LAW511 Australian Taxation Law

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Question

Charcoal Foods Pty Ltd is a private company with Con and his wife Eva being the two Directors and each owning one ordinary share. It has been operating since 2005. They migrated from Greece 40 years ago. In Melbourne they established a successful chicken take away shop. The company is registered for GST. Also the Company is registered as a Small Business Entity and uses the SBE taxation accounting system.

For the year ended 30 June 2017 their accountant, Theo prepared the following financial accounts. The figures in the financial accounts are net of GST (that is they have already excluded the GST from the figures) except where specifically stated.

Sales of chickens and other food items    $1,234,052

Opening stock                                                  12,000

Purchases                                                        155,000

Closing stock                                                     18,000

Cost of sales                                                  $149,000

Gross profit                                                 $1,085,052

Operating expenses

Administration expenses                                $485,375

Selling expenses                                             $324,678

Total expenses                                                $810,053

Net profit for accounting purposes          $274,999

In preparing the financial accounts, Theo provided the following information:

Administration expenses:

This includes the following items:

Accounting depreciation                                         $55,351

Provision for annual leave                                        $19,752

Provision for wastage of food                                  $13,578

Fine for breaching Health and Safety regulations      $4,250

Prepaid rental for the shop (Note 1)                          $18,000

Wage to Brad (Note 2)                                               $25,750

Loan application fee charged by Bank (Note 3)          $4,500

Interest on loan                                                          $10,417

Repairs (Note 4)                                                         $25,780

Normal operating expenses                                     $307,997

Total administration expenses                                  $485,375

Selling expenses are made up of the following:

Bad debts (Note 5)                                                       $2,985

Purchase of consumables (Note 6)                              $7,953

Advertising in the local paper                                    $12,758

Cleaning costs                                                            $22,589

Normal operating costs                                            $278,393

Total selling costs                                                      $324,678

Notes:

Note 1: The Company prepaid the 18 months rent for the shop for the period 1 August 2016 to 1 January 2018.

Note 2: Brad is aged 15. He is still at high school. The task he undertook was helping his grandmother Eva to prepare the salads after school. He only works for 2 hours a day for three days a week. The normal pay for a person to do this job would have been $6,670.

Note 3: The Company borrowed $250,000 from the bank. The bank charged a loan application fee of $4,500. The loan is for 10 years. The funds were borrowed on 1 July 2016.

Note 4: The repairs consisted of the following:

  • $800 to replace the shop window damaged by an act of vandalism,
  • $1,600 to install a new awning at the front of his shop. This was done on 17 April 2017,
  • $15,000 spent on initial repairs to a second hand freezer used for extra storage,
  • $4,300 spent to put in a sprinkler system to meet Fire Safety Regulations,
  • $4,080 on maintenance costs on the fryer, roaster and register caused by normal wear and tear.

Note 5: The bad debts represent a customer that they sold chickens to for a wedding on credit that refused to pay on the grounds that the chicken was too salty.

Note 6: This represents the purchase of cleaning aids, serviettes and plastic forks.

Other Information:

In preparing the accounts Theo advises you that the following items were not taken into consideration in preparing the above financial accounts:

Dividends: Theo has not taken into account any of the following dividends as he was not sure what to do about the imputation credits.

  • Cash dividend from the ANZ Bank of $12,465 which was fully franked,
  • Dividend from Apple Corporation in New York of AUD equivalent of $18,000 with $2,000 withheld in the US,
  • A cash dividend from Santos Ltd of $8,744 franked to 50%. 

Depreciating assets of the Company and new acquisitions: The figures are inclusive of GST.

