HI6028 Taxation Law: Income Derivation and Trading Stock in Funeral Services

HI6028 Taxation Law
Trimester 1, 2018
1

Contents
Part A.....................................................................................................................................................2
Part B.....................................................................................................................................................5
References.............................................................................................................................................8
2

Part A
a) Refer to the decision in Arthur Murray (NSW) Pty Ltd v FCT (1965)114 CLR 314. In
your own words, briefly describe the facts, issues and conclusions in that case.
The facts of the Arthur Murray principle relate to the recognition of income in the books of
accounts for tax purposes. The taxpayer provides the services of dance lessons to the
students. The students are charged a lifetime fees for the dance lessons which can be availed
at any time during the life of the student. The fees are not refundable to the students whether
or not the dance classes are taken by the students. The taxpayer does not include the amount
received in its assessable income since it follows the accrual system of accounting and the
amount is received in advance which relates to the unearned income of the taxpayer. The
Commissioner of Taxation included the amount of unearned deposits in the assessable
income of the taxpayer. On the objection made by the taxpayer the matter was sent to the
Board for review which also supported the commissioner’s view. The taxpayer appealed to
the High Court. The issue involved in the case was that whether the amount which is received
as advance payments from the students for dance classes shall be included in the assessable
income of the current period or not. It relates to the assessment of when the income of
business is considered to be derived income. The High court held in its decision that the
income earned by the taxpayer from the services provided in the current period will form part
of the assessable income of the taxpayer. The amount which is received in advance will be
regarded as the unearned income and the tax treatment done by the company for the amount
of fees received from the students is correct. The Court also held that the Carden’s case will
not be applicable to the business of the company (Barwick, 2017). Thus, the income which is
received as well as earned by the business will only be included in the assessable income of
the business.
 Advise RIP Pty Ltd when income is derived generally and when it derives its income
from funeral services and related activities.
As per Section 25(1) of Income Tax Assessment Act 1936-65, the assessable income of a
taxpayer which is resident in Australia will include income from all direct and indirect
sources and that if a non-resident taxpayer will include the gross income derived by the
taxpayer from all the sources in Australia. The inclusions and exclusions and the meaning of
3

the ‘income derived’ is explained in the decision of Arthur Murray case law. The decision is
that the prepayment of income under the future service contract will not be included in the
assessable income of the taxpayer. The reason for this is that under the accrual system of
accounting, the income which relates to the period for which services are provided shall be
recoded in that period only. RIP Pty Ltd provides funeral services on the basis of which the
charges are received from the customers in advance. From the application of Arthur Murray
principle on the company, it can be observed that the receipts from the customers will be
included in the assessable income when the services with respect to the amount received are
provided to the customers.
 Does the Arthur Murray principle apply to the company’s accounting treatment of
amounts in Easy Funeral Plan? Explain.
Easy Funeral plan is the contract for the company in which the company charges fixed prices
for the services provided by the company to its customers with deluxe funeral arrangement
and facilities. Under this contract the mount is paid by the customers at the time of entering
into the contract and the services are provided by the company at a future date. As per the
Arthur Murray principle, the amounts which are charged by a business as prepayment from
the customers are not included in the assessable income of the taxpayer. The amount which
relates to the services provided in the current year can only be recorded as income for the
current period. The accounting treatment made by the company for the charges received
under the Easy Funeral Plan are similar to that of the accounting treatment made in the Arthur
Murray case law. Under this principle also the accrual system of accounting is applied under
which the prepayments are not recorded as income rather they are included in the assessable
income in the year in which the services will be provided by the company.
 Does the commissioner or any other taxpayer have a choice in the method of
accounting for tax?
Under the accounting policies, the cash basis of accounting is also used part from the accrual
basis of accounting for recording the business transactions and identification of income and
expenses for recording in the financial statements of an entity. Thus, there is another
alternative for the method of accounting for tax purposes (Hyndman & Conolly, 2011). In the
Carden’s case law, the taxpayer followed the cash system of accounting and it was held by
the court that the receipts which are received from the professional services will be included
4

