Taxation Law

This article explains the provisions of Income Tax Assessment Act, 1997 (ITAA 1997) for calculating taxable income and tax liability of corporations and individuals. It also discusses the tax liability on compensation received and profit realized from sale of land as per ITAA 1997.

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

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Contents
Introduction:....................................................................................................................................3
Answer to question 1:......................................................................................................................3
Answer to question 2:......................................................................................................................8
References:....................................................................................................................................11

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Introduction:
In Australia, Income Tax Assessment Act, 1997 (ITAA 1997) contains all the provisions
and regulations to be followed by corporations and individuals to determine their taxable income
and resultant tax liability. As per the appropriate provisions of the ITAA 1997 applicable in the
facts of the two different cases provide in the document, a detailed explanation is given below.
Answer to question 1:
The explanations for the treatments made to each of the items of revenue and
expenditures in calculating the income liable to be taxed and tax liability of Bloomingdale
Florists Pty Ltd are given at the end of the computation table.
Income reconciliation statement of Bloomingdale Florists Pty Ltd as per the provisions of ITAA
1997 and subsequent income tax liability of the company are calculated in the table below:
Income reconciliation statement of Bloomingdale Florists Pty Ltd as on June 30, 2018
Particulars ($) ($)
Net profit as per accounting records 126,000.00
Add: Expenditures and assessable income
Accounting depreciation is not allowed as expenditures 12,000.00
Misleading advertisement penalty is disallowed for computing
taxable income
5,000.00

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Provision for long services leave is not an expenditure to be
deducted from revenue, hence disallowed
20,000.00
Provision for doubtful debt is not an expenditure, hence,
disallowed
17,000.00
Capital expenditure disallowed for income tax purpose
(Window replacement)
10,000.00
Painting of office and factory premises is revenue expenditure
allowed for tax purposes
-
Paramatta Eels League club gift expenditure is not allowed 10,000.00
Cost of borrowing is a capital expenditure to be amortized
over the period of loan, hence, disallowed.
3,000.00
Foreign resident company’s dividend receipt is ordinary
taxable income
1,000.00
Franked dividend is exempt from tax however, not franked
portion is taxable (9000 x 20%)
1,800.00
Director’s salary which is above the reasonable limit as set by
Tax Commissioner is disallowed for computing taxable
income
10,000.00
Total addition 89,800.00

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Profit after additions 215,800.00
Less: Expenditures allowed but not recorded and income recorded but not assessable
Long term service leave payment is an item of expenditure
allowed for tax purposes
10,000.00
Bad debt is an expenditure for tax purposes 15,000.00
Tax allowed capital allowances is considered 10,000.00
Closing stock is overvalued due to use of LIFO method is
reversed now (60000 -52000)
8,000.00
Borrowing cost amortized (3000/3) 1,000.00
Income exempt 10,000.00
Total subtraction 54,000.00
Assessable business income for tax purposes 161,800.00
Less: Previous year’s unabsorbed losses 20,000.00
Income liable to be taxed for the year ending on June 30, 2018 141,800.00
In Australia, corporates are taxed @30%, accordingly, the tax liability on the taxable income of
Bloomingdale Florists Pty Ltd is calculated below.

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Taxable income of Bloomingdale Florists Pty Ltd for the year ending on June 30, 2018 is
$141,800. Since the company belongs to 30% tax rate, thus, tax liability of the company is
(141,800 x 30%) = $42,540 for the income year 2017-18.
Notes to explain the tax treatments:
1. Long service leave is allowed on payment basis thus, no provision in respect of such long service
leave is not allowable expenditure for tax purposes. Hence, the actual payment made for long
services leave as been deducted in computing taxable profit as per subdivision of 83-B of ITAA
19971.
2. Section 25.35 of the act allows bad debt expenditures hence, the bad debt is deducted from
accounting profit2.
3. Replacement cost of wooden window by steel window is a capital expenditure hence, disallowed
in computing taxable income of the company.
4. Expenditure on gifts for hospital is allowed as donation but not to a club, hence, the gifts to
Paramatta Eels League is disallowed.
5. Capital allowances have been treated as per tax law.
6. LIFO method is not allowed for computing cost of goods sold, thus, the excess value of closing
stock due to use of LIFO method has been added to the accounting profit for taxation purpose, i.e.
$8,000 (60000 -50000)3.
1 Fry, Martin. "Australian taxation of offshore hubs: an examination of the law on the ability of
Australia to tax economic activity in offshore hubs and the position of the Australian Taxation
Office." The APPEA Journal 57, no. 1 (2017): 49-63.
2 Bowler-Smith, Mark. "Corporate Income Tax: What Is It Good for." Austl. Tax F. 30 (2015):
865.
3 Edvardson, Hannes. "Risk assessment." U.S. Patent 9,959,574, issued May 1, 2018.

