Fundamentals of Income Tax: Tax Reconciliation and Liability Analysis

This assignment solution addresses the income tax return preparation for Bend-it Physio Limited for the year ended March 31, 20X8. The solution begins with an analysis of non-allowable expenses, including entertainment expenditure, which is subject to specific deduction limitations. It then details adjustments to the accounting profit for items like depreciation, fines, and donations to determine the adjusted tax profit. The solution covers the treatment of company losses, provisional tax payments, and legal fees related to capital expenditure. It explains the impact of dividends from wholly owned companies and the application of imputation credits and RWT credits. Finally, the solution provides a tax reconciliation statement, a computation of tax liability, and the final tax payable, explaining the need for reconciliation due to differences between accounting and tax regulations. The solution follows the Income Tax Act 2007 and IRD guidelines.

Fundamentals of Income Tax

Income tax
Answer to the 1st part of Note 1:
The non-allowable expense is $3,250. Entertainment expenditure is subject to a special set of
rules that limits the deduction of business entertainment expenditure to 50% of the amount of the
expenditure. As per IRD guide on Entertainment Expense Food/drink consumed off premises &
Food/drink consumed in the course of client meetings are specified entertainment and eligible for
only 50% deduction thereof, so 50% of $6,500 is disallowed. Further Food/drink consumed in
course of a conference (4+ hours) & Entertainment consumed outside NZ falls under Excluded
entertainment as per IRD and eligible for a 100% deduction.
Answer to the 2nd part of Note 1:
This will increase the adjusted tax profit by $3,250 for the purpose of income tax. Since we are
disallowing a part of entertainment expense, the accounting profit shall have to be adjusted and
such disallowed portion shall be added back to the accounting profit to get adjusted tax profit for
the purpose of income tax (Wells, 2011).
Answer to the 1st part of the Note 2:
This will increase the adjusted tax profit by $1200 because the allowed depreciation as per IRD
is lower than that calculated as per Accounting Records. The income tax act has specified a
method for depreciation, and we shall follow that particular method to compute depreciation
instead of using Accounting method, therefore, any difference between these two shall be
adjusted and shall reflect in the tax reconciliation statement (ATO, 2018).
Answer to the 1st part of the Note 3:
Fines fall under the Non-Deductible Expenses. As per IRD, there is no deduction allowed for the
fines paid when a law has been broken (ATO, 2018). In the given case the Speeding Tickets are
paid on behalf of directors speeding on his way to the office. Hence a part of the non-deductible
expense and shall be disallowed and therefore shall be added back to the accounting profit.
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Income tax
So even the Speeding tickets fines were paid when the director was speeding his way to the
office, such expense is not as a deduction.
Answer to the 2nd part of the Note 3:
Since fines are non-deductible expenses, such expenses will be added back to the adjusted tax
profit and this will increase the adjusted tax profit because we are disallowing the Speeding
tickets expenses (Wells, 2011). IRD has specified to disallow the payments of any fines because
the law has been broken which shall not be allowed as a deduction (Nethercott, Richardson &
Devos, 2013).
So this amount of $120 shall be added back to the accounting profit and will result in increased
adjusted profit.
Answer to the 1st part of the Note 4:
A “donee organization” is a special type of organization, considered by the Inland Revenue to
have met the requirements as set out in the Income Tax Act 2007. Any organizations other than a
Donee organisation are a non-donee organization (Mayo, 2018).
Any donations made to donee organizations are eligible for 100% deductions, whereas donations
made to non-donee organizations are considered as disallowed expenses. Individuals, certain
companies and Māori authorities can get tax benefits by making gifts of money to donee
organizations (Nethercott, Richardson & Devos, 2013). Contrast this to donations made to Non-
Donee Organizations, which are not permitted, basically clients will get any tax benefits
Also, the maximum allowed deduction that a company can claim is limited to the amount of its
net income, calculated before taking into account the deduction (i.e. tax profit + donations
expense). If the tax profit before donations was less than the allowed amount, the maximum
amount claimed will be reduced (ATO, 2018).