in the assessable income of the taxpayer as and when they are received since the taxpayer
follows the cash basis of accounting or recording its revenues. Thus, following the decision
of the court in the Carden’s case, the Commissioner of Taxation or any other taxpayer has an
option to record the revenues on the receipt of revenues rather than when the revenues
become accrue. In the given case of RIP Pty Ltd also the commissioner of taxation has an
option to include the amount in the assessable income of the taxpayer on the receipt basis.
However the taxpayer follows the accrual basis of accounting and the tax treatment stated in
the Arthur Murray Principle will be more appropriate for RIP Pty Ltd.
b) Advise the company of the tax treatment of $16,200 in ‘Forfeited Payments Account’
in item (iv)
According the accounting policy of the company the fees charged from the customers as
fixed price for the contract of Easy Funeral Plan is recorded as prepayment at the time of
receiving the amount in the ‘Unearned deposits Account’. Later when the services are
provided the proportionate amount for the services are recognised as the revenue. For the
amount which relates to the services not provided or the services not claimed by the
customers, a separate account is used. This amount is transferred to the ‘Forfeited Payments
Account’ The amount in this account represents the fees charged under the fixed price
contract for which the services have not been provided. The amount of $16,200 in the
Forfeited payments account will be a gain to the company. This amount is not refundable in
future therefore it has to be recognised as gain in the current period. This amount will be
recorded as the extraordinary business gain and will form the part of comprehensive income.
The comprehensive income of the business includes the income of the business which is not
regular and which does not relate to the business activities. Thus the amount of $16,200 will
be included in the comprehensive income of the business and will be taxable. .
5

Part B
 The nature of trading stock, generally, whether the caskets and accessories would be
trading stock for tax purposes and how the amount of $25,000 is treated for tax
purposes
RIP Pty Ltd is a company having the business of providing funeral services to its customers
under the terms of contract. In order to deliver the services effectively under its ‘Deluxe
arrangement plan’, the company requires a number of accessories such as secular icons,
caskets, flowers etc. The issue is to identify the nature of trading stock generally for tax
purposes and for the business of RIP Pty Ltd. According to the accounting policies and
principles, trading stock is defines as the physical or intangible resources of a business which
are used in performing the core business operations directly and result in increased business
revenues. However the trading stock is different from the other business assets since it is
temporary in nature and held in the business for short-term. Also Section 11c of Income Tax
Assessment Act 1977 defines trading stock as the resource used for conducting business
activities by an entity. The caskets, secular icons and related accessories are temporarily held
for the business by RIP Pty Ltd in order to provide funeral services effectively and therefore
these assets will be considered as the trading stock of the company.
In general the nature of trading stock is current asset held temporarily for business activities.
For tax purposes the trading stock is allowed as deduction of business expense from the profit
or revenue of the business (Collier, et.al, 2015). The amount of $25,000 has been paid by the
company in order to purchase the inventory to be used in the future period. This is a
prepayment for the purchase of inventory and the prepaid inventory also forms part of the
inventory of the business on the closing date. Therefore the amount of $25,000 is deductible
from the revenues as business expense.
6