  • Chicken Roaster purchased on 1 September 2016 at a cost of $55,600. The cost of installation was $6,696. The effective life of the machine is 5 years.
  • Counters and benches were installed on 1 July 2016 at a cost of $25,780. The effective life is 8 years.
  • Cash register purchased on 1 July 2016 at a cost of $3,750. The effective life is 6 years.
  • A minivan for deliveries – this was purchased on 1 June 2017. The cost was $48,750. The effective life is 5 years.
  • The Company bought a new luxury motor car for Con and Eva to use for whatever purpose they like on 1 April 2017 for $110,500. The company paid Fringe Benefits Tax of $3,057. This amount has not been included in the financial accounts as Theo is not sure what to do about the FBT expense.
  • The general small business pool of assets as at 1 July 2016 was $245,786. GST has already been excluded from this figure. The above items have been added to the pool during the financial year.

Trading stock:

The value of the closing stock as at 30 June 2017 is:

Cost $18,000

Market value $11,890

In addition Con and Eva used some chicken for their own consumption. The estimated personal consumption amount is $1,800.

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In addition $10,250 of chicken wings were in transit from Ingham in Queensland and as at 30 June 2017 were in Sydney on a truck which arrived in their shop on 5 July 2017. They had paid for the chicken wings and the cost has been taken up in the purchases figure in the financial accounts prepared by Theo. This amount had not been included in the closing stock figure.

PAYG Instalments: The Company made the following payments of income tax to the ATO:

  • 1 October 2016 – $12,000
  • 1 January 2017 – $12,000
  • 1 April 2017 – $14,000
  • 30 June 2017 – $12,000

Required:

Theo has now given you the file in order to prepare the tax return for the company. You are very experienced in taxation law having studied very hard in this subject when at university. Theo did not study very hard in taxation law and as a result is only working as a basic accountant in the accounting practice.

Please calculate the tax payable for the company. You are required to provide a brief explanation of each item and why it is included or excluded.

Answer

The financial statement of Charcoal Foods Pty Ltd is provided in order to calculate the profit for the purpose of tax it is necessary to add back expenses that are not allowed in tax. The section 8-1 of the Income Tax Assessment Act states that the expenses that are incurred for generating taxable income is allowed as deduction. Therefore, provision for wastage of food is not allowed as deduction (Saad 2014). The section 26-5 of the Income Tax Assessment Act 1997 provides that the amount paid as penalty under an Australian law or foreign law or ordered by Court cannot be deducted from income for the purpose of tax. Therefore, the penalty amount should be added back with the accounting profit for calculating the accounting profit for the purpose of tax. The section 26-35 of the Income Tax Assessment Act 1997 provides that the taxpayer is not allowed to deduct an amount that is paid or incurred in relation to related parties. The meaning of related party includes relatives (James et al. 2015). The definition of relatives includes grandparents and grandchildren’s. Therefore, the amount paid to Brad is not allowed as deduction for the purpose of tax. The section 25-25 of the Income Tax Assessment Act 1997 provides that a taxpayer is allowed to deduct expenses that is incurred for borrowing. It is necessary that the amount borrowed should be used for producing assessable income. The deductions related to borrowing expenses is spread over the tenure of loan. The bank charges is included within the meaning of borrowing expenses. Therefore, in this case the borrowing expenses should be distributed over the period of loan of 10 years. The section 25-10(1) of the Income Tax Assessment Act 1997 provides that the expenditure that is incurred for repair of depreciating assets that is allowed as deduction. It is necessary that the assets should be used for producing assessable income (Tran-Nam et al. 2014). The expenses that are of capital nature should not be allowed as deduction. The section 25-35 of the Income Tax Assessment Act 1997 provides that the taxpayer is allowed to deduct bad debt provided the amount was included in the assessable income. In this case, it is assumed that sales figure provided in the income statement includes credit sales. Therefore, this expenditure should be allowed as deduction. The income from dividend is an ordinary income so it is included in the assessable income of the taxpayer. The franking credits and tax withheld is allowed as deduction from the taxable income.  The subdivision 328-D of the Income Tax Assessment Act 1997 provides the details relating to Capital allowances for small business entity. It is provided that the small business entity is allowed to calculate depreciation in a simpler method. The assets that have cost less than $20000 they are written off immediately. The assets that have cost of $20000 or more is depreciated at 15% in the first year. In the subsequent years the depreciation on the assets are calculated at 30%. In this case, as the company is a small business entity so simple method for calculating depreciation is applied. The fringe benefit is paid on the taxable value of the benefit provided by the employer to the employees (Braithwaite 2017). The employer is allowed to claim deduction for the cost of providing the benefit and the fringe benefit tax paid. The subdivision 328E deals with the trading stock for small business entity. If it is estimated that the trading stock value has not changed by more than $5000 then it is not necessary to account for the change in the value of stock. The company is a small business as the turnover is less than $10 million so a small business tax rate of 27.5% will be applied. 

