Tax (AU)
Assessment, Part A
Case study and task
Best Baker Pty Limited
Best Baker Pty Limited (BB) is an Australian tax resident company based in Adelaide. BB manufactures biscuits and slices mainly for the Australian market, but it also has some international buyers. BB is registered for GST and is a small business entity. BB was incorporated in 1986 and has been 100% owned by Ahn Notts since that time.
Letitia, BB’s Financial Accountant, has provided you with BBs draft financial statements for the income year ended 30 June 2022, which include the following:
• statement of profit or loss
• statement of financial position.
She has also provided additional notes to help you calculate BBs taxable income for the income year ended 30 June 2022.
BBs statement of profit or loss
Notes $ $
Income
Sales 1 4,014,340
Dividend received 2 33,000
Other income 1 230,000
Total income 4,277,340
Expenses
Cost of goods sold 4 (1,438,000)
Insurance 6 (39,000)
Electricity (7,000)
Interest (22,900)
Depreciation (49,200)
Cleaning (3,720)
Fines and penalties 8 (1,400)
Legal fees 5 (11,000)
Rent (132,900)
Entertainment 7 (5,800)
Repairs and maintenance 6, 9 (37,000)
Salaries and wages 10, 11 (1,151,400)
Rates (5,700)
Marketing expense (18,140)
Other expenses 3, 12 (15,880)
Total expenses (2,939,040)
Accounting profit before tax 1,338,300
BBs statement of financial position
Notes 2022 2021
$ $
Assets
Cash at bank 1,780,520 406,950
Stock 130,000 113,000
Property 1,029,000 928,000
Trade debtors 12 143,000 185,000
Plant and equipment 3 480,980 315,000
Accumulated depreciation (112,200) (63,000)
Total assets 3,451,300 1,884,950
Liabilities
Trade creditors 162,000 102,000
GST payable 10,000 8,950
Provision for superannuation 11 20,000 8,000
Provision for annual leave 10 21,000 25,000
Bank loan 402,000 243,000
Total liabilities 615,000 386,950
Total equity
2,836,300
1,498,000
Equity
Ordinary shares issued 268,000 268,000
Retained earnings 2,568,300 1,230,000
Total equity 2,836,300 1,498,000
Notes
1. One of BBs competitors bought BBs profitable Lemon Tart biscuit product line, which BB had been manufacturing since the company was incorporated. Before BB sold its Lemon Tart product line, it had not sold any other product lines. The purchase agreement was signed and executed in June 2022. Under this purchase agreement, BB received the following:
(a) $230,000 – for the Lemon Tart trademark. BBs cost base in the trademark was nil. All proceeds for the trademark were received in June 2022.
(b) $10,000 – for the sale of BBs stock on hand of Lemon Tart biscuits at cost. These biscuits were all manufactured in May 2022. The $10,000 is included in the sales amount. At the time of sale, the market value of these biscuits was $60,000. All proceeds for this sale were received in June 2022.
2. The dividend income includes:
(c) $7,000 received from Nice Slice Limited (Nice Slice), a New Zealand tax resident company that manufactures and distributes slices. This dividend was not subject to New Zealand withholding tax. BB has a 10% holding in Nice Slice.
(d) $26,000 cash dividend from Chocolate Chip Pty Ltd (Chocolate Chip), an Australian tax resident company. Chocolate Chip is one of BBs key suppliers for chocolate chips. This dividend was fully franked. BB has a 1% shareholding in Chocolate Chip. Chocolate Chip has a corporate tax rate of 25% for imputation purposes for the income year ended 30 June 2022.
3. On 1 July 2021, BB purchased a new coffee machine for the BB office kitchen for $1,980 and a bag of coffee beans for $20. For accounting purposes, the coffee machine was capitalised and has an effective life of five years. No depreciation has been calculated on the coffee machine for the income year ended 30 June 2022. The cost of the coffee beans has been included in ‘Other expenses’ in the statement of profit or loss.
4. In May 2022, BB discovered that an employee had stolen biscuits that were manufactured in April 2022. The employee was dismissed; however, BB was unable to recover the cost of the stolen goods. The manufacturing cost of the stolen biscuits was $2,500, but they could have been sold for $6,000. The cost of this stolen trading stock was not recorded in the statement of financial position.
