Taxation Law: Arthur Murray Principle and RIP Pty Ltd

This document analyzes the Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314 case and its application to RIP Pty Ltd, a funeral services company. It examines the tax treatment of advance payments, forfeited payments, and trading stock. The document also discusses adjustments to reported profit and deductions available on expenditure for RIP Pty Ltd.

HI6028 Taxation Law
Trimester 1, 2018

Contents
Part A.....................................................................................................................................................2
(a) Arthur Murray (NSW) Pty Ltd v FCT (1965)114 CLR 314...............................................................2
Facts of the case............................................................................................................................2
Issues.............................................................................................................................................2
Conclusion of the case...................................................................................................................3
b) Advise the company of the tax treatment of $16,200 in ‘Forfeited Payments Account’ in item
(iv)......................................................................................................................................................5
Part B.....................................................................................................................................................6
Nature of trading stock......................................................................................................................6
Adjustments in reported profit..........................................................................................................6
Deductions available on expenditure................................................................................................7
References.............................................................................................................................................9

Part A
(a) Arthur Murray (NSW) Pty Ltd v FCT (1965)114 CLR 314.
The decision in the Arthur Murray Pty Ltd V FCT case law is about the meaning of the
income derived by a taxpayer which becomes taxable in Australia. The facts, issues and
conclusion of the case are explained as follows:
Facts of the case
Arthur Murray (NSW) Pty Ltd is the taxpayer in this case, which is a registered company in
United States. The company is engaged in the business of providing dance lessons to the
students across Sydney and Melbourne in Australia. The contractual arrangements of the
company are such that the students are required to pay for 1200 lessons during the lifetime
with five, ten or fifteen hour lessons spread during the year in full or substantially at the time
of entering into the contract. Also the contract was not cancellable. However refunds were
made by the company for satisfactory explanations by students. The company used to prepare
its accounts using the accrual method of accounting in which the advanced payment for
contracts were not recorded as income at the time of receiving the payment rather than were
constituted as income at the end of the months in corresponding to the number of lessons
provided during the month. He advance amount was recorded as unearned deposit at the time
of receipt. The Commissioner of Taxation included the amount received in the revenue
rather than earned deposits included by the company. On the objection made by the taxpayer
the case was reported to Board for review and the Board also supported the assessments made
by the Commissioner. The taxpayer hen appealed to the High Court of Australia. The matter
in front of the court was whether the commissioner was justified in treating the amounts
actually received by the taxpayer as assessable income irrespective of whether or not the
dancing lessons were provided by the company to the students or not (Barwick, et.al, 2017).
Issues
The issues which are involved in the case include the differences in the Australian taxation
system and US taxation system. Under the Australian legislation, the tax is imposed on the
taxable income arrived after deducting the allowable deductions from the assessable income.
Apart from this, the major issue of the case is that when could be the receipt of a business or
a company is considered as the income derived of the taxpayer. Under the Income Tax

Assessment Act of Australia. The Act states that the amount received is not an income and
does not explain the income derived further. Thus the issue is to rely upon the general law or
any decided case law.
Conclusion of the case
\In this case it was held by the court that the income earned by the taxpayer company will be
the income for which the services have been provided irrespective of whether the amount for
the future contract is received by the company in advance. The court referred to the general
accounting and business principles to decide the issues. The Carden’s case could not be
applied to this case since the matter of the fact was reverse. However the statement of the
court in Carden’s case was used as the basis which stated that the taxable amount will consist
of the income which is received as well as earned by the taxpayer.
 Advise RIP Pty Ltd when income is derived generally and when it derives its income
from funeral services and related activities.
According to the provisions of Section 25(1) of Income Tax Assessment Act 1936-65, an
income is derived generally by a resident taxpayer of Australia when he earns gross income
directly or indirectly from all the sources in Australia. RIP Pty Ltd is providing funeral
services to its clients on contract basis for which advanced payment is received from the
clients. The company follows accrual basis of accounting for recording its receipts. Under
this method the receipts are included in the assessable income of the taxpayer as and when
the services are provided by the company and income is actually earned. RIP ltd will derive
its income from funeral and related activities when the services are provided as per the terms
of the contract instead of charging the income to gross revenue when the receipts from the
customers as prepayments is received for future service contracts. The company RIP Pty Ltd
is using the accrual basis of accounting for recording its income and therefore the company is
advised to charge its income to the gross revenue corresponding to the funeral services
provided to the clients on periodical basis. The company is advised to transfer the amount to
unearned deposits when it is received and on the provision of services to the customers later,
the amount shall be recorded as the income of the company for that period. In this way the
company will be able to record and account for its income in accordance with the accounting
principles and policies.

