Law505 Taxation | Generally Accepted Assessment Answers

Part 1

On 1 July 2016 Frank Lloyd commenced business as an architect. He operated as a sole proprietor from a converted garage at the rear of his residence. Much of his work consisted of preparing building designs and specifications for local council building permits but he quickly gained a reputation for quality drawings prepared within tight timeframes. By the end of 2016/17 he had a small client base of local builders and private referrals and billings (fees) of $75,000.

During the year (2016/17) Frank submitted a design as part of a national competition for

‘The Citadel’, the centrepiece of an ambitious urban redevelopment. His visionary design and revolutionary use of local materials left the judging panel speechless with admiration and, to national acclaim, he was awarded the prize and commissioned to build the structure. Immediately he borrowed $1 million, rented premises in Main Terrace, acquired state of the art equipment and employed six draughtsmen and two administrative staff. During 2017/18 his billings were $2.5 million.

Required 1:

Should Frank return on a cash or accrual basis in 2016/17 and 2017/18?

You must refer to appropriate case law. Your answer must include (but should not be limited to) a discussion of the following:

• What factors affect the choice of a cash or accrual basis?
• Does Frank have a choice of the basis he adopts?


Does the Commissioner of Taxation have a right to insist on a particular basis?
Should Frank’s basis be the same in both years?
Given the present availability of accounting software packages, in your view, is the traditional criteria for the cash/accrual distinction still relevant?

Part 2

Ruby Engineering Pty Ltd [Ruby] was incorporated in 1990 and produced engine components used in the Australian car industry. In 2016 the business and company assets were sold to Diamond Ltd. Under the terms of the agreement, Ruby remained liable for any claims arising before 2016. The company used the funds to invest in real estate and shares.

During the year ended 30 June 2018 Ruby incurred the following expenses:

Required 2:

Advise the directors of Ruby Pty Ltd of the tax deductibility of the above amounts. You must make reference to appropriate authorities and legislation.

• Ruby has owned and rented a residential property since 2008. Rental income for the current year is $35,000. During the year the company replaced the old kitchen fittings, including cupboards that had deteriorated through water damage and wear and tear. The new cupboards were of the same type as the old ones and the kitchen layout was not altered substantially. The cost was $8,500.
  
  
• In another of the rental properties a visitor to the tenants slipped on the steps and sustained injuries requiring medical attention. She claims one of the steps was loose and commenced legal proceedings against the partnership alleging her injuries were caused by the poor condition of the building. Ruby incurred legal expenses to date of $7,000 and the action has not been settled at 30 June.
  
  
• In March 2015 the company owned sold a batch of parts that were subsequently found to be defective. The purchaser, an Australian car manufacturer lodged a claim for damages in the Federal Court. The claim was settled in November 2017 and the company paid an amount of $750,000 to the car manufacturer.
  
  
• The directors of Ruby were concerned about the claim in (c) and the effect it had on the year’s reported profit. They resolved to set aside a small amount of funds annually to meet any future claims. Accordingly, an amount of $100,000 was set aside in a provision in the accounts for the year ended 30 June.
  
  
• In August 2017 the directors of Ruby decided to investigate the possibility of re-entering the car parts manufacturing industry using a new type of alloy. An amount of $220,000 was paid to consultants investigating the proposal but, due to uncertainty in the motor vehicle industry, the directors decided not to proceed at the time.

Required 2

Advise the partners and directors of Ruby Pty Ltd of the tax deductibility of the above amounts. You must make reference to appropriate authorities and legislation.

Answer:

Part 1

1.Cash basis of accounting tends to only recognize income when income is received, and expenses once they are paid for hence receipts have to be provided. Therefore, this method does not recognize the trade payables and trade receivable accounts since there is no credit given to the customers or from the suppliers.The Accrual basis of accounting is one that recognizes incomes and expenses in the period earned or incurred, no matter when the money is paid for or received (Australian Taxation Office, 2017) This method is also normally referred to as the GAAP(Generally Accepted Accounting Principles) is often used as opposed to the cash method according to The Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Limited (1938) 63 CLR 108.

Some of the factors that affect the choice of a cash or accrual basis include the simplicity of the transactions based on the form of business, and the savings available for use in the day to day activities of the business as per the case of Henderson v. Federal Commissioner of Taxation (1970) 119 CLR 612. Additionally, is the regulatory requirements such as the GAAP and the Accounting standards agreement on the most preferred and convenient accounting method. Next is the understanding of the firm’sfinancial position as well as the organization’s established framework. With this Frank can be in a position to come up with the analysis on both methods making it easier for him to make the final decision which will be of help in running his business according to Brent v Federal Commissioner of Taxation [1971] HCA 48.

2.Frankly, Frank does not have a choice of the basis he adopts, this is because in 2016/2017, he is running a start-up sole proprietorship out of his garage and has an over billing of $75,000 hence the loss can only be carried forward to the next fiscal year as loss that reduces his capital and also the net income of the next year. Being that the 2016/2017 ends with accrued expenses of $75,000, Frank is forced to take a loan in order to rent property and employ staff members in 2017/2018 and even with the 1 million loan, he runs an over billing of 2.5million. So again due to excess costs there are accrued expenses that have not been paid for. Therefore, the only choice that Frank has is to do his accounting on accrual basis as no cash is afloat to cater for the accrued expenses.