Answer to the 2nd part of the Note 4:
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Income tax
This will increase the adjusted tax profit because of the disallowance of donations of $1,500
made to non-donee organizations and hence shall be added back to the accounting profit to get
the adjusted tax profit for the purpose of income tax. Only donations made to Donee organization
shall be allowed as a deduction, any other donations will be disallowed and shall be added back
to the accounting profits and hence will increase the adjusted tax profit.
Answer to the 1st part of Note 5:
Company losses can be carried forward. If a company’s total expenses exceed its total income a
loss will be made. A company in a loss position does not have to pay an income. The loss can be
carried forward to be offset against future profits.
In the given case Bend-it-Physio has Brought forward profit of $1,080. To bring in the Effect of
the same we have to decrease the brought forward losses from the adjusted tax profit as the
brought forward losses are fully deductible from current year profits and hence $1,080 shall be
deducted from final adjusted tax profit of the company so calculated.
Answer to the 1st part of Note 6:
Provisional tax is a method of paying tax in installments during the year. A business is required
to pay provisional tax if the current year’s residual income tax is more than $2,500. It is a kind of
payment of tax by estimating the total income before actually earning it. Further the credit of
same shall be available to the payer and also a refund shall be granted if the provisional tax paid
is greater than the assessed tax (Mayo, 2018).
Provisional tax payments are due at different dates depending on whether a business is GST
registered and the provisional tax option they choose (Nethercott, Richardson & Devos, 2013).
So in the current case, the residual tax of the company exceeds $2,500 hence it is required to pay
provisional Tax.
Answer to the 2nd part of Note 6:
The Provisional tax is adjusted with the Actual tax liability, and any Refund/Payable is computed
thereon. If the provisional tax paid is greater than the assessed tax liability than the balance of the
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Income tax
excess provisional tax paid shall be refunded to the payer, and if the assessed tax is greater than
the provisional tax paid then the balance amount of assessed tax shall be payable.
In the given case for bend-it-physio had paid a provisional tax of $2,775, the same amount shall
be available as a tax credit and it shall be adjusted with the actual tax liability of $6,917 resulting
in reduced final tax liability for the company.
Answer to the 1st part of Note 7:
Legal fees relating to revenue expense or day to day activities are allowed fully as a deduction
whereas legal fees relating to capital expenditure are totally disallowed as per the Income Tax
Act (ATO, 2017). However, if the legal fees so paid for Capital Expenditure does not exceed
$10,000 then such amount is fully allowable as a deduction under the Income Tax Act and will
require no adjustment if such legal expenses do not exceed $10,000 in total for capital
expenditure.
So as per IRD, only payments up to $10,000 are allowed as a deduction for Capital Expenditure.
Answer to the 2nd part of Note 7:
Legal fees relating to capital expenditure for your business is not allowed in general, but since
the payment made is less than $10,000 when purchasing capital assets for your business such
expenditure is allowed as a deduction and hence we have to do no adjustments in the adjusted tax
profits therefore it will have no effect in the reconciliation. Since IRD has specified that legal
expense for capital expenditure purpose up to $10,000 are allowed and require no adjustments
for computing adjusted tax profit for the purpose of income tax.
Answer to the 1st part of the Note 8:
No, Dividends paid between NZ wholly owned companies fall under the Exempt income
category as per the Income Tax Act and shall not be forming a part of assessable income and
shall be reduced from accounting profit to eliminate the excessive profit due to such dividends.
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Income tax
The act specifically states that such dividends are non-assessable and hence will not be included
in total adjusted tax profit (ATO, 2017).
Answer to the 2nd part of the Note 8:
This will decrease the adjusted tax profit by $9,600 as of this Dividend from the wholly owned
organization is an exempt income and such dividend is not assessable as per the Income Tax Act
2007. Such amount shall be deducted from the Accounting profit and shall be reflected in the
reconciliation statement.
Answer to the 1st part of Note 9:
A person is required to include as assessable income any imputation credits received and is
entitled to a tax credit equal to the amount of the imputation credit. Where a shareholder that is a
company, has excess imputation credits for an income year, the excess credits convert into a loss
to carry forward (Sadiq et. al, 2014. Where an individual shareholder has excess imputation
credits for an income year, the excess credits are carried forward in their current form to the
following income year (ATO, 2018).
In the given case the imputation credits are $1,338 and such credits shall have to be deducted
from the tax liability computed thereon.
