Taxation Of Dividend, Interest, And Capital Gain

Case of Arthur Murray

Discuss about the Taxation of Dividend, Interest, and Capital Gain.

The business conducted by the taxpayer is of providing lessons in dancing. For this, the taxpayer received the fees in advance and encouraged students for providing advance fees by providing discounts. The taxpayer created a suspense account to include the fees that are prepaid and named the account as “Unearned deposit- untaught lessons account”. The proportionate fees for which tuition has been provided is transferred from the suspense account and is recognized as income. The prepaid fees were received on the condition that the taxpayer will not refund the fees but generally, the fees are refunded for students that do not complete the lessons (Burkhauser et al., 2012). The advance fees were not recognized as income by the taxpayer until the dancing lessons are provided. The assessable income of the taxpayer did not include the advance fees but only the fees of students to whom the dancing lessons has been provided. The tax authority however included the advance fees received in assessable income for determining the tax liability.

The issue before the court is to determine whether the advance fees received by the taxpayer should be included in assessable income in the year the service is provided or in the year, the fees are received in advance (Burkhauser et al., 2015).

In this case, the court held that the fees that are received in advance should be included in the assessable income of the taxpayer in the year the actual dancing lessons are provided. The judgment also referred to the general rule that advance fees received for the services that has not been provided should be treated as advance and not as an income (Atkinson & Leigh, 2013). There advance fees received was not to be refunded as per agreement but in practice, taxpayer refunded the fees of students that did not complete the lessons. Therefore, the court held that, as there is a possibility that the taxpayer might have to refund the fees so the prepaid fees should not be included in the assessable income of the taxpayer (Markle, 2015).

The incomes that are derived during the year are treated as assessable income by the taxpayer as per section 6-5 of the ITA Act 1997.  The income derived is explained in the section 6-5(4) of the act and it states that it is to be taken as income derived if the income is received by someone on behalf of the taxpayer or directly by the taxpayer (Mares & Queralt, 2015). The receipt method and the earning method are two most popular methods of recognizing income for the purpose of tax. The method that will reflect the income of the taxpayer in the most correct manner is considered as the appropriate method for recognizing income. The Para 19 and Para 20 of Taxation ruling 98/1 provides the general rule of recognizing the income. According to the Para, 19-receipt method is appropriate for income that are derived from non-business activity, investments and income derived by employee (Greenville et al., 2013). According to Para 20 of the ruling for income derived from business of trading and manufacturing the earning method is the most appropriate.

Accounting methods for tax purposes

The RIP Pty Ltd made a profit of $2.45 million by proving funeral and associated services during the income year 30 June 2016. The company collects the fees from customers under different options. It collected fees directly from customers after providing services by issuing a net 30 days invoice. The company also issued a net 30 days invoice and received fees from the external insurance companies (Tiley & Loutzenhiser, 2012). The company also received fees from RIP Finance, which carried on the business of providing credit on installments. The company also conducted a scheme of easy future plan and received fees in advance as installments. The earning method best reflects the income derived by the business so according to this method the RIP Pty Ltd should recognize income as the service is provided. Therefore, company should not wait for the actual receipt income but should recognize the revenues when the 30 days invoice is raised (Lang, 2014). The company received fees as advance installments under the easy future plan. The fees received are non-refundable and in case a customer fails to complete all the installments then the company forfeits the fees. The analysis above shows that the company derives income as the funeral service is provided.

Yes, the principles held in the case of Arthur Murray are applicable in the current situation of RIP Pty Ltd. It is because the circumstances under both the cases are almost similar. In the case of Arthur Murray, the court held that the taxpayer derives income in the year the service is provided. The court in this case also highlighted the general rule that advance fees that are received for providing a service is to be recognized as income in the year the service are actually provided. In easy future plan the RIP Pty Ltd receives fees in advance for providing a service of funeral in the future. The accounting treatment of the income received should be made based on the case of Arthur Murray (Cao et al., 2015). The prepaid fees received under this scheme should be treated as advance and should be transferred to income in the year the service is provided.

The Taxation Ruling 98/1 mentions two methods of accounting of income for the purpose of tax.  These two methods of determining income derived are receipt method and earning methods.  The receipt method also known as cash basis or cash received basis considers income derived in the year the actual or constructive fees is received. It is also provided in section 6-5(4) of the ITA Act 1997 that it will be considered as income derived if the fees are received by someone else on behalf of the taxpayer. There is another method called earning method that is used for determine income derived for the purpose of tax. The earning method is also known as accrual method or cash and credit method (Krever & Mellor, 2016). The earning method provides that the income is derived as the service is provided and the recoverable debt is created. The recoverable debt means the service that was required as per the agreement has been provided and the amount can be legally claimed and recovered.  Then analysis provided above shows that the commissioner of tax and the taxpayer have two choices for accounting of income for the purpose of tax. The method that reflects the income derived correctly for the income year should be chosen for determining income derived.

