Calculating Taxable Income: A Case Study of Timber Floors Pty Ltd

This report provides a detailed analysis of the taxable profit calculation for Timber Floors Pty. Ltd., an Australian resident private company, for the year ended 30 June 2018. It begins by highlighting the difference between accounting profit, prepared according to accounting standards, and taxab...Read More

In the case of Timber Floors Pty. Ltd., which is an Australian resident private company for tax
purpose, accounting profit has been computed by the Amanda, the accountant in accordance
with the accounting standards but that cannot be taken by the tax authorities as a base for
computing tax thereon since various adjustments would be required to be made from the same
to arrive at taxable profit in the nature of deductions and disallowances as per the Income tax
Act 1997, various rulings and judicial cases which allows certain expenditure and disallows
certain expenditure which would have been allowed under accounting standards.
Profitability is a measure of organization performance and hence accounting profit which is the
excess of revenue over expenses computed within the framework of financial accounting set of
rules forms the basis of how the company is performing. Taxable profits on the other hand, are
more of the calculation performed for the purpose of ascertaining the tax liability of the
organization and hence are different from the accounting profit since the laws governing the
computation and the purpose of both are different.
Accounting profit is a publicly accessible data and can be accessed from the company’s website
or from companies filing but taxable profit is a limited access data and is only accessed under
the supervision of the Australian tax officer with very limited access to the public at large and is
more of secretive nature.
So in case of Timber Floors Pty. Ltd., to arrive at the taxable profit various adjustments have to
be done in accounting profit, a synopsis of the same are shown as below:
1. Allowance for depreciation on depreciating Assets (Note 1 and 4)
In the case of Timber Floors Pty. Ltd., depreciation has been computed and deducted from fees
to arrive at accounting profit, so in normal parlance no adjustment should have been required
since depreciation is also allowable expenditure to compute taxable income but the difference
lies in the method of computation of depreciation.
Computation of depreciation as per books of accounts involves use of management estimated
life of assets wherein the asset is depreciation over the estimated useful life based on
management estimate, so an asset of $10,000 with useful life of 10 years and Nil salvage value
will have an annual depreciation of $1,000. However, for the purpose of depreciation as per
Income tax act, the scenario may be different.
In the case of computation of depreciation as per the income tax act, there are set of rules
which apply to the capital asset or depreciating assets, which states the assets to be
depreciated over the effective life of the asset expressed in years. Moreover, deduction for
depreciation is available only if the same is used for the purpose of business and are allowed to
be claimed only to the extent to which one uses the asset in the business to earn income, for

example if an asset is used for 20% of the time for business purpose then one can claim only
20% of the depreciation in the current year.
In the case of Timber Floors Pty. Ltd. the accounting depreciation as per note 4 comes out to be
$150,000 which is based on director’s estimate of effective life of all assets being 5 years and
has not been computed under the tax laws and hence has been added back to the accounting
profit and an allowance for depreciating assets has been made as per the Income tax rules and
acts.
Depreciation on New Spray Equipment, new Truck and three further assets
As per Section 376.185 (Income Tax Assessment Act 1997) “In determining an amount of
expenditure for the purpose of this Division, the expenditure is taken to exclude GST”, in our
example new spray equipment and new truck includes GST and hence the same has to be
excluded while computing depreciation.
Capital cost for the purpose of depreciation of New Spray Equipment excluding GST @10%
comes to $155,227 and that of new truck comes $157,484, since the further three assets were
purchased at a exclusive GST price we have considered the acquisition price at $ 170,080.
As per Section 40.102 (Income Tax Assessment Act 1997) relating to capping life of certain
depreciating assets, the effective life has been capped at 6 2/3 Years which comes to ~ 15% of
the assets value. Total value of assets as mentioned above comes to $482,791, depreciated at
15% gives depreciation of $72,419 since all the assets have been purchased on 1 July 2017.
Pool Assets - Depreciation
Timber Floors Pty Ltd.’s final records show that on 1 July 2017 the opening balance of the
company’s pooled depreciating assets was $18,000 and hence as per Section 328.185 (Income
Tax Assessment Act 1997) “If you are a small business entity for an income year and you have
chosen to use this Subdivision for that year, you deduct amounts for your depreciating assets
(except assets for which you have deducted or can deduct an amount under section 328-180)
through a pool, which allows you to deduct amounts for them as if they were a single asset,
thereby simplifying your calculations. You use one rate for the pool” and the rate of
depreciation on the pool asset has been defined in Section 328.190 (Income Tax Assessment
Act 1997) as the Opening pool balance X 30% which on $18,000 at a rate of 30% has been
applied calculates depreciation on pool assets to $5,400
Depreciation on Assets costing less than $1,000
Timber Floors Pty Ltd.’s also purchased a new Ipad at a cost of $990 (GST inclusive) which when
GST excluded as mentioned above will be $900 @ 10% GST since the same would be available

