3 ACC30005 Lecture 3 Sem 2 2021 PDF

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3 ACC30005 Lecture 3 Sem 2 2021
3 ACC30005 Lecture 3 Sem 2 2021...

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Topic 3: Trading Stock, Capital Allowances & Tax Accounting

ACC30005 Taxation

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Lecture Outline •

2 major specific deductions for businesses:

1. Trading stock; 2. Decline in value of assets (aka capital allowances) 3. Tax accounting 3

What is Trading Stock? • Trading stock is goods which have been produced & manufactured (by manufacturer) or acquired by (wholesaler or retailer); and • held for the purposes of manufacture or resale in the ordinary course of business (s 70-10 ITAA97).

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What is Trading Stock? Examples: • books for sale in a bookstore • motor vehicles produced by a motor vehicle manufacturer • raw materials acquired for the purpose of manufacturing; • land held by a business for the purpose of resale.

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Deduction for Trading Stock • A taxpayer can claim a deduction for trading stock purchased during the tax year under s 8-1 ITAA97. • If value of closing stock is > value of opening stock, the excess is included h s Ca line in the taxpayer’s assessable income On [s 70-35(2) ITAA97] • If value of opening stock is > value of closing stock, the excess is deductible to the taxpayer [s 70-35(3) ITAA97]. Operation Cost

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Example • If you purchased $200 trading stock in the tax year, you can claim a deduction under s 8-1 ITAA97 for $200. • You also have to account for movement in trading stock: • If closing stock ($75) > opening stock ($50), the difference of $25 is included as assessable income $25 [s 70-35(2) ITAA97] OR • If opening stock ($75) > closing stock ($50), the difference of $25 is included as an allowable deduction [s 70-35(3) ITAA97] 7

Trading Stock Valuation •

There are 3 alternatives for valuing trading stock (s 70-45 ITAA97):

1. Cost value (at point of purchase); OR 2. Market selling value (current / latest); OR The current selling value of the stock in the particular taxpayer’s own selling market e.g. in the case of a wholesaler, market selling value = current wholesale value of comparable items. 3. Replacement value (last day of tax year) The amount the taxpayer would have to pay in its normal buying market on the last day of the tax year to obtain an item substantially identical 8 & available in the market.

Trading Stock Valuation •

A taxpayer may use a different method for each different type of trading stock.

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Regardless of what method you use, closing value of trading stock at the end of one tax year will automatically become its opening value at the beginning of the next tax year.

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Disposals Outside Ordinary Course of Business

• If a taxpayer disposes of an item of trading stock outside the ordinary course of business (i.e. give as a gift to others) then, • the market selling value of the stock item on the day of disposal must be included as assessable income (s 70-90 ITAA97)

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Example • Anna owns a baby goods store. During the current tax year: ² Sales ($400,000) ² Purchases of trading stock ($200,000) ² Opening stock as at 1 July of the current tax year ($90,000) ² Closing stock as at 30 June of the current tax year (cost value @ $100,000) ² Other general deductions ($130,000) • Assessable income = $400,000 + ($100,000 - $90,000) = $410,000 • Allowable deduction = $200,000 + $130,000 = $330,000 • Taxable income = $410,000 - $330,000 11 = $80,000

Example • If Anna chooses to value her closing stock at market selling value of $80,000: • Assessable income = $400,000 • Allowable deduction = $200,000 + $130,000 + ($90,000 - $80,000) = $340,000 • Taxable income = $400,000 - $340,000 = $60,000 • For tax planning purpose, ________________ is preferable in this example as this trading stock valuation method provides lower closing stock, lower taxable income, and thus lower 12 income tax.

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Capital Allowances • Under s 8-1(2)(a) ITAA97, a taxpayer is denied a deduction for an outgoing of capital nature. • The government introduced special rules (Div 40) to allow taxpayers to claim deductions in decline in value/capital allowances for the cost of depreciating assets used for taxable purpose i.e. producing assessable income (s 40-25 ITAA97). • Under ITAA97, decline in value is known as capital allowances and commenced on 1 July 2001. • Instead of getting an outright deduction for the asset in the year it is acquired, the deduction is apportioned over the life of the asset. 14

What are Depreciating Assets? • Assets with a limited effective life that can be reasonably expected to decline in value over the time they are used (s 40-30 ITAA97). • Example ²Computers ²Office furniture ²Motor vehicles ²Plant & machinery • The followings are not depreciating assets [s 40-30(1) ITAA97]: ²Land (unlimited effective life & appreciate in value) ²Trading stock (for resale & not for own use) 15

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What is the Cost of an Asset for Decline in Value Purpose? • The cost of an asset has 2 elements: • (a) 1st element (s 40-180 ITAA97) • Expenses you incur to start holding the asset such as the amount paid to buy it including any non-cash benefits you provided. • Acquisition costs e.g. customs duty, delivery & installation costs • (b) 2nd element (s 40-190 ITAA97) • Additional expenses that contribute to its present condition and location such as costs to relocate the asset and initial repair (Topic 3). 17

What is Effective Life? • Effective life is the estimated period that a depreciating asset can be used by an entity for a taxable (income producing) purpose. • In deciding on the effective life, a taxpayer must assume that the asset will be subject to wear and tear at a rate that is reasonable for the taxpayer’s expected usage.

