STUDY NOTES DIRECT TAXATION (PDF)

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TAXATION LAW
EXPLANATION TO NOTES TO INCOME STATEMENT
NOTE – 4: POOL DEPRECIATION
Depreciation can be treated a part of the cost of a manufacturer's products or a selling
expense or an administrative expense. The nomenclature depends on the functioning of
the asset being depreciated. In this case study of Timber Floors Pty. Ltd (TFPL), the
assets are either those which are used in the manufacturing process, or are for use as
administrative tools or for selling of the products, But they are all being used by the
management for earning a business income. Hence, we will include all the depreciation
charged as an overhead cost of TFPL’s manufacturing process, says Barkoczy, (2018).
TFPL is a Small Business Entity (SBE) because from 1 July 2016 onwards its turnover
is less the $10million per annum, hence the management can use the simplified
depreciation rules. Under these rules, the management can –
 Claim full cost of assets costing less than $20,000 in the first year of their
purchase until 30 June 2018.
 Pool all assets which have higher costs than the threshold limit and claim a 15%
deduction as depreciation in the first year of purchase and a 30% deduction in the
subsequent years.
 Deduct the balance at the end of the income year in the Small Business Pool in
case the balance, before applying the depreciation, at that time is less than the
prescribed asset write-off threshold of $20,000.
When TFPL chooses to use these simplified depreciation rules, it must –
 Use them for working out deductions of all the depreciating assets, except those
which are excluded.
 Claim deduction for that portion of the cost of the asset which is being used either
for business purposes or for other taxable purposes and not for any personal use.
(See attached Excel Spreadsheet for the Small Business Pool Depreciation Table)

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NOTE – 5: PROVISION FOR UNREPORTED CLAIMS
TFPL, before making an estimate of the warranty expenses and liabilities (also known
as Unreported Claims), must evaluate –
 The number of product units sold during the income year.
 The percentage of the product units sold which may need repairs or replacement
on the basis of previous experiences.
 The average cost of the repair or replacement which is covered under the
warranty, as per Barkoczy, (2017).
The following equation is used for calculating the product units eligible for the warranty
expense: (Total number of units sold) x (Percentage of defective units)
The following are the recording heads cited in the FASB's Statement of Financial
Accounting Standards No. 5, Accounting for Contingencies.
1. Warranty Liability, which is recorded in the Balance Sheet.
2. Warranty Expense, which is recorded in the Income Statement.
Both these amounts are recorded at the time the product’s sale. In case, these amounts
are probable as in the case of TFPL, where the management is assuming both, the
number of customers who will be making claims for claiming the warranty and the
estimated amount of the claim, assert Barkoczy et al, (2017). Since the warranty liability
is probable and has been estimated, Amanda has shown a probable Warranty Expense
that may accrue in the current income year ending 30 June 2018 and the Warranty
Liability amount will be reflected in the Balance Sheet, as per Barkoczy et al, (2017).
NOTE – 6: REVENUE AND CAPITAL EXPENDITURE
Revenue Expenditure
These expenses, which are short-term expenses, can be bisected into two segments –
Expenditures Incurred to Generate Revenue
Expenses incurred for meeting the regular operational and running costs of TFPL have
been shown under this head. Unlike the capital expenditures, these expenses are
fully tax-deducted, to their full value, in the same income year in which they are
incurred, as explained by Nethercott, Devos & Richardson, (2018).
Expenditure Incurred to Maintain Revenue Generation

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Expenses incurred for ordinary repair and maintenance to keep the assets in working
condition but which do not substantially improve or extend the asset’s useful life are
covered under this segment, as per Smith & Koken, (2017).
Amanda has shown both the segments under ‘Repairs’ in the Income Statement.
Capital Expenditures
These are incurred on fixed assets such as property, plant or equipment. These
expenditures are claimed by TFPL over a number of years through their depreciation at
pre-determined rates, as explained by Deutsch et al, (2016).
NOTE – 7: REMUNERATIONS
It is essential for organisations such as TFPL to maintain such levels of remuneration
which are sufficient not only to attract but also to retain employee’s recruited for posts
of responsibility and decision making authority, asserts Barkoczy, (2015). Such
employees are essentially required for successful running of the company. The
management of TFPL believes in structuring the various components of the
remunerations paid to high-end employees so that rewards are automatically linked to
the employee’s individual and corporate performance, says CCH, (2017). Even for those
in the cadre of non-executive directors, TFPL follows the policy that the level of
remuneration must reflect and match the level of responsibilities and the experience
which are expected from those in the non-executive director cadre, as per Cassidy,
(2016).
In the present case of a director’s daughter, whose remuneration was challenged by the
Commissioner, it is essential to explain here that the structure of remuneration of this
particular employee included such factors as fees, salary and bonuses, as well as the
perks provided to such a high-ranking official who is responsible for taking decisions of
business growth for TFPL, says Marsden, (2016). These factors are essential to be taken
into account while setting the remuneration of such a valuable employee because it has
long-term implications for motivating such employees, asserts Renton, (2017).

