Taxation Law: Accounting Methods and Allowable Deductions

This article discusses the two methods of accounting, factors affecting the choice of cash or accrual basis of accounting, and allowable deductions under Taxation Law. It also provides expert guidance on Desklib.

Running head: TAXATION LAW
Taxation Law
Name of the Student
Name of the University
Authors Note
Course ID

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Table of Contents
Answer to Part 1:........................................................................................................................2
Answer to Part 2:........................................................................................................................6
Answer to A:..........................................................................................................................6
Answer to B:..........................................................................................................................7
Answer to C:..........................................................................................................................8
Answer to D:..........................................................................................................................8
Answer to E:...........................................................................................................................9
Reference:................................................................................................................................10

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Answer to Part 1:
There are two methods of recording the transaction namely the cash method and the
accrual method of accounting. The main difference between the two methods of accounting is
time when the transactions are recorded. Nevertheless, upon aggregating the transaction over
the time the result that is yielded approximately the identical time (Ball et al., 2016). The
cash method of accounting records the revenue when it is received from the customers while
the expenses are recorded when it is paid to the suppliers and employee. Under the accrual
basis of accounting the revenues are recorded when it is earned and the expenses are recorded
when it is consumed (Hui et al., 2016). The differences in time is mainly because of the
revenue recognition which is delayed under the cash basis unless the customer pays to the
company.
In “Carden v FCT” the commissioner in its opinion held that the tax accounting
method must yield considerably an appropriate reflex of the taxpayer’s true income. Whereas,
the court of law in “Henderson v FCT” expressed its opinion by stating that for any taxpayer
there is simply one right process of ascertaining the taxable income.
Factors affecting the choice of cash or accrual basis of accounting:
The choice of cash or accrual basis of accounting is reliant on certain different factors
which is listed below;
a. Size of the taxpayer’s business
b. Proportion of business income that originates directly from the taxpayer’s personal
efforts.
c. Difficulty of the business
d. Debts receivable by the taxpayer

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As understood from the above listed factors forms a noteworthy element in
determining the choice of accounting method.
Choice of adopting the accounting basis:
According to the “taxation ruling of TR 98/1” an individual and entities for taxation
purpose should make the use of cash or accrual method of tax accounting to ascertain the
taxable income (Ato.gov.au, 2018). Paragraph 8 and 9 of the “Taxation ruling TR 98/1”
provides that the size of the taxpayer business is relevant in deciding the accounting basis.
The receipts or cash basis is usually appropriate to determine income for employee, non-
business income obtained from provision of knowledge or business income where the income
is earned through the provision of knowledge.
The accrual methods in majority of the cases is regarded as more appropriate to
ascertain the business income obtained from trading or manufacturing business. The taxation
commissioner in “Carden v FCT” expressed its judgement by stating that the basis of
accounting procedure should be such that it offers true and correct reflex of taxpayer’s
taxable income (Barkoczy, 2014). Likewise in the case of “Henderson v FCT” the taxation
commissioner held its judgement by stating that the accrual basis of accounting is more
accurate method of ascertaining the taxable income for businesses.
Denoting the explanation that is made in the case of “Henderson v FCT” in the
present case of Frank, the accrual basis of accounting is the correct process of determining
the taxable income. Despite the fact that Frank has the options of selecting any of the
accounting basis however, it is recommended that the accrual basis of accounting should be
followed for recording the revenues. This would help in determining the substantially true
reflex of Frank taxable income.
Rights of Taxation Commissioner:

