Tom Ltd is an Australian company which is involved in the business of selling clothes. Following transactions have taken place.
- Stock worth $180,000 has been purchased for the year
- $ 10,000 has been paid as bonus to the CEO of the company
- A customer who had purchased the goods on credit has defaulted with an outstanding balance of $ 10,000.
- Legal fees to the tune of $ 30,000 has been incurred for protection of business interests
- The company has received fully franked dividends to the extent of $ 35,000 while the company has paid fully franked dividends to the shareholders to the extent of $ 280,000.
To determine the tax implications of the various transactions underwent by Tom Ltd as highlighted above.
A company which is incorporated in Australia is considered a tax resident of Australia.
- For a cloth company, the total change in stock tends to highlight the use of trading stock which would be deductible as highlighted in Section 8(1), ITAA 1997.
- Salary and related expenses for employees are also required to derive income from running the business and hence would be deductible as highlighted in Section 8(1), ITAA 1997 and TR 98/6.
- As per s. 63(1) , ITAA 1936 and tax ruling IT 92/18, bad debt expense is debt deductible only if previously it has been included as assessable income.
- In accordance with ATO ID 2003/145 and s. 8-1, ITAA 1997, legal expenses related to rights and damages are not tax deductible and instead in accordance with s. 108-5, contribute to the capital base of the business.
- With regards to fully franked dividends, the franking credit would be added to the taxable income but the deduction to the same amount can be made from the tax payable as per ATO 2012/5.
Application & Conclusion
- The trading stock that would be used would be the cost of raw material used and deductible from the income for tax purposes.
Trading stock used = Beginning stock + Purchases – Ending stock = 120000 + 180000 -160000 = $ 140,000
- The bonus paid to the CEO to the tune of $10,000 is deductible under s. 8-1.
- The bad debt would have been initially recognized as income on account of accrual system and thus contributed to assessable income in the past. As a result, this would be tax deductible.
- The legal expenses would not be tax deductible but would enhance the cost base of the asset in line with s.108-5.
- Dividend income received = $ 35,000
Franking credit = (30/70)*35,000 = $ 9.000
Hence, total taxable income on account of dividend = 35000 + 9000 = $ 44,000
Dividend paid = $ 280,000
Franking debit = (30/70)*280000 = $ 120,000
Thus, net balance of the franking account = 9000 – 120000 = -$ 111,000
Already, a tax in this regard of 15,000 has been made and thus $ 96,000 more would be need to be paid to the ATO.
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Kerrie, Sadiq, et. al., Principles of Taxation Law 2015, (Pymont,Thomson Reuters, 2015)
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Stephen, Barkoczy, Foundation of Taxation Law 2015, (North Ryde, CCH, 2015)
Gilders, Frank, et. al., Understanding taxation law 2015. (LexisNexis, Butterworths 2015), 77
Sadiq, Kerrie, et. al., Principles of Taxation Law 2015, (Pymont,Thomson Reuters, 2015), 103
Barkoczy, Stephen, Foundation of Taxation Law 2015, (North Ryde, CCH, 2015), 69-70
Deutsch, Robert, et. al., Australian tax handbook. (Pymont, Thomson Reuters, 2015), 135