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7. Section 25.25 of ITAA 1997 provides that borrowing cost is a capital cost not to be deducted
from revenue in Income statement for computing income liable to be taxed. Sine, entire
borrowing cost was deducted in computing accounting profit hence, the entire borrowing cost has
been added back to the accounting profit as per sec. 25.25 of the act to calculate taxable profit of
the company.
8. Credit sales, whether retail or whole sale, included in debt is ordinary income thus, it is included
while computing taxable income. The amount is already included in computing accounting profit
hence, no adjustments are needed for the retails sales on credit included in debt4.
9. Dividend received from resident companies in Australia, if franked is fully exempt for income tax
purposes. However, to the extent dividend of resident companies is not franked is to be included
in computing income liable to be taxed. Dividend received from foreign companies is ordinary
income as per s6-5 of ITAA 1997. Accordingly, foreign company’s dividend is included here for
calculating income liable to be taxed5.
10. Tax Commissioner is the final authority when it comes to determining the deductibility of certain
expenditures for calculating taxable income. In case of any expenditures if exceeds the reasonable
limit determined by Tax Commissioner then, the excess amount if disallowed for tax purposes. In
4 Ting, Antony. "iTax-Apple's international tax structure and the double non-taxation issue."
(2014).
5 Yarram, Subba Reddy, and Brian Dollery. "Corporate governance and financial policies:
Influence of board characteristics on the dividend policy of Australian firms." Managerial
Finance 41, no. 3 (2015): 267-285.

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this case the excess salaries paid to directors in excess of reasonable limits is added back to
accounting profit for tax purposes6.
11. Previous year’s unabsorbed losses is allowed for setting off from taxable profit to determine the
net taxable income or loss of an entity for an income year.
Answer to question 2:
Issue:
There are two issues in this case, these are as following:
(1) Tax liability on Matchsticks Limited for receiving $1,000,000 as compensation from its major
customer for termination of contract as per Income Tax Assessment Act 1997 (ITAA 1997).
(2) Implications on income tax liability of Matchsticks Limited for the profit realized from sale of
land, i.e. $10,000,000 as per ITAA 1997.
Rules:
Division 6 of ITAA 1997 explains the concept of Eligible Termination Payments (ETPs) and its
implication on taxable income and tax liability of a tax payer in the country. ETPs are ordinary
income taxable as per div. 6 of ITAA 1997. It is important to consider the circumstances of each
case while determining whether the compensation is to compensate loss of revenue and profit or
6 Balachandran, Balasingham, Darren Henry, and Berty Vidanapathirana. "Long-Term Price
Reaction to Dividend Reduction in an Imputation Environment–Evidence from Australia."
(2016).

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for capital purpose. In case the compensation is to compensate for loss of revenue then it is
taxable as ordinary income of the recipient as per s6-5 of ITAA 19977.
Capital gain is recognized on profit realized from sale of capital assets. It is important to
remember that if capital assets is depreciated and the depreciation has been allowed as
expenditure for computing taxable income of an entity then such assets shall not be eligible for
capital gain purpose8. In such case profit on sale from such assets is taxable as ordinary income
as per s6-5 of ITAA 1997. Land is a capital asset on which depreciation is not allowed for tax
purposes and hence, in case of profit realized from sale of land by an individual or by an entity
then, such profit is taxed as capital gain and tax is imposed on such gain as per the appropriate
tax rate applicable for capital gain in the country.
Application:
Subsequent to the termination of a contract by Strike a Light Pty Ltd, the most major customer of
Matchsticks Limited responsible for 80% sales of the company, an amount of $1,000,000 has
been paid to Matchsticks Limited as compensation. It is clear that the compensation of
$1,000,000 paid by the customer to Matchsticks Limited is to compensate for the loss of revenue
7 Akhtar, Shumi. "Dividend payout determinants for Australian multinational and domestic
corporations." Accounting & Finance 58, no. 1 (2018): 11-55.
8 White, Judy, and Adele Townsend. "Deductibility of employee travel expenses: The ATO's
guidance." Taxation in Australia52, no. 11 (2018): 608. Available at:
https://search.informit.com.au/documentSummary;dn=666904065308957;res=IELBUS
[Accessed on 10 October, 2018]