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1. Immediate Deduction • An immediate deduction is available to a taxpayer in the year in which he/she purchases an asset if: 1. the cost of the asset is < $300; and 2. The asset is predominantly used for the purpose of producing employment income, non-trading business & property income. • In other words, those assets costing < $300 can be written off immediately [s 40-80(2) ITAA97] 19

Non-Business Assets Costing $300 or Less • Predominantly means > 50%! • The immediate deduction rule is restricted to expenditure incurred by employees who buy work-related depreciating assets.

• Example: ²Tools used by an employee builder; ²Briefcase used by an office employee; ²Furniture purchased by a landlord for his/her rental property. 20

Immediate Deduction: Examples • Meg is an employee accountant. She purchased a briefcase that she used predominantly for work purpose for $150. She can/cannot claim an immediate deduction for the $150 under s 40-80(2) ITAA97 because ① cost of the asset is < $300; and ② briefcase is predominantly used for the purpose of producing employment income. • Max is a landlord of a rental property. He purchased a refrigerator for $400. He can/cannot claim an immediate deduction for the cost of the fridge under s 40-80(2) ITAA97 because although the fridge is predominantly used for the purpose of producing property income e.g. rental income, the cost of the fridge is not < $300. 21

2. Low-Value Pool • An asset that costs < $1,000 (newly-purchased low-cost assets) or which has declined in value to < $1,000 using the diminishing value method (DVM) (aka reducing balance) (newly-added low-value assets) can be grouped into a lowvalue pool and treated as a single asset. • Low-value pool assets are depreciated using DVM (s 40-425 ITAA97): ① 1st year - 18.75%; and ② Subsequent years - 37.5% [s 40-440(1) ITAA97)].

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Low-Value Pool: Example (Video 3) • XYZ Pty Ltd has a low-value pool of $4,500 as at 30 June of the previous tax year. During the current tax year, they acquired a depreciating asset for $950. • What decline in value can XYZ claim for the current tax year? • Decline in value for a new low-cost asset = $950 * 18.75% = $178 • Decline in value for existing low-value pool = $4,500 * 37.5% = $1,688 • Total decline in value = $178 + $1,688 = $1,866 • Closing balance of low-value pool = opening balance of low-value pool + new low-cost assets + new low-value assets - total decline in value = ($4,500 + $950) - $1,866 = $3,584 23

3. Intangible Assets • Common types of intellectual property rights include copyrights, patents, and registered designs. • Certain intangible assets have specific statutory lives • See Table 8.2 of Australian Taxation for list of intangible assets that have a statutory life • Copyright is depreciated over the shorter of 25 years or the period until the copyright ends • Must use PCM to claim decline in value [s 4070(2) ITAA97] except licence • Licence can be depreciated either using PCM or DVM 24

4. All Other Depreciating Assets • For all other depreciating assets that are $1,000 or more then: • the taxpayers can claim a deduction for decline in value of the asset, depending on the method they choose (DVM or PCM) using the effective life of the asset they have determined [s 40-65(1) ITAA97]. 25

Car Cost Limit • A motor vehicle cost for decline in value purpose is limited by the government to $59,136 - 2020/21 (s 40-230 ITAA97) . • The taxpayer must select the method of decline in value (either DVM or PCM) and choose the effective life for the motor vehicle.

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1. Diminishing Value Method • S 40-72 ITAA97       =     ×  ×      

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2. Prime Cost Method • S 40-75 ITAA97       =     ×  ×      

• • • •

Example Cost of asset = $30,000, Effective life = 8 years Yearly deduction = $30,000/8 = $3,750

• If the asset was only 60% used for business purpose during the current tax year, deduction = $3,750 * 60% = $2,250 28

Balancing Adjustment • When you stop holding an asset (i.e. sell it, lose it, gift it or its stolen), then • you may have to include an amount in your assessable income or claim an amount as a deduction. • The adjustment reconciles the amount should be claimed as deduction with the actual change in value of the asset (market value) [s 40-295 ITAA97]. • This is called a balancing adjustment. 29