Answer to the 2nd part of Note 9:
Refundable tax credits are those that arise from tax payments made by or on behalf of the
taxpayer (including payments for PAYE tax, provisional tax, RWT and non-resident withholding
tax (NRWT)). The full list of refundable tax credits is found within section YA 1 of the Income
Tax Act. Also included are tax credits for families under the Working for Families package, and
tax credits for retirement scheme contribution tax paid (RSCT credits). Some refundable tax
credits are also subject to an ordering rule, such as those arising from PAYE and RWT (ATO,
2017).
In the given case Bend-it-Physio has an RWT credit of $239 on dividends which is included in
the dividend amount. Such amount shall be adjusted towards the total tax payable and hence the
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Income tax
RWT will decrease our tax liability by $239. And this will reflect in our reconciliation after
computing the tax liability.
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Income tax
Answer to the Question 2 : Tax reconciliation statement, and computation
of Tax liability and final tax payable there on.
Bend-It Physio
Tax Reconciliation for the year ended 31 March
20X8
$ $
Accounting Profit 29,314
Deduct: Non-assessable income
Dividends (wholly owned) - - 9,600
- 9,600
Add back: Non-allowable
deductions
Accounting Entertainment
Expenses
13,988
Taxation Entertainment Expense - 10,738 3,250
Accounting Depreciation 9,047
Depreciaion as per IRD - 7,847 1,200
Speeding tickets - 120
Accounting Donations 7,500
Allowed Donations - 6,000 1,500
6,070
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Income tax
Tax Profit 25,784
Losses brought forward - 1,080
Adjusted tax profit 24,704
Income Tax liability (28%) 6,917
Less: Tax credits
Imputation credits - 1,338
RWT on Dividends - 239
Provisional Tax - 2,775 - 4,352
Tax Payable 2565
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Income tax
Answer 3
Reconciliation is needed because accounting profit takes into account the different items and
uses different amounts than that permissible by the Income Tax Act 2007 and IRD. The
difference between accounting profit before tax in the income statement and the adjusted tax
profit relates to the non-assessable income items and the non-allowable expenses that shall be
adjusted (Pratt & Kulsrud, 2013). Rather than creating a whole new income statement following
taxation rules, we work backward from the current Accounting Profit before tax to work out the
taxable profit. So effectively we calculate the tax profit by reversing out the income and
expenses that are not allowed for tax purposes (ATO, 2018).
Thus a process of reconciliation is required. This entails a series of adjustments. The process,
simply put, is one of deciding what is to be included in the profit and what should be put out of
the profit (Pratt & Kulsrud, 2013). The result is a series of increasing and decreasing the
adjustments from the Accounting profits to get the adjusted profit for the purpose of tax
computation as per the Income Tax Act, 2007.
Importantly, it is an accounting profit that is modified to get to taxable income. This means that
any adjustments must work with items set out in the profit and loss account or statement to arrive
the adjusted tax profit which is basically the purpose of Reconciliation Statement.
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Income tax
References
ATO. (2017) Reducing the Corporate rate tax. Available from
https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-for-
businesses/Reducing-the-corporate-tax-rate/ [Accessed 30 June 2019]
ATO. (2018) Accessing your payment summary. Available from:
https://www.ato.gov.au/Individuals/Working/Working-as-an-employee/Accessing-your-
payment-summary/ [Accessed 30 June 2019]
Mayo, W. (2018) Time to Upgrade Australia’s Company Tax System From Imputation to
Integration. Australian Tax Forum, 33(4), 1-57. Available from:
https://ssrn.com/abstract=3311250 [Accessed 30 June 2019]
Nethercott, L., Richardson, G.,& Devos,K. (2013) Australian Taxation Study Manual. Oxford
university Press
Pratt, J. W. and Kulsrud, W. N. (2013) Federal Taxation. Penguin Publishers
Sadiq,K., Coleman, C., Hanegbi, R., Jogarajan,S., Krever, R.,Obst, W., & Ting, A. (2014)
Principles of Taxation Law. Sydney.
Wells, J.T. (2011), Corporate Fraud Handbook: Prevention and Detection; John Wiley & Sons,
Hoboken, NJ.
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