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As defined under the “taxation ruling of TR 98/1”, business with annual sales
turnover of greater than $10 million is required to keep their books of accounts under the
accrual tax accounting method (Ato.gov.au, 2018). On noticing that the sales revenue is not
higher than $10 million limit, the businesses in such situation can opt for either the cash basis
or the accrual accounting method. In such a situation the taxation commissioner does not has
the authority of forcing the taxpayer to adopt a specific method of accounting. The taxation
commissioner can make a request to the taxpayer to adopt the either of the accounting
method. But if it give rise to any conflict of interest among the commissioner and taxpayer
then the parties to the conflict can opt for tribunal guidance.
Basis of accounting for both accounting years:
In the accounting year of 2016/17 the annual sales turnover reported by Frank stood
$75,000. On the other hand, in the succeeding year of 2017/18 the sales turnover of Frank
was $2.5 million. Depending upon these facts for the both 2016/17 and 2017/18 the sales
revenue recorded by Frank was well within the limit of $10 million. In “FC of T v
Firstenberg (1976)” the taxpayer was the practicing solicitor and returned on cash basis
(Jover-Ledesma, 2014). The taxation commissioner considered the taxpayer for assessment
under the cash basis. While in “FC of T v Dunn (1989)” the taxpayer in was the practicing
accountant. In the first instances the taxpayer accounted under the accrual basis of accounting
but later changed to cash accounting method. The taxpayer was for assessment under the
accrual accounting method and held that cash basis of accounting was the correct method.
In the current instance of Frank it is noticed that for both the accounting year of
20167/17 and 2017/18 the total sales revenue did not exceeded $10 million threshold limit.
Denoting the decision held in “FC of T v Dunn (1989)” a recommendations can be made in
this by stating that Frank must account for the revenues under the accrual tax accounting

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method as this method is helpful in providing the true state of taxpayer’s chargeable earnings
(Kenny et al., 2018).
Use of accounting software:
As stated by Gordon et al., (2017) the traditional process of tax accounting method
namely cash or accrual procedure are not anymore held relevant due to the availability of the
software packages. The current software packages such as MYOB and ZERO enables a
business and taxpayer in making long-term sales forecasting. The software packages provides
the taxpayer with easy maintenance of cash flow than the traditional method of accounting.
With the help of current software packages a business can make better forecast of cash and
revenue which the traditional method fails to provide.

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Answer to Part 2:
Answer to A:
The “taxation ruling 97/23” lay down the explanation in relation to the circumstances
where the legal expenditure that is occurred by the taxpayer is held as the allowable
deductions under “section 25-10, ITAA 1997” (McCouat, 2018). The ruling mainly deals
with the term of repair stated under “subsection 25-10 (1)” and expenses incurred in
remodifying the defects, damage or deterioration that is prevalent in the property which is
used for generating assessable income.
In context of the term “repair” stated under “section 25-10” refers to work that is
done on the premises. Repairs for majority of the part is held as occasional and partial (Sadiq
et al., 2018). Repairs comprises of restoring the efficiency of function of the property which
is being repaired without causing any change in the character and might comprise of restoring
back to its previous conditions. In “BP Oil Refinery Ltd v FC of T (1992)” the law court
conveyed its opinion by stating that work would not be held as repairs unless it comprises of
the restoration of something that is lost or damage.
Ruby Pty Ltd owned a rental property and derived a rental income of $35,000. During
the income year the company incurred expenses for repairing the cupboards and fittings of
kitchen of rental residential property that was damaged through the water and normal wear
and tear. Referring to the case of “BP Oil Refinery Ltd v FC of T (1992)” the repairs done on
the rental residential property would be allowed for deductions under “section 25-10, ITAA
1997” (Taylor et al., 2018). The repair done were for restoring the efficiency of function of
the property without causing any change in the character.

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Answer to B:
According to the “taxation ruling of ATO ID 2003/484” it provides explanation
relating to the deduction of legal expenses that is incurred by the landlord in defending the
claims for damages in relation to the injuries that is suffered by the third party on their rental
property (Woellner et al., 2018). The interpretation of ATO states that a taxpayer can claim
deduction for specific expenses that they incur during the period when the rental property is
rented out or available for rent. The ATO states that the legal expenses that is incurred by the
taxpayer in generating their rental income are entitled for deductions. These legal expenses
comprise of the costs incurred in defending the claims of compensations relating to the
injuries that is suffered by the third party on their rental property.
In “Putnin v Federal Commissioner of Taxation (1991)” the court explained its
opinion that legal expenses will be held as permissible deductions given the expenses have
originated out of the consequence of taxpayer’s revenue generating activities (Taylor et al.,
2018). Similarly, in “Hallstorm Pty Ltd v Federal Commissioner of Taxation (1946)” the
court explained that the legal expenses may be categorized as outgoing based on revenue
account or the account of capital nature depending upon the reason for which the expenses
are occurred.
Ruby Pty Ltd incurred legal expenses of $7000 for defending the suit for injuries
suffered by the visitor to the tenants on the steps. A deduction will be allowable deduction
“section 8-1 of the ITAA 1997” because the expenses were occurred as the result of risk to
the landlord. The expenses will be allowed as deductions because it originated from
subletting the building to the tenants and for generating the taxable income.