3.The Commissioner of taxation has a right to insist on a particular basis by setting the various Goods and Services Tax (GST) laws on both cash and accrual methods. As per the Australian tax laws on GST, the method chosen affects when the GST should be reported (Legal Database, 2018). However, the law also approved that business with turnover of less than 10 million can use either method but other business with larger income must use accrual basis. Under the cash basis, there are various advantages such as claiming GST credits during the specific fiscal year in which you pay for the partly cost of business purchase.

Moreover, use of the accrual basis just means that accounting for the GST on the business’s financial statement which covers the period in which a tax invoice is issued or a payment for a sale received or an invoice receivedfrom the supplier, or a payment made for a specific purchase according to FCT v Dunn (1989) 85 ALR 244. GST tax credits can be claimed if during the reporting period a tax invoice is issued or a payment for a sale received or an invoice received from the supplier, or a payment made for a specific purchase.

4.Frank should use the same basis for both years being that he has several over billings. However, the Australian tax laws allows for the changes in the accounting method from cash to accrual which can only take effect on the first day of the period of tax as per FC of T v. Firstenberg (1976) 27 FLR 34 at 58. During the initial tax period after the change in the accounting method, there needs to be accountability for the purchases and sales that had not been accounted for or claimed previously (Journal of the Australasian Tax Teachers Association, 2018). In simple terms, there GST on any sales that had invoices issued before the date of change but pay had not been received yet need to be reported in line with Arthur Murray (NSW) Pty Ltd v. FC of T (1965) 114 CLR 314.

Having done my research, there are 15 available and recognized accounting software packages. They incude: Nummuspay, QuickBooks Enterprise, FreshBooks, NEWOLDSTAMP,Zoho Books, Sage 50cloud,Tipalti,NetSuite ERP,Xero, Happay,FreeAgent,Microkeeper,FinancialForce Accounting, Brightpearl, and Sage Intacct,(Financesonline.com, 2018). They all have the advantage of making accounting easier and more accurate. Since the named above best accounting software’s are the best in the industry, they after various advantage such as automatic tax deductions when directed to. Additionally, they do give guidance on the allowable accounting methods in the various financial statements.

However, I believe that the traditional criteria for the cash/accrual distinction still relevant especially for start-ups and small and medium sized enterprises. They also help in the learning of the accounting skills and knowledge which are then later advanced to the available accounting software’s. Having the traditional knowledge allows an accountant to easily detect any errors that the software may have or even come up with the financial statements manually if there are technical errors.

Should Frank return on a cash or accrual basis in 2016/17 and 2017/18?

Conclusively, based on the laid above facts in the different sections, Frank should return on an accrual basis in 2016/2017 and 2017/2018 due to the billings and the loans that he has. Besides, the utilization of the accrual basis just implies that representing the GST on the business' money related proclamation which covers the period in which an expense receipt is issued or an invoice for a deal got or a receipt got from the provider, or an invoice made for a particular buy (Kumar, 2018). GST impose credits can be asserted if amid the announcing time frame an assessment receipt is issued or an invoice for a deal got or a receipt got from the provider, or an invoice made for a particular buy as per J Rowe and Son Pty Ltd v. FC of T (1971) 124 CLR 421.

Part 2

1.Under considerations in of the Australian property law specifically the Residential Property Investment, GST is not charged on any rental income from a residential property. However, GST is charged on any property maintenance, management, and repairand other costs of ownership (Cao et al., 2015). Based on this law, my advice to the directors and the partners of Rubi property limited is that the rental income will be treated as non-taxable income and GST will not be charged hence reducing the assessable income.

Additionally under income tax on rental properties, there are various tax deductions that can be claimed such as gardening and maintenance, as well as depreciation on furniture, fittings and equipment used in the rental property (Mangioni, 2015). According to the case study, the 8500 was spent to old kitchen fittings, including cupboards that had deteriorated through water damage and wear and tear. Therefore, based on this law, my advice to the directors and the partners of Rubi property is that the depreciation on this fittings in the property can be treated as capital allowance or the wear and tear allowance hence an allowable expense that reduces the assessable income under s 8.1(2)(3a) of the ITAA 97. They cannot be deducted.

