i) Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314
Facts: The case is about the tax position of the received income and not yet earned. This was also in Garden’s case.
Issues: The company was offering tuition services whereby students were paying advances. The commissioner needed taxable income computation for the received income and not the earned income. The lessons not taken and yet the money was received in advance, the commissioner advised for refund of the money to the students, thus failing to be an income to the company.
Conclusion: Income needs not only to be received, but also earned in order to be assessable. The company only receive d the fees, but was not earning it. The amount paid could only be assessable once the students took the lessons.
a. The income derive generally and income derived from the funeral services
The income derived generally is the income that is acquired from any source or earned in the active conduct of business transaction. Income derived from funeral services and related activities is an ordinary income (Henderson v FCT (1970) 119 CLR 612). The income derived generally is different from the income derived through the funeral services and the related services. The received fee from the funeral services is an assessable income (Murray, 2012). The income acquired from the provision of funeral services are taxed according to the provisions in section 6-5 of Income Tax Assessment Act 1997or provision of services on contractual basis. RIP Pty Ltd deals in the provision of funeral services. The company earns some income from a contractual obligation (Thompson, 2013). The ordinary income comprises of the periodical payment used to compensate for the ordinary expenses, as in Carden’s case.
The generally derived income in most cases is the one received after the company has offered the required service (Income Tax Assessment Act 1936 (Cth). This makes the income derived from the funeral services to be identified as regularly earned income (Thompson, 2013). If the income is derived generally, it would not be associated with some restrictions as compared to the income derived from the funeral services.
b. Arthur Murray Principles on assessable income
The Arthur Murray principle states that irrespective of whether in the instances it might efficiently be held that the receipt of money without having some earning is income. The company offers its services efficiently and even requires the client to pay before the provision of the service. Arthur Murray principle states that if a person receives something with the purpose of providing a service or if the earning is subject to some qualifications, the payment is not yet earned until the particular event has already occurred. This means that for a payment to become income, there has to be earning of a receipt (Devos, 2012).
RIP Pty has some payments that are not fully received, which could not be included in their income statement, thus the prove of Arthur’s principles of receipt. Considering that RIP Pty Ltd do not receive all the payments by the time of offering the funeral services, for instance; there is the “Fees payable under a ‘net, 30 days’ invoice” and the “Fees payable under several external insurance contracts under a ‘net, 30 days’ arrangement.” There is the fee received from the RIP Finance Pty Ltd, which offers credit in the installment repayment plan. This required RIP Pty Ltd not to consider the payments as income before they are receipt. The money required to be received regularly for the future funeral plans by the particular clients in order by the time a person dies, he or she would have completed paying the agreed amount. No payments can be reported as assessable income even if the company has already received the money, but needs to record them and wait until they are earned, for the taxation purposes (Devos, 2012). The payments received in advance are not assessable income when received, but after the company offers the agreed funeral services and when it is earned.
The company receives the payments before the provision of the required services to the clients. This is because the clients are expected to have contributed their agreed amount before their death (Murray, 2012). The company only needs to include the payments in the receipt payments once the earnings are received and after the provision of the agreed services. The receipts are included in assessable income once they are earned or when the event occurs. The money received by the company but nor earned should be included in the unearned income. This company should operate an accrual method of accounting in order to cater for the money paid but not received. The down payments and the cash advances received by the company should not be included in the assessable income for the computation of the income because they are not earned.
c. Accounting methods
There are two methods applied in the computation of a taxable income, cash and accrual basis. In cash bases, income is only recorded once cash is received and expenses recorded when paid (Devos, 2012). In the accrual basis, the transactions are recorded the moment one makes an order, when services occur and when the items are delivered irrespective of the time the money is paid or received. Cash method is popular and very easy since it is initially applied in any business, and helps in effective assessment of the financial condition. The accrual method offer enough information about expenses and income, prepaid cash receipts, and the outstanding services, hence efficient profit and loss measurements, as per tax Ruling 98/1 . It is advisable for businesses to use the accrual method in every plan with almost or over 1 million every year. This helps in the avoidance of IRS charges and efficient record keeping.