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Answer to C:
As defined under “section 26-5 of the ITAA 1997” a person is not allowed to claim
deductions under this act for or an amount relating to penalties and fines order by the court to
be paid for offence against the Australian law (McCouat, 2018). Examples of non-deductible
penalties include the business fines for indulging in the misleading and deceptive conduct.
The explanation of court in “Sun Newspaper Ltd v FCT (1938)” stated that the deductions
are not allowable for the expenses that is incurred for structural purpose but only allowed for
functional purpose.
Ruby Pty Ltd was found to have breached the Australian business conduct when it
supplied defective car parts to the car manufacturing company. A claim for compensation
was filed against Ruby Pty Ltd which ultimately resulted the company to pay $750,000.
Citing the reference of “section 26-5, ITAA 1997” Ruby Pty Ltd would not be entitled to
deductions since it is a breach of business conduct.
Answer to D:
As stated by the Australian Taxation Office a taxpayer is prohibited from claiming a
permissible deduction relating to business provision expenditure. Under “section 63 of the
ITAA 1997” a taxpayer is permitted to claim deductions where the expenses are physically
existent (Barkoczy, 2014). While the taxpayer is permitted to an allowable deduction under
“section 63 (1), ITAA 1997” relating to expenses which is entirely written off.
Ruby Pty Ltd undertook the decision of setting aside an amount of $100,000 as
provision for accounts. Mentioning “section 63, ITAA 1997” the company shall be
prohibited from claiming a permissible deduction for provision expenses since these expenses
are non-allowable general business provision.

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Answer to E:
According to the “section 8-1, ITAA 1997” no deductions are allowable for losses or
outgoings that are preliminary in starting any business or revenue generating activities since
they are held as not in the course of business activity. The court in “Goodman Fielder Wattie
v FC of T (1991)” denied the company from claiming allowable deductions for the expenses
incurred in research and development (Jover-Ledesma, 2014). This is because the activates
were provision in nature and the taxpayers has neither made any commitment nor made any
definite decision towards the project.
In the same way, Ruby Pty Ltd incurred expenses on investing the possibility of re-
entering into the car manufacturing industry. Citing the judgement of “Goodman Fielder
Wattie v FC of T (1991)” the expenses incurred were provisional in nature and preliminary in
starting the business or revenue generating activities. Therefore, no deductions are allowable
under “section 8-1, ITAA 1997” since they are not incurred in the course of business activity.

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Reference:
Accounting methods. (2018). Retrieved from https://www.ato.gov.au/Business/Income-and-
deductions-for-business/Assessable-income/Accounting-methods/
Ball, R., Gerakos, J., Linnainmaa, J.T. & Nikolaev, V., (2016). Accruals, cash flows, and
operating profitability in the cross section of stock returns. Journal of Financial
Economics, 121(1), pp.28-45.
Barkoczy, S. (2014) Foundations of taxation law.
Gordon, E.A., Henry, E., Jorgensen, B.N. & Linthicum, C.L., (2017). Flexibility in cash-flow
classification under IFRS: determinants and consequences. Review of Accounting
Studies, 22(2), pp.839-872.
Hui, K. W., Nelson, K. K., & Yeung, P. E. (2016). On the persistence and pricing of industry-
wide and firm-specific earnings, cash flows, and accruals. Journal of Accounting and
Economics, 61(1), 185-202.
Jover-Ledesma, G. (2014). Principles of business taxation. Cch Incorporated.
Kenny, P., Blissenden, M., & Villios, S. (2018). Australian Tax.
Legal Database. (2018). Retrieved from https://www.ato.gov.au/law/view/document?
DocID=TXR/TR981/NAT/ATO/00001&PiT=99991231235958
McCouat, P. (2018). Australian master GST guide.
Sadiq, K., Coleman, C., Hanegbi, R., Jogarajan, S., Krever, R., & Obst, W. et al.
(2018). Principles of taxation law.
Taylor, C., Walpole, M., Burton, M., Ciro, T., & Murray, I. (2018). Understanding taxation
law.

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Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2018).Australian taxation
law.