5. On 1 January 2022, BB paid $11,000 in legal fees to its solicitor to conduct legal due diligence on BBs takeover attempt of a supplier, which was unsuccessful.
6. During the income year ended 30 June 2022, BB made the following payments:
(a) On 30 September 2021, BB paid $22,000 to Green Pty Ltd (Green) under a contract for Green to provide monthly gardening maintenance services for 12 months. The full amount was included in ‘Repairs and maintenance’ in the statement of profit or loss.
(b) On 1 July 2021, BB paid $14,000 under a contract for insurance that would specifically cover damage or loss of goods during transit for the 24-month period to 30 June 2023. The full amount was included in ‘Insurance’ in the statement of profit or loss.
7. To expand its customer base, BB hosted a high tea with food and drink in February 2022 in Melbourne, Victoria, for a select group of potential clients. The cost of the food (which did not include any BB products) and drink (which included champagne) was $5,800 and recorded as Entertainment expenses. BB did not pay FBT in respect of the high tea. The BB employees who were required to attend the function did not participate in the high tea.
8. BB has been fined $1,400 by the South Australian government. $700 of the fine relates to illegal dumping of waste and the other $700 relates to work, health and safety breaches. The entire expense was included in ‘Fines and penalties’ in the statement of profit or loss.
9. The Repairs and maintenance expense in the statement of profit or loss includes $15,000 paid on 1 July 2021 for the replacement of some roof tiles on the factory building BB has owned since 2017. The building qualifies as an industrial building which was constructed in 2001. The roof tiles required replacement after being cracked or displaced in a bad storm. The broken tiles were replaced with an equivalent tile made of similar material. The building is held on the tax fixed asset register.
10. The provision for annual leave represents the amount of accrued expenditure for employees’ annual leave entitlements that has not yet been taken by employees.
11. The provision for superannuation represents the unpaid superannuation contribution in respect of June 2022 wages, which will be paid in July 2022. BB only makes contributions to complying superannuation funds.
12. In relation to doubtful debts and bad debts:
(a) Trade debtors are recorded net of a provision for doubtful debts of $12,000, which has not been written off as at 30 June 2022 (in 2021 this amount was $6,300). The movement in the provision was included in ‘Other expenses’ in the statement of profit or loss.
(b) One of BB’s customers, Custard Slice Pty Ltd (Custard Slice), went into liquidation on 1 July 2022. Custard Slice originally owed $5,000 to BB, which has previously been included in BBs assessable income. As at 30 June 2022, Custard Slice still owed BB $4,000 for slices supplied.
On 3 July 2022, BB’s accountant reviewed the trade debtors balance for preparation of the 30 June 2022 balance sheet and wrote this amount off as a bad debt. The debt was therefore not included in the trade debtors balance in the 30 June 2022 balance sheet.
Part B
Question – Part (a) (52 marks)
You are an accountant at Kleinfield Chartered Accountants (KCA). Your manager has asked you to review a tax reconciliation prepared by the financial accountant of one of KCA’s clients, Dream Builder Pty Ltd (DB).
DB is an Australian tax resident company that builds residential properties. DB has an aggregated turnover of
$60 million for the income year ended 30 June 2022, which is consistent with prior income years. DB wishes to minimise its taxable income where possible.
DB has prepared its tax reconciliation for the income year ended 30 June 2022 with brief notes, as follows:
Notes $ $
Profit/(loss) per financial statements 2,180,000
Add
Accounting depreciation 1 48,000
Office building accounting depreciation 3 25,000
Travel expenses 7 7,000
Entertainment 4 9,000
Prepayment – tax fees 6 8,000
Total addbacks 97,000
Subtract
Tax depreciation 1 (259,000)
Net capital gain 2 (40,000)
Office building tax depreciation 3 (1,250)
Trust distribution 5 (1,950)
Prepayment – tax fees 6 (5,000)
Total to subtract (307,200)
Taxable income/(loss) 1,969,800
Notes
1. For the income year ended 30 June 2022, $48,000 of depreciation was recorded in the financial statements. The depreciation relates to new assets purchased of $259,000 and installed ready for use during the income year ended 30 June 2022 and costing less than $150,000 each. The accounting depreciation has been calculated in accordance with the effective lives of depreciating assets on the Australian Taxation Offices website. This amount does not include any depreciation on the office building (refer to note 3 below).(Topic – Explanation of tax treatment – Depreciation).