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due to the termination of contract. Hence, it is an ETP as per div. 6 of ITAA 1997. Thus, the
entire compensation is assessable as ordinary income under section 6-5 of ITAA 19979.
Matchsticks Limited has realized a profit of $10,000,000 from sale of land. The realized profit is
a capital gain of the company and shall be taxed accordingly. The land is a capital asset which is
not allowed to be depreciated thus, the realized profit from sale of land to Matchsticks Limited is
not to be considered as ordinary income as per s6-5 of ITAA 1997 even if the objective of
acquiring the land was not to dispose it off in the future. Thus, the entire gain on sale of the land
to the company, i.e. $10,000,000 is taxable as capital gain of the company10.
Conclusion:
Matchsticks Limited shall include the amount of compensation of $1,000,000 received from its
customer for termination of contract as ordinary income under section 6-5 of ITAA 1997. Tax
payable on business income of the company shall be calculated after including the compensation
9 Smith, Fiona, Kate Smillie, James Fitzsimons, Bruce Lindsay, Gary Wells, Victoria Marles,
Jane Hutchinson, B. O. Hara, Tom Perrigo, and Ian Atkinson. "Reforms required to the
Australian tax system to improve biodiversity conservation on private land." Environmental and
Planning Law Journal 33 (2016): 443-450.
10 Huizinga, Harry, Johannes Voget, and Wolf Wagner. "Capital gains taxation and the cost of
capital: Evidence from unanticipated cross-border transfers of tax base." Journal of Financial
Economics (2018). Available at:
https://www.sciencedirect.com/science/article/pii/S0304405X18301132 [Accessed on 10
October, 2018]

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of $1,000,000 in calculating its taxable income from business11. The profit of $10,000,000
realized from sale of land is a capital gain of Matchsticks Limited and to be taxed as per
applicable rate of tax for long term capital gain.
References:
Akhtar, Shumi. "Dividend payout determinants for Australian multinational and domestic
corporations." Accounting & Finance 58, no. 1 (2018): 11-55.
Balachandran, Balasingham, Darren Henry, and Berty Vidanapathirana. "Long-Term Price
Reaction to Dividend Reduction in an Imputation Environment–Evidence from Australia."
(2016).
Bowler-Smith, Mark. "Corporate Income Tax: What Is It Good for." Austl. Tax F. 30 (2015):
865.
Dixon, J. M., and Jason Nassios. Modelling the impacts of a cut to company tax in Australia.
Centre for Policy Studies, Victoria University, 2016.
Edvardson, Hannes. "Risk assessment." U.S. Patent 9,959,574, issued May 1, 2018.
Fry, Martin. "Australian taxation of offshore hubs: an examination of the law on the ability of
Australia to tax economic activity in offshore hubs and the position of the Australian Taxation
Office." The APPEA Journal 57, no. 1 (2017): 49-63.
11 Dixon, J. M., and Jason Nassios. Modelling the impacts of a cut to company tax in Australia.
Centre for Policy Studies, Victoria University, 2016.

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Huizinga, Harry, Johannes Voget, and Wolf Wagner. "Capital gains taxation and the cost of
capital: Evidence from unanticipated cross-border transfers of tax base." Journal of Financial
Economics (2018). Available at:
https://www.sciencedirect.com/science/article/pii/S0304405X18301132 [Accessed on 10
October, 2018]
Smith, Fiona, Kate Smillie, James Fitzsimons, Bruce Lindsay, Gary Wells, Victoria Marles, Jane
Hutchinson, B. O. Hara, Tom Perrigo, and Ian Atkinson. "Reforms required to the Australian tax
system to improve biodiversity conservation on private land." Environmental and Planning Law
Journal 33 (2016): 443-450.
Ting, Antony. "iTax-Apple's international tax structure and the double non-taxation issue."
(2014).
White, Judy, and Adele Townsend. "Deductibility of employee travel expenses: The ATO's
guidance." Taxation in Australia52, no. 11 (2018): 608. Available at:
https://search.informit.com.au/documentSummary;dn=666904065308957;res=IELBUS
[Accessed on 10 October, 2018]
Yarram, Subba Reddy, and Brian Dollery. "Corporate governance and financial policies:
Influence of board characteristics on the dividend policy of Australian firms." Managerial
Finance 41, no. 3 (2015): 267-285.