to the TR 98/1, it states that for the purpose of computation of tax there are two different method of account for income. As under the receipt method, the income is generated in the year when the income is actually received thus this method is also called cash basis or cash received basis. According to section 6-5(4) of the ITAA 1997, if the taxpayer or anyone on his behalf receives the income, then such income will be considered as income derived. There exist yet another method for accounting of income for tax purpose besides the receipt method. Earning method is the other method used for accounting of income for tax purpose, which is sometimes regarded as cash and credit or accrual method.
In this method, a recoverable debt is created and the income is derived as soon as it is earned (Gunnarsson and Svensson 2016). The taxpayer can legally claim for the income and transfer it to the recoverable debt once the task is carried out as per the agreement and performed completely. Thus it can be stated that for the purpose of computation of income for taxation purpose, the taxpayer and the commissioner can use the earning or the receipt method.
Answer to Question ii
There is a scheme called Future Plan run by the RIP Pty Ltd. This is a method where the clients are required to make the payment of the fees for the funeral services to be received in future in advance as instalments. These fees which are paid by the customers in advance of receiving the services from RIP Ltd as instalments are non-refundable. In case where any customers fails to make the payment for any instalments, then the money which is already paid by the customer is not refunded and it is forfeited. Such amount is then transferred to an account called “Forfeited Payment Account”. Moreover as the customers did not paid the fees in full, thus the company does not have any liability (Gobena and Van Dijke 2016). Therefore, as the agreement states that the defaulter’s fees are non-refundable and there is also no liability for the company to offer services in the future, thus it is appropriate to treat the forfeited fees as income for the year. The total amount of fees forfeited in the year was $16,200.00.
Part B Answer to Question i
Anything which is developed or manufactured in the normal course of business or used for purpose of sell, exchange or manufacture of goods as stated under section 70-10 of the ITAA 19997, it is referred to as trading stock. In the definition of the trading stock, the CGT assets and Financial Agreements are included. The amount that are acquired for trading stock should not be treated as capital nature as mentioned under section 70-25 of the ITAA 1997. Hence all those accessories and caskets which are purchased by the company (RIP Ltd.) and are used in the ordinary course of business shall not be considered as assets of capital nature but trading stock (Hodgson and Pearce 2015).
The amount incurred by RIP Pty Ltd for the purchase trading stock is allowed as deduction as under section 8-1 of the ITAA 1997, general deductions are allowed for the purchase of trading stock. In the year when the stock becomes a part of the in hand stock of the company, in that year the deduction for the purchase of trading stock is allowed. General deduction is allowed in this section for those expenditure which are necessary in order to carry out the business and also to produce the assessable income and this is also mentioned under section 8-1 of the ITAA 1997 (Katic and Leigh 2016).
In the present case an amount of $25,000.00 is prepaid by the company the stock for which is to be delivered in the next year of income. Hence, on the basis of the above clarification, it is advisable that the company shall treat the amount that is prepaid as advance for the year of income ending 30th June 2016.
Answer to question ii
Any income which is ordinary and received by any resident individual shall be included under ordinary income as per section 6-5 of the ITAA 1997. Thus RIP Pty Ltd must treat and include the dividend received as taxable income as per the section. As the dividends are franked fully, thus the company will be able to take franking credits. Under section 100-25 of the Income Tax Assessment Act 1997, the advance payment made for rental storage are not accounted under the list of capital assets as provided by the section. Thus the advance payment of rent must not be considered as assets of capital nature.
Under section 8 of the ITAA 1997, the rent received in advance includes the rent of four months of the present income which is further allowed as general deduction by this section (Guglyuvatyy and Evans 2015). Moreover, as per section 83-80 of the ITAA 1997, the long services that are unused must be considered in the assessable income. Thus in the present case, a long service leave for three months in advance is paid by RIP Pty Ltd which shall not be treated as any advance for the year ended June 2016 but as an expense.
Answer to Question iii
Under section 8 of the ITAA 1997, any taxpayer, for the purpose of creating assessable income, can claim for general deduction. Land and Building are included in the list of CGT assets as specified under section 100-25 of the ITAA 1997. As per section 8 of the ITAA 1997, any expenses which are spent on land and building must not be treated as general deduction but to be regarded as expenses of capital nature (Dowling 2014). However, such expenses are also to be considered as capital expenses and not as general deduction which are related to onsite parking, equipment expenses, landscaping expenses, etc.
Reference
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Braithwaite, V. ed., 2017. Taxing democracy: Understanding tax avoidance and evasion. Routledge.
Brooks, C.S., 2018. Metal recovery from industrial waste. CRC Press.
Burkhauser, R.V., Hahn, M.H. and Wilkins, R., 2015. Measuring top incomes using tax record data: A cautionary tale from Australia. The Journal of Economic Inequality, 13(2), pp.181-205.
Dootson, P. and Suzor, N., 2015. The game of clones and the Australia tax: Divergent views about copyright business models and the willingness of Australian consumers to infringe. UNSWLJ, 38, p.206.
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