Treatment of fees received in advance

In the scheme of easy future plan the RIP Pty Ltd received fees in advance installments. The scheme provides that if not all the installments are paid by the customers then the fees received should be forfeited and the company will have no liability for providing the services. The fees that are forfeited are transferred to a separate account called Forfeited payment account (Tran-Nam et al., 2014). The balance in the forfeited payment account should be recognized as income because the fees are non-refundable and the company has no liability of providing e services in the future.

The trading stock includes items that are produced, manufactured or acquired and is used by the business for the purpose of manufacture, sale or exchange. The meaning of trading stock is defined under section 70-10 of the ITA Act 1997. The nature of trading stock can be better understood if it is clear that trading stock does not include CGT assets and financial agreements. The amount that is incurred of capital nature should not be included in the trading stock as per section 70-250 of the ITA Act 1997. The RIP Pty Ltd has purchased caskets and accessories.

The company use this items for proving general service to the customer so this items should be treated as stock. The amount that is paid for purchasing trading stock is deductible under section 8-1 as general expenses. The amount paid for the purchase of stock is allowed as deduction in the year the stock becomes part of the stock in hand of the company (Saad, 2014). The RIP Pty Ltd has paid an advance of $25000.00 for items to be delivered in August of the next income year. The general deductions can be availed by a taxpayer in respect of payments that are made for carrying on business with the intent of producing an assessable income as per section 8-1 of the ITA Act 1997.

In this case the company has paid in advance for items of stock that are to be delivered in the next income year. Therefore, based on the provisos mentioned in section 8-1 of the act, the advance made has not produced any assessable income so such advances should not be included in the assessable income of the taxpayer. It is advised to treat $25000.00 as advance and not as expenses for the year 30 June 2016.

The ordinary income is defined in section 6-5 of the ITA Act 1997 and it states that income received from any source by a resident Australian should be included in the assessable income. The RIP Pty Ltd is a resident company so the dividend received by the company should be included in the assessable income. The dividend received by the RIP Pty Ltd is fully franked so the company is allowed to take the franking credits. The CGT assets are defined under section 100-25 of the act and there is also a list CGT assets provided under that section. According to the meaning of CGT assets and the list provided under that section advance rent paid for rental storage space does not qualify to be a CGT asset.

Deductibility of trading stock

Therefore, it is advised that the amount paid should be treated as an advance and the rent of four months belonging to the current year should be treated as expenses (Harding, 2013). This four-month’s rent is allowed as general deduction under section 8 of the ITA Act 1997. The unused long service leave is to be included in the assessable income of the taxpayer as per section 83-80 of the ITA Act 1997.

The Rip has paid an unused long service leave of three months in advance. This payment for long service leave should not be treated as advance but expenses for the tax purpose.

The amount that is paid for producing assessable income can be claimed as general deduction under section 8 of the ITA Act 1997.  The land and building is included in the list of CGT assets provided under section 100-25 of the ITA Act 1997. The expenses that are incurred for the purpose of land and buildings are the expenses of capital nature and should not be allowed as general deduction under section 8 of the act (Rimmer et al., 2014).

The expenses incurred by the company during the year for the purpose of landscaping, constructing onsite parking and equipments are all of capital nature and should not be included as general deduction as per section 8-1 of the ITA Act 1997.

Reference

Atkinson, A. B., & Leigh, A. (2013). The Distribution of Top Incomes in Five Angloâ€ÂSaxon Countries Over the Long Run. Economic Record, 89(S1), 31-47.

Burkhauser, R. V., Feng, S., Jenkins, S. P., & Larrimore, J. (2012). Recent trends in top income shares in the United States: reconciling estimates from March CPS and IRS tax return data. Review of Economics and Statistics,94(2), 371-388.

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.

Cao, L., Hosking, A., Kouparitsas, M., Mullaly, D., Rimmer, X., Shi, Q., … & Wende, S. (2015). Understanding the economy-wide efficiency and incidence of major Australian taxes. Treasury WP, 1.

Greenville, J., Pobke, C., & Rogers, N. (2013). Trends in the Distribution of Income in Australia. Melbourne: Productivity Commission.

Harding, M. (2013). Taxation of Dividend, Interest, and Capital Gain Income.

Krever, R., & Mellor, P. (2016). Australia, GAARs–A Key Element of Tax Systems in the Post-BEPS Tax World. GAARs–A Key Element of Tax Systems in the Post-BEPS Tax World (Amsterdam: IBFD, 2016), 45-64.

Lang, M. (2014). Introduction to the law of double taxation conventions. Linde Verlag GmbH.

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Markle, K. (2015). A Comparison of the Taxâ€ÂMotivated Income Shifting of Multinationals in Territorial and Worldwide Countries. Contemporary Accounting Research.

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Tiley, J., & Loutzenhiser, G. (2012). Revenue Law: Introduction to UK Tax Law; Income Tax; Capital Gains Tax; Inheritance Tax. Bloomsbury Publishing.

Tran-Nam, B., Evans, C., & Lignier, P. (2014). Personal taxpayer compliance costs: Recent evidence from Australia. Austl. Tax F., 29, 137.