 What adjustments (if any) should be made to the company’s reported profit for tax
purposes in regard to items (b), (c) and (d).
Item b
RIP Pty Ltd received a dividend amounting to $21,000. The dividend income is included in
the assessable income of the taxpayer and therefore the amount of $21,000 received by RIP
Pty Ltd from RIP Finance has to be included in the assessable income of RIP Pty Ltd.
However the dividend was fully franked which means that the tax on the amount of dividend
has already been paid by RIP Finance Ltd before distribution of dividend to shareholders.
Therefore the amount of franking credit on such dividend received by RIP Pty Ltd can be
reduced as deduction from the tax payable by the company. Thus, there is no need to make
any adjustment in the net profit of the company if the dividend is already included in its
taxable net profit. However, after calculation of tax payable on such net profit, the amount of
franking credits will be reduced.
Item c
The company paid $57,000 on 1 March 2016 for the advance lease rent of the storage space
for 2 years. The amount of lease rent is a periodical expense and as per the accrual basis of
accounting, the amount shall be apportioned throughput the period for which the expense has
been incurred. The lease expires within 24 month and up to the completion of tax year on 30
June 2016, the lease rent expense will relate to four months. Thus for the tax year ending 30
June 2016, the amount of lease rent to be recorded in the books of the company will be
$57,000X4/24 = $9.500. The remaining amount of $47,500 will be considered as the prepaid
expense for lease rent for the company. The prepaid expenses are included in the current
assets of a business and therefore the capitalisation of $47,500 and recording expense of
$9,500 for the year ending 30 June 2016, in the books of accounts is correct tax treatment. N
adjustment is needed to be ad in the profits.
Item d
According to the fundamental principles of accounting, the business is required to record a
liability in its books of accounts even of the amount of payment is not certain and the
probability of liability is not high. Under the conservatism approach of accounting, the
7

liability is required to be recorded as soon as it is discovered. His principles of accounting
state to record the liability which is uncertain by making provision for the liability from the
profits of the current year. The director of the company commenced his long service leave for
three months. The company recorded he liability of payment of $22,000 to be made on the
completion of long service leave duration as the provision for long services leave. However
the payment was made in advance and the amount was certain and definite. This is the
advance payment for employee entitlements. Rather than recording the amount as provision,
it has to be recorded as advance payment of future obligation which has to be included in the
current assets of the company. Also out of three months, only the amount of one month shall
be considered as the expense for current period. Thus, the amount of net profit has to be
increased by the advance payment which relates to two months.
 What deductions (if any) are available for expenditure set out in item (e)? Explain.
As per the positive limb of Section 8-1 of Income Tax Assessment Act, the business expenses
which are incurred by an entity to conduct the business operations are allowed as deduction
form the profits of the business. Aldo the negative limb of the section states that only the
revenue expenses are deductible and the capital expenses incurred for the business are not
deductible (Hemmings & Tuske, 2015). The capital expenses are those expenses which are
likely to provide long term economic benefits whereas revenue expenses are incurred for
generating the revenues in the current period. The company incurred various types of
expenses for the construction of built facility to accommodate its employees. The
construction of built facility is likely to generate economic benefits to the company for long
term. The development of architectural designs in the year 2013 for $250,000, acquisition of
land amounting to $1.25 million and demolition charges paid amounting to $50,000 are all
fixed expenses. The cost of construction amounting to $2.5 million, equipment installation
expenses, on-site parking expenses and landscaping cost are all the fixed capital expenses for
the company. Since all the expenses are capital expenses therefore no deduction can be
claimed by the company in respect of these expenses. These construction and other related
expenses shall be capitalised to the cost of building of the company. The building has to be
recorded in the books of the company as fixed asset with an amount equal to the sum of all
the construction expenses incurred for the building. However, the deduction in respect of
depreciation for the building can be availed and the amount of deprecation on the total cost of
building can be deducted from the net profit of the company.
8

References
Hemmings, P. and Tuske, A., 2015. Improving Taxes and Transfers in Australia.
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.
Braithwaite, V. ed., 2017. Taxing democracy: Understanding tax avoidance and evasion.
Routledge.
Barwick C.J., Kitto and Taylor, JJ., 2017. High Court of Australia. Jade, pp-316-320.
Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for
decision making. John Wiley & Sons.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2012. Australian taxation
law. CCH Australia.
Tiron Tudor, A. and Mutiu, A., 2012. Cash versus accrual accounting in public sector.
Weil, R.L., Schipper, K. and Francis, J., 2013. Financial accounting: an introduction to
concepts, methods and uses. Cengage Learning.
Hyndman, N. and Connolly, C., 2011. Accruals accounting in the public sector: A road not
always taken. Management Accounting Research, 22(1), pp.36-45.
9