Example:

on Disposal

• • • •

Scenario 1 You purchased an asset on for $10,000 Decline in value = $8,500 Adjustable value (carrying amount) of the asset = $1,500 [s 40-285(1) ITAA97] • If you sell the asset for $600 (termination value = capital proceeds), then the asset has a market value of $600 [s 40-300(1) ITAA97] • Balancing adjustment = $1,500 - $600 = $900 [s 40-285(2) ITAA97] • Adjustable value > termination value = allowable deduction 30

Example:

on Disposal

• OR • Scenario 2 • If you sell the asset instead for $2,000 (market value) then, • You would need to include an amount in our assessable income of $500 [s 40-285(2) ITAA97] (i.e. $2,000 - $1,500). • Termination value > adjustable value = assessable income 31

Value of Assets for Certain Balancing Adjustment Events •

There are some instances when an event occurs and we have to assign a value to an asset in order to determine if any balancing adjustments are required. ① If we stop using an asset (e.g. selling it), termination value = market value of asset when you stop using it. ② If the asset is lost or destroyed, termination value = insurance value of the asset [s 40300(2) ITAA97]. 32

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Tax Accounting: When is Income Derived? s 6-5 ITAA97

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Income is taxed in the tax year it is derived

• In the majority of cases, physical receipt of income will constitute derivation of that income …... but there are exceptions.

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Cash vs. Accrual Accounting: TR 98/1

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Cash Basis • Recognise income when it is actually received. Accrual Basis • Recognise income when the right to receive payment arises, usually at the time the invoice is issued.

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1. Service/Employment Income (Salary & Wages)

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Brent

In the case of rendering personal services, income is generally derived when it is actually physically received.

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2. Interest Income

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Interest income is generally derived when received (cash basis).

Exceptions: • Money lenders (such as banks and financial institutions) are an exception to this rule. Reason: • Carrying on a business of trading money • Considered to derive their interest income as accrues Australian Guarantee Corporation Ltd 37

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3. Trading Business Income • There are 2 different accounting methods for determining when business income is derived: Cash basis Accrual basis •

Trading income should be returned on an accrual basis .

• Small to medium-sized businesses should account on cash basis since it provides the best cash flow advantage. 38

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4. Non-Trading Business Income Example of income from non-trading activities could be returned on a cash basis : – specialised knowledge – skill (professional practices) – investment income i.e. dividend, rent and royalties

The company may announce a dividend on 1 June of the current tax year, however, the individual does not derive the income until the dividend is actually paid by the company on 10 July of the next tax year.

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4. Non-Trading Business Income •

Small professional practices should account on cash basis since it provides the best cash flow advantage.

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Large professional practices

should use accrual basis in calculating taxable income.

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4(a) When is the Cash Basis appropriate?

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Commissioner of Texas (South Australia) v Executor, Trustee & Agency Co of South Australia Ltd (also known as Carden) v The taxpayer was conducting business as a sole medical practitioner and adopted the cash basis in determining taxable income. v Where the receipts represent a reward for professional skill, then the cash basis forms a fair and appropriate foundation for estimating taxable income. 41

4(b) When is the Accrual Basis appropriate?

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Barratt & Ors The taxpayers were 2 doctors who carried on a pathology practice in partnership. However, they had 66 nurses and 92,000 patients! The income should be accounted on the accrual basis . The presence of employees who carry out much of the work and high overheads for medical equipment made it more appropriate for a small partnership to recognise income derived on an accrual basis. In light of the size of the taxpayer’s business, the cash basis was not appropriate.

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5. Business Income Received in Advance Business may receive a prepayment for services to be performed in a future period. Where a taxpayer receives an amount paid in advance: • Recognises the advance payment in unearned revenue account with a possibility that some of the unearned income may have to be refunded. • Income is not derived and not taxable in the tax year it is received. • The income is derived only when the goods/services are delivered.

• Recognises the advance as income in their account. • Income is derived and taxable in the tax year it is received. Cash Basis Accrual Basis

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5. Business Income Received in Advance

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Arthur Murray (NSW) Pty Ltd The taxpayer received an advance payment for dancing lessons to be provided over a future period. Legally, these payments were non-refundable. However, in practice, refunds were sometimes given. The taxpayer accounted for these unearned revenue by crediting them to an unearned deposits - untaught lessons account (i.e. other payables) in the balance sheet. Once the dancing lessons were provided to the customer, the company then recognised the unearned revenue as income. 44

5. Business Income Received in Advance

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Decision The prepayments received were not assessable in the tax year they were received as they had not been derived. The taxpayer would generally provide refunds when all the lessons were not taken. Court The taxpayer did not treat such receipts as derived income as these prepayments are subject to the contingency that the whole or some part of it may have to be paid back. Therefore, prepaid amounts are NOT treated as derived income and thus not assessable income until the tax year in which the supply of the service or the provision of goods has occurred. 45...