 Does the Arthur Murray principle apply to the company’s accounting treatment of
amounts in Easy Funeral Plan? Explain.
As per the Arthur Murray principle, when a business earns income partially for a contract in
which future services are to be provided and payments are received in advance, then in such
case the income shall be recognised by the company in its accounts when it is actually earned
and not when the amount for the same is received from the customers under the contract. The
Easy Funeral Plan of RIP Pty Ltd is such that the customers of the company are required to
pay the fixed amount of the contract in advance for the deluxe funeral services to be provided
on the death. The contract price is not refundable by the company if these services are not
availed by the customers upon death or in case the customer dies abroad ad is unable to claim
the services from the company. However the amount received by the company is certain, but
the amount cannot be considered as the gross revenue for the period since the company is
following the accrual basis of accounting. The facts of RIP Pty Ltd are similar to that of
Arthur Murray case and therefore the principle completely applies to RIP Pty Ltd. RIP Pty
Ltd shall record the amount collected under the Easy Funeral Plan as the amount of unearned
deposit and transfer the amount to the revenue when the funeral services under the pa are
provided to the customers.
 Does the commissioner or any other taxpayer have a choice in the method of
accounting for tax?
Under fundamental accounting policies, there are two methods of accounting used by the
business entities. The first is the cash basis of accounting and another is the accrual basis of
accounting. Under cash basis revenues are recognised when the cash is received for the
services provided whereas under accrual basis, the revenue is recognised when it is actually
earned by delivering the services (Hemmings & Tuske, 2015). The Arthur Murray case
supports the accrual basis of accounting for the recording f advance payments received for
future contracts as revenue whereas the Carden’s case law recognises the cash basis for
recording the advance receipts. In the case of Commissioner of Taxes (S.A) v Executor,
Trustee and Agency company of South Australia Limited, the medical practitioner submitted
his tax returns on the basis of cash system of accounting and the court held that his assessable
income will include the amounts received in a year and will not include amounts earned but
not received. In this way Cardens’ case law supports another view from the Arthur Murray
principle. In the given case of RIP Pty Ltd, the another view which can be taken by the

Commissioner to tax the gross receipts of the company is the cash basis of accounting in
which the gross receipts will be included in the assessable income of the taxpayer in the year
in which the income will be received and not on proportionate basis in the year of providing
services. In this way the Commissioner or any other tax [payer have a choice of a different
accounting method then Arthur Murray principle which is the application of cash basis of
accounting as per the Carden’s case.
b) Advise the company of the tax treatment of $16,200 in ‘Forfeited
Payments Account’ in item (iv)
As the company follows the accrual basis of accounting, the advance payments which are
received under the contract by the company for the funeral services to be provided later, are
transferred by the company to the Unearned deposits account. The amount which relates to
the services provided by the company are recognised as revenue and the amount which
relates to the services not claimed are not refunded and therefore transferred to ‘Forfeited
Payments Account’. For the current year, the company has a balance of $16,200 in this
account. This amount cannot be recognised a revenue sine it is not actually earned by
providing the services to the customers. It is an extraordinary gain to the company and will be
included in the statement of comprehensive income of the company for the year. Thus, this
amount will be the gain for the company and will form the part of comprehensive income
which will be taxable and included in the assessable income of the taxpayer.

