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BULAW3731 Income Tax Law And Practice

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BULAW3731 Income Tax Law And Practice

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BULAW3731 Income Tax Law And Practice

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Course Code: BULAW3731
University: Federation University is not sponsored or endorsed by this college or university

Country: Australia


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.
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?

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:
Advise the directors of Ruby Pty Ltd of the tax deductibility of the above amounts. You must make reference to appropriate authorities and legislation.
(a)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.
(b)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.
(c)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.
(d)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.
(e)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.


Answer to Requirement 1:
Answer to (I):
The difference between the cash and the accrual method of accounting is based on the sale and purchase that are recorded in the accounts (Woellner et al., 2016). As Held in “Carden v FCT” the cash method of accounting identifies the revenue and expenditure only on the circumstances when it changes hand however in the accrual method of accounting it recognizes the revenue when it is earned. An individual taxpayer can use them of the cash or accrual accounting system based on the certain factors. The cash method of accounting might be easy to maintain and understand.
There are no accruals and allocations to compute. In the actual world not much of the business function under the entirely cash method of accounting because a business may sell products that are paid later or other forms of transactions that occur and payment that is received in the later period (Braithwaite, 2017). In “Henderson v FCT” using the accrual method accounting it provides the business with the better scenario regarding the income and the expenditure originating out of profitability. Factors such as double entry bookkeeping may be considered useful in choosing the method as the business would obtain the knowledge regarding the accounting equation. Cash flow factors forms the best in deciding the accounting method which provides a business with the better idea regarding the cash flow.
Answer to (II): 
Frank has the basis of adopting either of the accounting method. Referring to decision in As Held in “Carden v FCT” Frank can select accounting for cash basis. The basis for adopting the cash basis of accounting would help in identifying the revenues based on the receipt of cash and expenditure that is received (Snape & De Souza, 2016). This method would be helpful in identifying the accounts receivable or the accounts payable. Frank can consider opting for the cash basis of accounting since it is very easy to maintain.
Furthermore, it is easy to ascertain whether the transaction has incurred and there is no need of tracking the receivables or the payables (Bushman et al., 2016). For Frank there is a choice of adopting the cash or the accrual basis of accounting. Accounting based on the cash basis represents the accounting for GST on the business activity statement that would cover the period in which a business makes the payment for the sale and purchase.
Answer to (III): 
The commissioner of taxation in “FCT v Henerson” held that it has the right of insisting on the particular basis of accounting. The taxation commissioner states that a person is held taxable for the assessable income based on the cash basis by including the payment that is received by a business irrespective of when the work was performed (Nallareddy et al., 2017). The commissioner under the cash basis insist the business in including those payments that are eventually received for the year as the taxable income. The commissioner of taxation insists that business with aggregate yearly turnover over of less than $10 million can selected to account for the GST based on the cash method of accounting.
Accounting for the cash basis represents that the business should account for the GST on the business activity statement that covers the particular period in which the business receives or makes the payment for the purpose of sale and purchase (Ball et al., 2016). The commissioner of taxation insists that a business gains the advantage under the cash basis of accounting as this method helps the business in better aligning the liabilities of the activity statement and hence easy to administer the cash flow.     
Answer to (IV): 
As understood from the case study it can be stated that during the year ended 2016/17 the company has earned a sum of $75,000 while in the subsequent year of 2017-18 the annual turnover of the company stood $2.5 million. In both the financial year of 2016/17 and 2017/18 the annual turnover of the business stood lower than the prescribed limit of $10 million (Miller & Oats, 2016). The basis of accounting under the cash basis requires an entity to account for the cash basis if the annual turnover of the business is lower than $2 million and $10 million respectively.