2.As per the Australian tax laws on residential rental properties, Ruby can claim income tax deductions on legal expenses based on the defence of a claim on damages due to the suffering of injuries by a third party on the company’s rental property (Christensen, 2017). Therefore, based on the Ruby’s case study, since the visitor is a third party who actually incurred injuries due to slipping on the steps of the property with poor conditions, a tax deduction on the same can be offered (Australian Taxation Office, 2018). My advice to the directors and the partners is that the $7,000 incurred legal expenses can be treated as allowable expenses thus reducing the Ruby’s assessable income. This in turn reduces the tax that Ruby needs to pay hence the partners, and the directors are both satisfied with the decision under s 8.1(a)

3.Relatively, based on the accounting standards, defective goods should be deducted during the valuation of trading stock in determination of the profit margin that later affects the assessable income (Simeon, & John, 2018). Being that the defective goods worth $75,000 was paid for in 2017, the same amount should be written off in the valuation of trading stock. With this effect, the damaged goods can be written off from the inventory without actually changing the cost of goods sold but through the reduction of income balances. The other option is to report the loss of the good separately hence adjusting in both the inventory and cost of goods sold. I would then advise filing a tax deductibility claim against cost of goods. With that then the directors and partners will be happy to recognize a deduction in the assessable income as the claim would be an allowable expense under s 8.1(a) of the ITAA

4.Based on recognized accounting standards, the best way to account for this transaction is to recognize the fact that it can be treated as an inventory cost hence allowed (Miller & Oats, 2016). Being that the carriage inwards is deducted from the stock in obtaining the cost of sales then the inventory cost should be taken as an expense. The amount will then be taken into account as an allowable expense. Tax is twisting up continuously indispensable as contention for remote wander heightens and associations end up being more adaptable. Australia's corporate tax rate is high stood out from various countries we battle with for hypothesis, especially those in the Asia Pacific region.

While association tax is paid by associations, the weight is passed on to speculators, clients and specialists. A more forceful business tax condition would stimulate bigger measures of enthusiasm for Australia and preferred standpoint all Australians through extended work and wages as time goes on. According to tax laws, allowable expenses results into tax deductibility due to the reduced assessable income. My advice then to the directors and the partners is to treat this as explained above under s 23-35 of ITAA 97.

1.The R&D Tax Incentive gives a tax reduction to organizations to help counterbalance a portion of the cost of leading qualified innovative work exercises. The tax incentive on R&D which is a program of self-evaluation program, suggeststhat one has control of surveying whether the research and development program and the company meet the necessary standards of qualifications (Department of Industry, 2018). These prerequisites are dictated by enactment. To apply for the R&D Tax Incentive, you should enlist your qualified R&D with the Department of Industry, Innovation and Science (the division).My advice to the partners and directors is the application of the R & D tax incentive hence the company will be in a position to spend the $200,000 and till have a tax reduction on the assessable income.

Conclusively, as explained above, I believe that Ruby ltd will be in a position to have a minimized taxable income. This based on tax deductibility due to the fact that GST is not charged on any rental income from a residential property, the fact that income tax deductions can be claimed on legal expenses based on the fact that the victim is a visitor is a third party who actually incurred injuries due to slipping on the steps of the property with poor conditions. Additionally, the is the application of the research and development incentive on taxes, and the fact that is a evaluation program for the company itself under s 8.1(a) of the ITAA 97

References

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Kumar, N. (2018). GST and its Control over the Tax Collection. GST Simplified Tax System: Challenges and Remedies, 1(1), 214-217.

Journal of the Australasian Tax Teachers Association. (n.d.). Retrieved August 28, 2018, from https://classic.austlii.edu.au/au/journals/JlATaxTA/2005/6.html

15 Best Accounting Software Systems For Your Business. (n.d.). Retrieved August 28, 2018, from https://financesonline.com/15-best-accounting-software-systems-business/

Mangioni, V. (2015). Land Tax in Australia: Fiscal reform of sub-national government. Routledge.

Cao, L., Hosking, A., Kouparitsas, M., Mullaly, D., Rimmer, X., Shi, Q., ...&Wende, S. (2015). Understanding the economy-wide efficiency and incidence of major Australian taxes. Canberra: Treasury working paper, 2001.

Christensen, S. A. (2017). Tax update for property buyers. Australian Property Law Bulletin, 32(4), 63-65.

Simeon, E. D., & John, O. (2018). Implication of Choice of Inventory Valuation Methods on Profit, Tax and Closing Inventory.

Miller, A., & Oats, L. (2016). Principles of international taxation. Bloomsbury Publishing.

Australian Taxation Office. (2017, June 30). Choosing an accounting method. Retrieved August 28, 2018, from https://www.ato.gov.au/business/gst/accounting-for-gst-in-your-business/choosing-an-accounting-method/

Department of Industry. (2018, June 29). R&D Tax Incentive. Retrieved August 28, 2018, from https://www.business.gov.au/assistance/research-and-development-tax-incentive

Australian Taxation Office. (2018, August 09). Expenses deductible immediately - management, maintenance, interest. Retrieved August 28, 2018, from https://www.ato.gov.au/general/property/residential-rental-properties/expenses-deductible-immediately---management,-maintenance,-interest/

Legal Database. (n.d.). Retrieved August 28, 2018, from https://www.ato.gov.au/law/view/document?DocID=TXR/TR981/NAT/ATO/00001&PiT=99991231235958

Need Australian Tax Advice? (n.d.). Retrieved August 28, 2018, from https://www.smats.net/Tax/PropertyInvestors.aspx