for credit. As per Section 328.180 (Income Tax Assessment Act 1997) “You can also deduct, for
an income year for which you are a small business entity and you choose to use this
Subdivision, the taxable purpose proportion of an amount included in the second element of
the cost of an asset for which you have deducted an amount under subsection (1) if:
(a) the amount so included is less than $1,000; and
(b) you started to use the asset, or have it installed ready for use, for a taxable purpose
during an earlier income year”
So in tax computation as per the above section, we have deducted $900 from the accounting
profit as deduction.
2. Effect of receiving a franked dividend (Note 2 and 3)
Before we get into the discussion of tax treatment of franked dividend, let us know what the
concept of franked dividend is. Franked dividend is an Australian method or arrangement to
eliminate the double taxation of dividends. Dividends can be fully franked meaning the tax
credit will be available on whole dividend or partially franked wherein tax credit will be
available on dividend to the extent it is franked. Franked dividends helps reducing the tax since
it is dependent on the tax slab of the person receiving the franked dividend, if tax rate is below
the company’s tax rate the person will be entitled to refund of the difference from the
Australian Tax office (ATO).
On 30 November 2017, Timber Floors Pty. Ltd received a cash dividend of $100,000 (franked to
80%), As per Section 207.5 (Income Tax Assessment Act 1997) this would mean that 80% of the
30% tax has been credited to Timber Floors Pty Ltd. and hence we need to do grossing up of the
dividend received and add the same to accounting profit since the same has not been
accounted for while computing accounting profit which comes to $134,826
(($100,000*100/70*30%*80%) + $100,000) and a franking credit of $34,826 should also been
given for franked dividend tax paid by company.
On 31 August 2017, Timber Floors Pty. Ltd also received a cash dividend of $120,000 from a US
company who has also withheld $20,000 as withholding tax. Australia has a double tax
agreement with the US. Since Australia has a double tax treaty, the dividend income of
$140,000 has been added to the accounting profit and a $20,000 tax credit has also been given
for the tax withheld in US.

3. Repairs (Note 6)
The tax treatment of repairs expenditure depends on the type of repair expenditure done,
whether it’s a minor repair so as not to be of capital nature or of such major type so as to be
classified as capital expenditure.
In the present case, Timber Floors Pty. Ltd. has incurred repair cost of $30,000 consisting of
painting the company premises for $10,000 and replacing the old rotting wooden office window
frames with new steel window frames for $20,000. As per Section 25.10 (Income Tax
Assessment Act 1997) “You can deduct expenditure you incur for repairs to premises (or part of
premises) or a depreciating asset that you held or used solely for the purpose of producing
assessable income” and also mentions that “You cannot deduct capital expenditure under this
section”, since painting of walls classifies under purpose of repairs to premises it is an
allowance deduction and hence has been shown as deduction, replacing the old rotten wooden
office window with new steel window frame is considered a capital expenditure and will not be
allowed as deduction.
4. Reducing deductions for amounts paid to related entities - Wages (Note 7)
As per Section 26.35 (Income Tax Assessment Act 1997) relating to reducing deduction for
amounts paid to related entities “If, under another provision of this Act, you can deduct an
amount for a payment you make, or for a liability you incur, to a related entity, then you can
only deduct so much of the amount as the Commissioner considers reasonable” and hence for
expenditure of wages of $50,000 paid for marketing services provided by director’s service, the
allowance can be made only for $20,000 which has been considered reasonable for the services
provided by the Commissioner.
5. Value of trading stock at end of income year (Note 8)
As per Section 70.45 (Income Tax Assessment Act 1997) relating to Value of trading stock at
end of income year “You must elect to value each item of trading stock on hand at the end of
an income year at:
(a) it’s cost; or
(b) it’s market selling value; or
(c) it’s replacement value.”
In case of Timber Floors Pty Ltd, stock at the beginning of the year is $180,000 which is more
than the stock at the end of the year in any of the above principle of valuation, to ensure

minimum tax liability we should value the closing stock at cost i.e $133,467 to get maximum
deduction amount which in this case would be $46,433
6. Payment for restraint of trade agreement (Note 9)
It is generally accepted that a payment in consideration for agreeing to a restraint of trade is a
receipt of a capital nature (Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR
337) and hence the same has been disallowed.
7. Certain expenditure allowed on payment basis (Note 10)
Certain expenditure are allowed when payment for the same has been made like provision for
unreported claims, provision for long service leave and hence has been disallowed.
8. Tax Offsets - PAYG (Note 11)
Pay as you go (PAYG) installments refer to a system of making regular payments towards
expected annual income tax liability. It only applies only if one earns business and/or
investment income over a certain amount.
In this case, Timber Floors Pty Ltd. has paid a total of $255,000 in PAYG Installments during the
financial year and hence allowed to offset against the tax liability ascertained.
References
 Austlii.edu.au (2018). INCOME TAX ASSESSMENT ACT 1997. [online] Available at:
http://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/. [Accessed at 2 June 2018]
 ato.gov.au (2018). Guide to depreciating assets 2017. [online] Available at:
https://www.ato.gov.au/Individuals/Tax-return/2017/In-detail/Publications/Guide-to-
depreciating-assets-2017/. [Accessed at 2 June 2018]