Charcoal Foods Pty Ltd
Statement showing Tax payable during the year
ParticularsAmountAmount
Net Profit as per financial accounts  $  274,999.00
Add: Non tax amount  
Accounting depreciation $    55,351.00 
Provision for annual leave $    19,752.00 
Provision for wastage of food $    13,578.00 
Fine for breaching Health and Safety regulations $      4,250.00 
Prepaid portion of the rent $    11,000.00 
Wage to Brad $    25,750.00 
Loan application fee charged by Bank $      4,050.00 
Repairs $    19,300.00 
Total add back  $  153,031.00
Gross taxable profit  $  428,030.00
ANZ Bank  
dividend received $    12,465.00 
Add: franking credit $      5,342.14 
Gross dividend income  $    17,807.14
Apple Corporations  
dividend received $    18,000.00 
Tax withheld $      2,000.00 
Gross dividend income  $    20,000.00
Santos Ltd  
dividend received $      8,744.00 
Franking credit $      1,873.71 
Gross dividend income  $    10,617.71
Increase in valuation of stock  $    14,450.00
Assessable Income  $  918,934.86
Less: Deductions  
FBT $      3,057.00 
Depreciation $  113,540.11 
Allowable deduction  $  116,597.11
Taxable Income  $  802,337.74
Tax Payable  $  220,642.88
Less:  
PAYG  $    50,000.00
Imputation credits  $      9,215.86
Net tax payable  $  161,427.02

 Table 1: Income tax payable(Source: created by Author) 

Calculation of depreciation
Particulars Amount AmountRateDepreciation Amount
Chicken Roaster $    55,600.00   
Less: GST $      5,054.55   
Installation cost $      6,696.00   
Total cost  $    57,241.4515% $                        8,586.22
Counters and benches $    25,780.00   
Less: GST $          234.36   
Total cost  $    25,545.6415% $                        3,831.85
Cash register $      3,750.00   
Less: GST $            34.09   
Net cost  $      3,715.91100% $                        3,715.91
Mini van $    48,750.00   
Less: GST $          443.18   
Net cost  $    48,306.8215% $                        7,246.02
Luxury Car $  110,500.00   
Less: GST $      1,004.55   
Net cost  $  109,495.4515% $                      16,424.32
Pool of assets  $  245,786.0030% $                      73,735.80
Total    $                    113,540.11

 Table 2: Depreciation(Source: created by Author)

Reference

Braithwaite, V. ed., 2017. Taxing democracy: Understanding tax avoidance and evasion. Routledge.

Brown, C., Handley, J. and O’Day, J., 2015. The dividend substitution hypothesis: Australian evidence. Abacus, 51(1), pp.37-62.

James, S., Sawyer, A. and Wallschutzky, I., 2015. Tax simplification: A review of initiatives in Australia, New Zealand and the United Kingdom. eJournal of Tax Research, 13(1), p.280.

Saad, N., 2014. Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, pp.1069-1075.

Taylor, G. and Richardson, G., 2013. The determinants of thinly capitalized tax avoidance structures: Evidence from Australian firms. Journal of International Accounting, Auditing and Taxation, 22(1), pp.12-25.

Tran-Nam, B., Evans, C. and Lignier, P., 2014. Personal taxpayer compliance costs: Recent evidence from Australia. Austl. Tax F., 29, p.137.

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