The following factors are considered. The taxpayers need to determine when the particular income is derived through the adoption of a method of accounting for income (Murray, 2012). A taxpayer requires adopting the accounting method cash or accrual method that in any case is efficient when accounting for the income for the taxation reasons (Carden’s case). When conducting credit and cash sales, either cash or accrual basis can apply. Cash method applies when the income is recognised and accrual basis apply when customer takes goods and services on credit (Dixon J in Carden's case). The payment of employees is done through cash method depending on the level of profit to a company. The suitability of the accounting method applied by the taxpayer in capital equipment is a core test used in the determination of the method that needs to be applied, same with Barratt's case, Henderson's case, and Brent's case, which should be accrual basis. When relying on circulating money, the accrual method can be suitable because of circulation of the income derived. The same depends on the personal circumstances when trading stock as it was identified in Carden's case where Dixon J affirmed that the circumstances gives a clear direction on cash basis since it is most appropriate.
Taxpayer and commissioner’s choice on accounting method
Due to the growth of a business, the taxpayer is allowed a choice to the accounting method, thus making a change to be necessary (Taylor, & Richardson, 2012). Some countries taxation rules identify the necessity of a taxpayer changing the accounting method because of the changes realized to the income. The adjustments help in the avoidance of double or lack of the taxation of the income. Other nations have general principle related to the judicial standards. The change of an accounting method might prevent the realization of an adverse effect on the revenue. The commissioner mandated to secure the uniformity through which the revenue is collected. The commissioner should carefully investigate the change in the accounting system (Taylor, & Richardson, 2012). Businesses can use any of the two methods of accounting at the initial transaction, but only make changes and adopt the other method when the business is rgrown. Small firms choose cash basis, but when expanding their business they can use the accrual base of accounting. Income should be calculated separately for each year. This was the case in FCT v. Dunn. If the taxpayer accounts for the business items using a cash basis, it is vital for the taxpayer to continue adopting the specific method until the moment it will prove to be inappropriate. Such circumstances are identified once the business grows to be bigger than it was or because of being engaged in a wider variety of activities.
ii) Forfeited payment account
The forfeited payment account of the company needs to be treated as an ordinary income in the form of capital received in the hands of the particular company. The amount of money that the clients fail to pay to the company as agreed or the due fee that is not cleared. The company needs to make some provisions for the forfeiture. The amount is credited to the account of the deferred compensation fund and used as an administrative expense and the amount already paid by the client might be refunded back to the client (Taylor, & Richardson, 2012). The company should not include the forfeited payment in the assessable income but should be deducted in the form of forfeitures acquired by the particular company. The tax of the forfeiture payment should be calculated up to the last transaction through which the client made some payment to the particular company. The amount is not a receipt in the company’s account because it is not yet paid. (Devos, 2012). The item is allowable to the clients in the form of forfeiture in the company.
Devos, K. (2012). The impact of tax professionals upon the compliance behaviour of Australian individual taxpayers. Revenue Law Journal, 22(1), 31.
Murray, I. (2012). Travel to Invigorate the Mind and the Wallet: Do the International Tax Rules Appropriately Encourage United States–Australian Academic Visits?. Adelaide Law Review, 33, 2013-09.
Taylor, G., & Richardson, G. (2012). International corporate tax avoidance practices: evidence from Australian firms. The International Journal of Accounting, 47(4), 469-496.
Cases and legal issues
Henderson v FCT (1970) 119 CLR 612
FCT v. Dunn
Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314.
