Calculation Of Taxable Income And Tax Liability For Bloomingdale Florists Pty Ltd For Year Ended June 30, 2018

Sales, COGS, and Gross Profit

In Australia, Income Tax Assessment Act, 1997 (ITAA 1997) contains all the provisions and regulations to be followed by corporations and individuals to determine their taxable income and resultant tax liability. As per the appropriate provisions of the ITAA 1997 applicable in the facts of the two different cases provide in the document, a detailed explanation is given below.

The explanations for the treatments made to each of the items of revenue and expenditures in calculating the income liable to be taxed and tax liability of Bloomingdale Florists Pty Ltd are given at the end of the computation table.

Income reconciliation statement of Bloomingdale Florists Pty Ltd as per the provisions of ITAA 1997 and subsequent income tax liability of the company are calculated in the table below:

Income reconciliation statement of Bloomingdale Florists Pty Ltd as on June 30, 2018
Particulars   Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	($)	($)
Net profit as per accounting records	126,000.00
Add: Expenditures and assessable income
Accounting depreciation is not allowed as expenditures	12,000.00
Misleading advertisement penalty is disallowed for computing taxable income	5,000.00
Provision for long services leave is not an expenditure to be deducted from revenue, hence disallowed	20,000.00
Provision for doubtful debt is not an expenditure, hence, disallowed	17,000.00
Capital expenditure disallowed for income tax purpose (Window replacement)	10,000.00
Painting of office and factory premises is revenue expenditure allowed for tax purposes	–
Paramatta Eels League club gift expenditure is not allowed	10,000.00
Cost of borrowing is a capital expenditure to be amortized over the period of loan, hence, disallowed.	3,000.00
Foreign resident company’s dividend receipt is ordinary taxable income	1,000.00
Franked dividend is exempt from tax however, not franked portion is taxable (9000 x 20%)	1,800.00
Director’s salary which is above the reasonable limit as set by Tax Commissioner is disallowed for computing taxable income	10,000.00
Total addition		89,800.00
Profit after additions		215,800.00
Less: Expenditures allowed but not recorded and income recorded but not assessable
Long term service leave payment is an item of expenditure allowed for tax purposes	10,000.00
Bad debt is an expenditure for tax purposes	15,000.00
Tax allowed capital allowances is considered	10,000.00
Closing stock is overvalued due to use of LIFO method is reversed now (60000 -52000)	8,000.00
Borrowing cost amortized (3000/3)	1,000.00
Income exempt	10,000.00
Total subtraction		54,000.00
Assessable business income for tax purposes	161,800.00
Less: Previous year’s unabsorbed losses	20,000.00
Income liable to be taxed for the year ending on June 30, 2018	141,800.00

In Australia, corporates are taxed @30%, accordingly, the tax liability on the taxable income of Bloomingdale Florists Pty Ltd is calculated below.

Taxable income of Bloomingdale Florists Pty Ltd for the year ending on June 30, 2018 is $141,800. Since the company belongs to 30% tax rate, thus, tax liability of the company is (141,800 x 30%) = $42,540 for the income year 2017-18.

Notes to explain the tax treatments:

