SE Machinery Pty Ltd [SEM] is a private resident Australian company incorporatedin 1981. The company...

Question

SE Machinery Pty Ltd [SEM] is a private resident Australian company incorporatedin 1981. The company develops and manufactures Teftoffel, a component used in themanufacture of small engines.The following financial information relates to SEM for the year ended 30 June 2012.[Disregard GST.]RevenueGross trading income $3,035,000Australian public company dividends received($600 imputation credits attached) 2,000Profit on sale of fixed assets – furniture 2,600 3,039,600ExpensesBad debt written off 8,000Cost of borrowing funds to finance working capital 300Depreciation (including Buildings) 175,000Education fees 22,000Entertainment expenses 15,000Fringe benefits tax 43,000Legal expenses 4,600Loss on sale of fixed assets – precision machinery 1,000Overseas travelling expenses 24,000Provision for long service leave 26,000Repairs & maintenance 64,500Research & development (carried out by CSIRO) 20,000Salaries & wages 948,650Superannuation contributions 76,000Other expenses (all tax deductible) 200,000 1,628,050Net profit before tax 1,411,550Other information1. On 1 May 2011 SEM received a special order and payment for ten cartons ofTeftoffelex – a new product. The manufacture of Teftoffelex required somemodification the company’s production system. The customer agreed tocontribute $500,000 to the cost of modifications. Under the terms of thecontract the amount was described as ‘capital contribution to establishmentand construction costs’.The contract provided for supply of Teftoffelex in August 2012 and theadvance payment of the agreed price as follows:Capital contribution to modifications $ 500,000100 cartons @ $7,000 $ 700,000$1,200,000The amount of $1,200,000 is included in gross profit.Required 1 [Approx 500 words](a) Advise the taxpayer whether the amount of $500,000 is assessable under s6-5.[Cite relevant authority.](b) Advise the taxpayer whether the Arthur Murray principle applies to some orall of the $1,200,000 amount.Other Information (continued)2. The bad debt of $8000 was written-off after SEM entered into a scheme ofarrangement to accept 40 cents in the dollar from a bankrupt debtor.3. On 1 February 2012 SEM borrowed $25,000 for 3 years @ 8% to financeworking capital. Borrowing expenses were $300.4. Depreciation:Company policy is to use straight line [prime cost] depreciation and toadopt tax rates for accounting purposes except in respect of buildings.Building depreciation was $15,000. Apart from extensions [Note 6], allbuildings were constructed before 1982. Included in the expense isdepreciation on motor vehicles provided to staff (except new car forManaging Director – Note 5).5. Fixed assets disposed of during the year were:? Furniture - cost $4,000- adjusted value 2,926- termination value 20/6/12 5,526? Precision machinery – cost 5,000- adjusted value 3,277- termination value 1/11/11 2,2776. Additions to fixed assets during 2011/11:? Extensions to administration building – construction commenced1/10/11; occupied 1/4/12: $100,000? Motor vehicle for Managing Director – purchased 1/7/11; $65,466.7. Education expenses:In accordance with a resolution of the directors, the company paid theschool fees of the directors’ children. The reason given for the policywas to provide a standard of educational instruction appropriate to thepossible future directors of the company.8. Entertainment expenses of $15,000 was spent on meals at restaurants. Recordsshow 60% related to employees and their associates and 40% related to clients.The company uses the actual basis for FBT meal entertainment valuationpurposes.9. Legal expenses comprised:? Redrafting the company’s Memorandum and Articles 2,000? Debt collection 2,100? Advice on dismissal of a senior staff member for misconduct XXXXXXXXXXOverseas travel:In December 2011 one of the directors travelled to the USA to seek outnew agencies to handle the company’s products; costs totalled $11,000.In February 2012 the Marketing Manager attended the InternationalEngine Exhibition in Singapore. His wife accompanied him. After theExhibition they travelled to China for a week’s holidaying.- Singapore costs: 5,000- China costs 8,000 13,000(The company accepts FBT liability for the China trip.)11. Long service leave paid in 2011/12: $20, XXXXXXXXXXThe following amounts were debited to Repairs & Maintenance Expense:? Costs incurred in early November 2011 replacing the roof on a buildingpurchased for use as a warehouse in August 2011. The work wascompleted on 12 November: $7,000.? Costs of converting an old store into a lunch and change room foremployees; completed 31 October 2011; life 5 years:- showers and toilets 30,000- partitioning and panelling 10,000- furniture for lunch room 5,000Required 2:1. Indicate with explanations, sections of the Acts and relevant caselaw how the Revenue and Expense items (together with the Notes)in the company’s accounts are treated for tax purposes.2. Calculate SEM Pty Ltd’s taxable income for 2011/12.

Robert · Accepted Answer

Required 1(a)  
Income according to ordinary concepts or ordinary income is included in assessable income 
per the requirements of Section 6-5 of the Income Tax Assessment Act 1997 and as per the 
section; it includes all the income that is derived during the income year. In order to 
determine whether an amount is ordinary income, the courts have established various 
principles such as the nature of the payment in the hands of the recipient, the form of the 
receipt- whether lump sum or periodical, and the motive of the person making the payment 
(Re Hayes v FC of T). As was held in the case of Kelley v FCT, it is important that the 
amount received must have a connection with the earning activity of the tax payer and the 
receipt must come to the tax payer beneficially. In order to understand the meaning of the 
term ‘derived’, we rely on the use of the generally accepted principles based upon the 
decisions of the various courts. These suggest that depending upon the circumstance of the 
taxpayer; the ordinary income may be derived on receipts or accruals basis. If the receipts 
basis is most appropriate for him, income shall be derived when received and if accruals basis 
is most appropriate, income will be derived when a recoverable debt is there. On application 
of these to the issue in hand, we find that the amount of $500,000 is seen to be derived on 
accruals basis. It comes under the explanation of ordinary income as it has a clear connection 
with the business activity of the tax payer and is coming beneficially to the tax payer. Thus,  
the said amount is assessable under Section 6-5.  
 (b)   
As per the ruling in the Arthur Murray case and the principle determined, it is considered that 
the income is not said to be derived until the good or service arranged to be provided by the 
service provider has been actually received by the customer or the client. Thus, what it 
essentially implies is that in case where a tax payer receives an advance payment for services 
to be provided in future, then in that case, the tax payer is treated as having derived the 
income only at the time when such services are actually rendered, and not treated as having 
derived the income at the time of receipt. On this basis it is seen that out of the sum 
of$1,200,000 the amount representing the payment for 100 cartons of Teftoffelex at the rate 
of $7,000 per carton, and coming to $700,000, received by SE Machinery Pty Ltd from a 
customer represents the advance payment received for supply of Teftoffelex in August 2012.

SE Machinery Pty Ltd [SEM] is a private resident Australian company incorporatedin 1981. The company develops and manufactures Teftoffel, a component used in themanufacture of small engines.The...

Solution

Answer To This Question Is Available To Download

Related Questions & Answers

Submit New Assignment