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TFPL’s long experience of employing such highly paid employees has shown that such
motivation drives the employees in giving their best, they are more creative and come
out with better ideas for enhancing the success of TFPL through enhanced market share
and customer satisfaction, as per Nethercott, Devos & Richardson, (2018). Such steps,
which TFPL has been taking previously too in case of such high-end employees have
emphasised management’s confidence and has also shown the significance of this
structure of remuneration, asserts Deutsch et al, (2016). The motivation which is
indicative from the provision of such a suitable salary as remuneration can significantly
change the results of the company’s sales and also motivates the shareholders into more
investments for increasing the company’s overall performance, says Barkoczy, (2017).
As regards the family ties, the present management of TFPL has always noted that
family members of directors are not interested in simply having high incentives, instead
they are keen to show results which can prove that they are acceptable as independent
individuals and are worthy of their remuneration by being an invaluable part of the
company’s progress, says Barkoczy, (2018).
NOTE – 8: STOCK VALUATION
There are three different amounts given for finalising the total value of the trading stock
of TFPL, on hand, at the end of the income year 2018. The amounts given are –
Closing Stock Valued at Cost Price - $133,567
Closing Stock Valued at Market Price - $135,278
Closing Stock Valued at Replacement Price - $167,889
The management has to select any one value for consideration to be shown as Closing
Stock in the Balance Sheet. This is essential as the difference between the total value of
the stock at 1 July 2017 and 30 June 2018 will provide the gain or loss derived from the
trading stock and calculated for the purpose of taxation under section 70-45 of Income
Tax Assessment Act of 1997, as explained by Barkoczy et al, (2017). Under this
section, when there is an increase in TFPL’s trading stock value over the period of
current income year, it is considered as assessable income. In case there is a decrease
in TFPL’s trading stock value over the period of current income year, it is considered as
an allowable deduction, as detailed by Smith & Koken, (2017).

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To evaluate this consideration, it advisable for Amanda to use the Market Selling Value
for determining the closing value of stock, as per CCH, (2017). This is the most
appropriate method as it shall clearly reflect the income earning potential of TFPL in
case of disposal of its closing stock, if it is sold by the company in normal course of its
business, explains Cassidy, (2016). Hence, for practical purposes, say Smith & Koken,
(2017), the difference shall be –
= Opening Value of Stock as on 1 July 2017 LESS Closing Value of Stock as on 30
June 2018
= $180,000 - $135,278
= $44,722.
Since the value of stock has decreased over the period of current income year, this
amount of $44,722 shall be reflected in the Income Statement of Timber Floors Pty.
Ltd. for the year Ended 30 June 2018 as a Deductible Expense, as per Nethercott,
Devos & Richardson, (2018).
NOTE – 9: RESTRAINT OF TRADE AGREEMENT
In the Commonwealth of Australia, a Restraint of Trade Agreement is considered as a
Common Law Doctrine, except in the State of New South Wales, where a Restraint of
Trade Agreement is governed by the Restraints of Trade Act, 1976 (NSW). In NSW, the
Act prevents a party from restricting the other party's ability of engaging in a trade or an
employment opportunity, unless it is proven beyond doubt that the restraint agreement
can prove to be of reasonable interest for both the parties as well as the public, assert
Nethercott, Devos & Richardson, (2018).
Since TFPL is not operating from NSW, hence it shall be governed by the
Commonwealth of Australia Law and the prevailing governing common law principles
which are enforceable for Restraint of Trade agreement under the following clauses, and
I quote – “A contractual provision of restraining trade is prima facie void. However, this presumption can be rebutted and the restraint allowed if on the
facts of the case it can be established the restraint is reasonable to provide
adequate protection by reference to the interests of the parties and the public.

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 A goodwill covenant will be considered reasonable if the restraint is confined to
an area where the competition of the seller would injure the purchaser.” Unquote.
NOTE – 10: LONG SERVICE LEAVE
An employee of TFPL is entitled to long service leave on the basis of the qualifying
period of their continuous service. An employee who has been in continuous service for
10 years is entitled to take equivalent of 8.6667 weeks of their wage payment. In case
the employee continues in service for another 5 years, they are entitled to take an
additional 4.3333 weeks' payment of their wage payment. For employees who continue
in service beyond 15 years, their access to further leave accrued amount is not subjected
to any qualifying period, asserts Marsden, (2016).
All long service leave amounts are paid to the employee at their ordinary rate of wage
and is excluding their overtime payments. The amount is paid at the time of availing the
leave. Employees also have an entitlement of receiving a proportionate payment of their
long service leave in case their employment is terminated after completing 7 years of
continuous service. However, the payment of such employees is based on pro-rata long
service leave period, as per Barkoczy, (2015).
LIST OF REFERENCES
Barkoczy, S. 2015. Australian Tax Case book. CCH Australia Limited, North Ryde,
NSW.
Barkoczy, S. 2017. Foundations of Taxation Law. CCH Australia Limited, North Ryde,
NSW.
Barkoczy, S. 2018. Core tax legislation and study guide. CCH Australia Limited, North
Ryde, NSW.

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Barkoczy, S., Rider, C., Baring, J. and Bellamy, N. 2017. Australian tax casebook. CCH
Australia, North Ryde, NSW.
Cassidy, J. 2016. Concise Income Tax. Federation Press, Annandale, NSW.
CCH. 2017. Australian Master Tax Guide. CCH Australia Limited, Sydney, NSW.
Deutsch, R., Friezer, M., Fullerton, I., Gibson, M., Hanley, P. and Snape, T. (2016)
Australian tax handbook. Thomson Reuters, Pyrmont, NSW.
Marsden, S. J. 2016. Australian Master Bookkeepers Guide. CCH Australia Limited,
Sydney, NSW.
Nethercott, L., Devos, K. and Richardson, G. 2018. Australian taxation study manual:
questions and suggested solutions. CCH Australia Limited, Sydney, NSW.
Renton, N. E. 2017. Family Trusts: A Plain English Guide for Australian Families of
Average Means. John Wiley & Sons, Milton, QLD.
Smith, B. and Koken, E. 2017. The Superannuation Handbook. John Wiley & Sons,
Milton, QLD.

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