1. Long service leave is allowed on payment basis thus, no provision in respect of such long service leave is not allowable expenditure for tax purposes. Hence, the actual payment made for long services leave as been deducted in computing taxable profit as per subdivision of 83-B of ITAA 1997.
2. Section 25.35 of the act allows bad debt expenditures hence, the bad debt is deducted from accounting profit.
3. Replacement cost of wooden window by steel window is a capital expenditure hence, disallowed in computing taxable income of the company.
4. Expenditure on gifts for hospital is allowed as donation but not to a club, hence, the gifts to Paramatta Eels League is disallowed.
5. Capital allowances have been treated as per tax law.
6. LIFO method is not allowed for computing cost of goods sold, thus, the excess value of closing stock due to use of LIFO method has been added to the accounting profit for taxation purpose, i.e. $8,000 (60000 -50000).
7. Section 25.25 of ITAA 1997 provides that borrowing cost is a capital cost not to be deducted from revenue in Income statement for computing income liable to be taxed. Sine, entire borrowing cost was deducted in computing accounting profit hence, the entire borrowing cost has been added back to the accounting profit as per sec. 25.25 of the act to calculate taxable profit of the company.
8. Credit sales, whether retail or whole sale, included in debt is ordinary income thus, it is included while computing taxable income. The amount is already included in computing accounting profit hence, no adjustments are needed for the retails sales on credit included in debt.
9. Dividend received from resident companies in Australia, if franked is fully exempt for income tax purposes. However, to the extent dividend of resident companies is not franked is to be included in computing income liable to be taxed. Dividend received from foreign companies is ordinary income as per s6-5 of ITAA 1997. Accordingly, foreign company’s dividend is included here for calculating income liable to be taxed.
10. Tax Commissioner is the final authority when it comes to determining the deductibility of certain expenditures for calculating taxable income. In case of any expenditures if exceeds the reasonable limit determined by Tax Commissioner then, the excess amount if disallowed for tax purposes. In this case the excess salaries paid to directors in excess of reasonable limits is added back to accounting profit for tax purposes.
11. Previous year’s unabsorbed losses is allowed for setting off from taxable profit to determine the net taxable income or loss of an entity for an income year.

Issue:

There are two issues in this case, these are as following:

• Tax liability on Matchsticks Limited for receiving $1,000,000 as compensation from its major customer for termination of contract as per Income Tax Assessment Act 1997 (ITAA 1997).  
• Implications on income tax liability of Matchsticks Limited for the profit realized from sale of land, i.e. $10,000,000 as per ITAA 1997.

Rules:

Division 6 of ITAA 1997 explains the concept of Eligible Termination Payments (ETPs) and its implication on taxable income and tax liability of a tax payer in the country. ETPs are ordinary income taxable as per div. 6 of ITAA 1997. It is important to consider the circumstances of each case while determining whether the compensation is to compensate loss of revenue and profit or for capital purpose. In case the compensation is to compensate for loss of revenue then it is taxable as ordinary income of the recipient as per s6-5 of ITAA 1997.

Capital gain is recognized on profit realized from sale of capital assets. It is important to remember that if capital assets is depreciated and the depreciation has been allowed as expenditure for computing taxable income of an entity then such assets shall not be eligible for capital gain purpose. In such case profit on sale from such assets is taxable as ordinary income as per s6-5 of ITAA 1997. Land is a capital asset on which depreciation is not allowed for tax purposes and hence, in case of profit realized from sale of land by an individual or by an entity then, such profit is taxed as capital gain and tax is imposed on such gain as per the appropriate tax rate applicable for capital gain in the country.

Operating Expenses

Application:   

Subsequent to the termination of a contract by Strike a Light Pty Ltd, the most major customer of Matchsticks Limited responsible for 80% sales of the company, an amount of $1,000,000 has been paid to Matchsticks Limited as compensation. It is clear that the compensation of $1,000,000 paid by the customer to Matchsticks Limited is to compensate for the loss of revenue due to the termination of contract. Hence, it is an ETP as per div. 6 of ITAA 1997. Thus, the entire compensation is assessable as ordinary income under section 6-5 of ITAA 1997.

Matchsticks Limited has realized a profit of $10,000,000 from sale of land. The realized profit is a capital gain of the company and shall be taxed accordingly. The land is a capital asset which is not allowed to be depreciated thus, the realized profit from sale of land to Matchsticks Limited is not to be considered as ordinary income as per s6-5 of ITAA 1997 even if the objective of acquiring the land was not to dispose it off in the future. Thus, the entire gain on sale of the land to the company, i.e. $10,000,000 is taxable as capital gain of the company.    

Conclusion:

Matchsticks Limited shall include the amount of compensation of $1,000,000 received from its customer for termination of contract as ordinary income under section 6-5 of ITAA 1997. Tax payable on business income of the company shall be calculated after including the compensation of $1,000,000 in calculating its taxable income from business. The profit of $10,000,000 realized from sale of land is a capital gain of Matchsticks Limited and to be taxed as per applicable rate of tax for long term capital gain.

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