Part B
The advice to the company RIP Pty Ltd on the basis of tax legislations and case laws can be
provided as follows:
Nature of trading stock
According to the section 11c of Income Tax Assessment Act 1977, a trading stock is defined
as the physical or tangible resources which are either acquired or manufactured by a business
for conducting the business activities which relate to manufacturing or selling at the later
stage (Collier, 2015). It includes all those resources which can be used to produce the goods
to be sold to the customers or arranging for the services which are to be provided to the
customers by the business. RIP Pty Ltd is engaged in the business of providing funeral
services to the customer under various payment plans and all the facilities needed. The
caskets and the range of accessories which are used by the company in providing the funeral
services are the resources for the company used to conduct the business and will be therefore
regarding as the trading stock. Similarly the range of accessories will also assist in providing
the funeral services by the company and will be therefore regarded as the trading stock of the
company. However the company made advance payment for the purchase of accessories and
caskets and availed the discount of advance payment but this fact will not affect the assigning
of these items as trading stock. Thus the items will be recorded as inventory by the company
irrespective of the time of purchase. Moreover the valuation of the inventory will also be
made as per the provisions of AASB 102 irrespective of the amount paid for the purchase of
inventory.
The amount which is paid for the purchase of inventory for the business is an allowable
business deduction under section 8-1 of Income Tax Assessment Act 1977
Adjustments in reported profit
The reported profit is an amount which is the amount of profit presented by the company in
its books of accounts and financial statements presented to the stakeholders. This amount is
the amount of net profit calculated and reported by the entity to its stakeholders. The amount
of reported profit differs from the amount of net profit calculated by the company for tax
purposes (Woellner, et.al, 2012). The assessable income is the net profit for tax purposes

which is calculated by allowing the deduction of some of the business expenses. Therefore
the reported profit is adjusted for allowable expenses and deductions for tax purposes. The
adjustments in the reported profit of RIP Pty Ltd for various items are explained as follows:
 The company received a dividend of $21,000 from RIP Finance Pty Ltd. The amount of
dividend is fully franked which means that the tax on the dividend has already been paid
by RIP Finance Pty Ltd before distribution of amount of dividend to its shareholders Thus
the fully franked dividend received by the shareholders is not taxable . The shareholder
receives franking credits corresponding to the amount of tax paid on the profits by the
company distributing the dividend. Thus, the amount of tax payable can be reduced by the
amount of franking credits by the taxpayer which is the shareholder receiving the
dividend. As per he provisions of ITAA 1977, the amount of franking credit can be used
to reduce the amount of tax payable but the amount of dividend has to be included in the
assessable income of the shareholder. Thus, the amount of full franked dividend has to be
included in the reported profit of the company so that the amount of franking credit on the
divided and be claimed as reduction in the amount of tax payable by the company.
 The company paid the amount of lease rent for the period of two years in advance and
therefore the amount of $57,000 is regarded as the prepaid lease rent expense. The
amount of $57,000 is for two years out of which the amount of $9,500 relates to four
months up to 30 June 2016. Thus, in the financial statements of the company the amount
of expense up to 30 June 2016 is required to be reported as per the accrual basis of
accounting. The remaining amount can be capitalised as lease and will be charged from
the profit in the future years on proportionate basis following the accrual system.
Therefore, no adjustment is required to be made in the reported profit of the company.
 The amount of long service leave to be payable by the company to the director is a future
liability for the company. As per the accounting policies and principles the business is
required to make provision for the liability which is payable in future. The director of the
company started his long service leave for which the amount will be required to be paid
after three months. Therefore it is a liability and provision is required to be made. Hence
no adjustment is required to be made in the reported net profit of the company. The
amount is accurately reported.

Deductions available on expenditure
The expense incurred by the business in running the business activities is defined as business
expenditure which is allowed as deduction from the profit for the business as per the
provisions of Section 8-1 of Income Tax Assessment Act 1977. However only the revenue
expenses of the business are deductible and the capital business expenses are not allowed as
deduction from the profit of the business under the negative limb of the Act. The company
constructed a built facility for the accommodation of its employees which is a business
expense for the company. It paid $250,000 for the architectural design which is a capital
expense not deductible from the profits of the current year. Similarly the acquisition of land
amounting to $1.25 million and the demolition of building amounting to $50,000 is also a
capital expense not deductible from the profits of current year.

References
Hemmings, P. and Tuske, A., 2015. Improving Taxes and Transfers in Australia.
ATO 2018, Deductions for prepaid expenses 2010-11. [online] Available at:
https://www.ato.gov.au/Forms/Deductions-for-prepaid-expenses-2010-11/?page=3 [Accessed
20 May. 2018].
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.
EDD, 2012. Information Sheet, Employment Deveopment Department, State of California,
pp 6-12. Available at: http://www.edd.ca.gov/pdf_pub_ctr/de231eb.pdf [Accessed 27 April,
2018]
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.