As evident in the situation of frank the basis of accounting method would change for the accounting year as the business is primarily small and is below the annual turnover limit of $10 million. As evident the commissioner in “Dunnv FCT (1989)” assessed the taxpayer on accrual basis. Frank should attribute the input tax credit for the creditable purpose during the tax period in which it offers considerations for acquisitions but only till the extent that Frank provides the consideration during that tax period (Robin, 2017). Hence, the basis of accounting for Frank would change for the accounting period of 2018. Referring to “Dunnv FCT (1989)” Frank should return based on the accrual basis.
Answer to (V):  
The present availability of software packages makes the traditional criteria of accounting cash or accrual basis is not relevant anymore. The use of electronic system creates differences than the traditional method of accounting (Blakelock & King, 2017). The cash basis of accounting is considered to be highly suitable for the business that has the turnover of less than $2 million.
The cash and accrual method of accounting is different from the traditional accounting because it helps in treatment of some items in a different manner. For example, maintenance of business records becomes easier which includes keeping track of the records relating to the income and expenditure such as purchase of business assets, valuation of stock at the end of the accounting period and payment of employees (Burton, 2017). With the availability of accounting software packages, it is simple to keep track of the business cash flow and provides a better picture of total amount of money that a business has as a cash in hand and bank accounts. 
Answer to requirement 2: 
Answer A: 
“Section 8-1 of the ITAA 1997” allows a taxpayer to deduction from their assessable income the expenses that are incurred in gaining the assessable income except on the conditions that the expenses are not capital in nature (Maley, 2018). An individual is allowed to claim rental deductions for the expenses that is incurred when the property is rented out or available for rent. According to the “subsection 25-10 (1)” the meaning of repair includes the restoration of the asset to its previous conditions without altering the necessary character or function.
The repair might involve renewal and replacement of subsidiary portions of a whole but does not include an entire reconstruction. The cost incurred by Ruby for replacing the kitchen fittings along with the deteriorated cupboard destroyed in storm can be allowed for general deductions under “section 8-1 of the ITAA 1997” as these repairs constitutes general repairs for which deductions can be claimed (Bankman et al., 2017). The repair constitutes the restoring the efficiency and function of the asset and does not cause any change or improving its character.
Answer B:
As held in “FC of T v Snowden & Wilson Pty Ltd (1958)” taxpayers is allowed t claim deductions for cost incurred in gaining taxable income. Citing the case of “Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1991)” there is some legal expenditure that are incurred in producing the rental income are considered deductible. These comprises of cost incurred in evicting the non-paying tenant, undertaking any court action for the loss of rental income and for defending the claims relating to the injuries that is suffered by the third party on the rental property (Schenk, 2017). Similarly, there are most of the legal expenditure that are capital in nature and hence non-deductible. Non-deductible legal expenditure that are capital in nature might however become the part of the cost of property for the purpose of capital gains tax.
Ruby reported a legal expenditure of $7,000 as one of her tenants slipped on the steps and suffered injuries. Referring to “Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1991)” the, legal expense of $7,000 will be allowed as deductions since the expenses constituted defending the damage claims originating from the injuries that is suffered by the tenant on the rental property. The expenditure originated as the letting out of premises to the tenant with the objective of generating assessable income (Murphy & Higgins, 2016). The legal expenditure that is occurred by Ruby possess connection with the rental income such that the expenditure is held as incidental and relevant in producing the taxable rental income. There was no such enduring benefit that was generated by the expenses and hence it is appropriate to consider the expenses as being the revenue account.
Answer C: 