Income Tax Assessment Act 1936 (Cth)
i. Nature of trading stock and treatment of the $25000
According to S70-10 of the Income Tax Assessment Act (1997), trading stock is anything that is sold or exchanged in the normal course of doing a business. The caskets and accessories would be trading stock for tax purposes and since they are sold and are not fixed assets (Woellner, Barkoczy, Murphy, Evans, & Pinto, 2011). In RIP Pty, caskets and accessories are manufactured for sale and exchanged in the course of conducting the business. The company provides different funeral services and sells caskets.
The prepaid amount of $25,000 in June and delivered in August is not treated as trading stock for tax purposes. As articulated by Murphy (2011), the value of the trading stock at hand at the end of a business year will be included in the taxable income for that financial year. The materials are trading stock and if between June and August the business financial year will not have ended, the amount will be added in the taxable income, but it was during the 1st July 2016 to 30th June 2017 tax year (Saad, 2014). The prepaid expenses are only assessed for taxation purposes if received and earned.
ii. Treatment of fully franked cash dividend in Australian taxation
The cash dividend received form a part of income, either the partly or fully franked cash dividend. The received credits from franking are part of the taxable income in relation to the credit associated with dividend. If one has a high taxable income, the person is not likely to be entitled to acquire some additional tax liability (Income Tax Assessment Act 1936 (Cth). The companies are not provided some refund but get the amounts being carrier forward to reduce the tax burden in the following tax year. In case of the need to pay more tax, this reflects to the tax loss in the following tax year (Murphy, 2011).
The fully franked cash dividend of $21,000 was received from RIP Finance Pty Ltd needs to be added back to the earnings prior the interest and tax. However, it would be excluded in the profit and loss account since it would be an expense by the company. RIP Pty would have a taxable income of $29,371; and a tax liability of $8811, if it had a turnover of less than 2 million dollars. Otherwise, the taxable income would be $30,000 and tax liability of $9000.
The rental lease costs should be assessed to the lessor and eliminated by the leseee, as per the lease agreement, and under Ss 8-1, 6-5. In the RIP Pty case, the lease amounted to $57,000. A portion from it was expensed and subtracted from the assessable income, $9500, since it was expensed in 2016, thus remaining with $47500, which would be deducted in the year it will be expensed maybe in 2017 or later.
Leave to the managing director
There was an advanced payment of the leave associated expense, thus being deducted from the year it was incurred. The managing director was paid in the year ending 30th June 2016, thus required to deduct the amount the same year s26-10 (Norbury, 2014). If accrued to the following year, the amount might be taken as an income. If earned and received in the present year, it would be accounted for in the same year
iii. Deductions available for expenditures set out in (v)
For taxation purposes, the deductions present for the expenditure set out or the capital assets are provided some depreciation allowances as per the universal rules of depreciation. The remaining costs need to be capitalized since they are associated with the structural and land improvements. The RIP Pty will be able to claim for the capital works construction expenses at a certain rate depending with the number of years held (Bookkeepers Knowledge Base (2016). The deduction of the capital work expenses would be the same year the expenses were incurred. Part of the company’s profit, the profit would be computed through the deduction of $250,000, for preliminary architectural designs. The amount spent in the construction of the new premises amounting to $2.5m, on-site car parking, $125,000, and landscaping of the site, $40,000 would be deducted.
BookKeepers Knowledge Base. (2016). The tax treatment for trading stock. Retrieved from; http://www.austbook.net/files/custom/edition/47817-edition-54---the-tax-treatment-of-trading-stock.pdf
Murphy, K. (2011). Moving forward towards a more effective model of regulatory enforcement in the Australian Taxation Office. http://www.sweetandmaxwell.co.uk/Catalogue/ProductDetails.aspx?recordid=331&productid=6594
Norbury, M. (2014). When do primary production activities constitute a business?. Taxation in Australia, 48(9), 530.
Saad, N. (2014). Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, 1069-1075.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2011). Australian Taxation Law Select: legislation and commentary. CCH Australia.
Income Tax Assessment Act 1936 (Cth)
Income Tax Assessment Act (1997)