According to “section 8-1 of the ITAA 1997” it allows for deductions relating to all the losses and outgoings till the extent that the outgoings are occurred in producing the taxable income, excluding the circumstances where the losses or outgoings are capital in nature and it is related to the derivation of the exempted income (Buenker, 2018). The court in “Hallstroms Pty Ltd v FCT (1946)” in ascertaining whether the deductions for the legal expenditure is allowable under the provision of “section 8-1 of the ITAA 1997”, the nature of the expenditure should be considered. As evident in the current situation of Ruby Pty Ltd the company incurred expenses on paying the compensation damage. The settlement of claim amount stood $750,000 for the car manufacturing company.
The court of law in “Sun Newspaper Ltd v FCT (1938)” held that expenditure that is devoted in the direction of structural instead of operational purpose, then such expenditure is regarded as capital nature and the expenditure are non-allowable deductions (Schmalbeck et al., 2015). The compensation that is occurred by the Ruby Pty Ltd cannot be allowed as allowable deductions. The expenses were much devoted towards structural purpose rather than the operational purpose. The expenditure is capital expenses and hence the expenses will not be allowed for deductions for Ruby Pty Ltd.   
Answer D: 
According to Australian taxation office provision expenditure is considered as non-allowable deductions over the eligible period. To obtain deduction under the section 63 of the Act, the expenses should exist before it can be allowed as deductions. A deduction is allowed to the taxpayer under the “subsection 63 (1)” given the taxpayer has written off a part of the expenses (Woellner et al., 2016). Under the current situation it is noticed that Ruby set aside a provision of $100,000 in the accounts for the income year ended 30 June. As the general rule the provisional business expenditure is not allowed for deductions since they are not incurred in gaining the assessable income and hence non-allowable as deductions under the general provision of “section 8-1 of the ITAA 1997”. 
Answer E: 
The court in “Goodman Fiekdr Wattie v FCT” held that any type of losses or outgoings that are preliminary in the commencement of the income generating business activities are not occurred in the course of such as activity are not considered as allowable deductions under the general provision of “section 8-1 of the ITAA 1997”. Referring to the decision in “Softwood Pulp & Paper v FCT (1976)” the company incurred expenditure on feasibility study and other relevant expenses to ascertain whether the start a new production unit of paper mill (Miller & Oats, 2016). The commissioner of in its judgement stated that the costs incurred by taxpayer on feasibility study would not be allowed as allowable deductions as everything which was done was considered preliminary in nature in the commencement of the income generating activities.
As evident in the current situation of Ruby Pty Ltd the company incurred investigation expenditure of $220,000 for a possible entry into the car manufacturing industry. Citing the reference of “Softwood Pulp & Paper v FCT (1976)” the expenses that were incurred by the company are preliminary to the beginning of the income generating activities and the same is not incurred in the course of generating the taxable income. Therefore, the market investigation expenses cannot be considered as the allowable deductions under the general provision of “section 8-1 of the ITAA 1997”.  
Ball, R., Gerakos, J., Linnainmaa, J. T., & Nikolaev, V. (2016). Accruals, cash flows, and operating profitability in the cross section of stock returns. Journal of Financial Economics, 121(1), 28-45.
Bankman, J., Shaviro, D. N., Stark, K. J., & Kleinbard, E. D. (2017). Federal Income Taxation. Wolters Kluwer Law & Business.
Blakelock, S., & King, P. (2017). Taxation law: The advance of ATO data matching. Proctor, The, 37(6), 18.
Braithwaite, V. (2017). Taxing democracy: Understanding tax avoidance and evasion. Routledge.
Buenker, J. D. (2018). The Income Tax and the Progressive Era. Routledge.
Burton, M. (2017). A Review of Judicial References to the Dictum of Jordan CJ, Expressed in Scott v. Commissioner of Taxation, in Elaborating the Meaning of Income for the Purposes of the Australian Income Tax. J. Austl. Tax’n, 19, 50.
Bushman, R. M., Lerman, A., & Zhang, X. F. (2016). The changing landscape of accrual accounting. Journal of Accounting Research, 54(1), 41-78.
Maley, M. N. (2018). Australian Taxation Office Guidance on the Diverted Profits Tax.
Miller, A., & Oats, L. (2016). Principles of international taxation. Bloomsbury Publishing.
Murphy, K. E., & Higgins, M. (2016). Concepts in Federal Taxation 2017. Cengage Learning.
Nallareddy, S., Sethuraman, M., & Venkatachalam, M. (2017). The changing landscape of accrual accounting: Implications for operating cash flow predictability.
Robin, h. (2017). Australian taxation law 2017. Oxford University Press.
Schenk, D. H. (2017). Federal Taxation of S Corporations. Law Journal Press.
Schmalbeck, R., Zelenak, L., & Lawsky, S. B. (2015). Federal Income Taxation. Wolters Kluwer Law & Business.
Snape, J., & De Souza, J. (2016). Environmental taxation law: policy, contexts and practice. Routledge.
Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2016). Australian Taxation Law 2016. OUP Catalogue

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