2. On 1 June 2022, DB signed a contract to sell vacant land held for long-term investment, making a profit of $40,000 on the sale that was included in accounting profit. The contract completed in July 2022. DB also has $50,000 of carry forward capital losses from the sale of a painting it purchased seven years ago for $75,000. There were no incidental costs relating to the acquisition and the sale of the vacant land. (Topic – Explanation of tax treatment – Net capital gain).
3. On 1 July 2021, DB completed the purchase of a pre-used office building for $1,000,000 and started to use the building straight away. It was originally constructed in 1970 for $50,000, and the previous owner made $200,000 worth of structural improvements in 2020. The building and improvements qualify for the 2.5% rate for capital works. DB has adopted the same rate for accounting purposes. (Topic – Explanation of tax treatment – Office depreciation).
4. During the income year ended 30 June 2022, DB purchased $9,000 worth of gift hampers from a local Indigenous business. The hampers contained food and drink, and they were provided to local clients upon completion of their respective building projects. This amount was included in the financial statements as an entertainment expense. No FBT was paid relating to this expense. (Topic -Explanation of tax treatment – Entertainment).
5. During the income year ended 30 June 2022, DB received a $1,950 distribution from a unit trust, which was recorded in accounting profit. DBs share of the net income of the unit trust was $1,400 (the difference being timing differences between accounting and tax depreciation). Before the distribution, DB had a $1,800 cost base in the units. (Topic – Explanation of tax treatment – Trust distribution).
6. DB prepaid its tax fees to a tax agent for its 2022 tax return, which is to be completed in August 2022. The financial statements include a prepayment for the tax fees of $8,000 at 30 June 2022. The prepaid tax fees balance at 30 June 2021 was $5,000. (Topic – Explanation of tax treatment – Prepayment – tax fees)
7. DB paid $7,000 of travel expenses on behalf of its sales representatives who visited the residential properties with prospective clients. (Topic – Explanation of tax treatment – Travel expenses)
Question – Part (b) (28 marks)
You are a tax advisor in accounting firm A-Plus Accounts Ltd (AAL). You have been asked to advise on the following client situations relating to the income year ended 30 June 2022. The clients (and their situations) are not connected to one another, and all are Australian tax residents.
1. The Aroha Partnership
(Topic – Explanation of income tax treatment – Partnership interest incurred)
Rahul and Huhana are partners in the Aroha Partnership that carries on a business providing wedding planning services and venue hire for events. Each partner has contributed 50% of the partnerships $1,000,000 initial capital.
On 1 January 2022, the Aroha Partnership borrowed $400,000 from Oz Bank at an interest rate of 5% per year. The funds were used to repay $200,000 of each partner’s original capital contribution. Rahul used the money to renovate his family home and Huhana used the money to start a separate business (independent of the partnership).
Rahul and Huhana are unsure how much, if any, of the interest paid by the Aroha Partnership is deductible in the income year ended 30 June 2022.
2. Rugged Up Pty Ltd (RUPL)
(Topic – Explanation of income tax treatment – Disposal of trading stock)
RUPL is a company that manufactures woollen jackets and scarves. RUPL recently donated 100 scarves to For the Children Australia (FCA). FCA is a deductible gift recipient and will auction the scarves to raise funds for its cause. RUPL was named as a donor on FCA’s website and mentioned at the auction event in exchange for the donation. This donation was part of RUPL’s marketing activities and in line with its company values, which include giving back to the community. Each scarfs market selling price is $120 and the manufacturing cost is $55. All of the donated scarves were manufactured during the prior income year and RUPL records its trading stock at cost.
RUPL’s accountant is unsure how to account for the donated scarves in the income year ended 30 June 2022.
3. Money Waster Pty Ltd (MW)
(Topic – Explanation of income tax treatment – Loss carry back tax offset)
MW is a company that is not a base rate entity. Since its incorporation in 1992, MW has maintained a good tax compliance history with all tax returns and other lodgements occurring on time.
• In the income year ended 30 June 2022, MW had an aggregated turnover of $1 billion and made a tax loss of
$4 million. Its closing franking account balance as at 30 June 2022 was $3 million.
• In the income year ended 30 June 2021, MW made a tax loss of $8 million.
• In the income year ended 30 June 2020, MW paid $2 million in income tax and derived $300,000 of net exempt income.
MW is seeking to maximise its income tax refund for the income year ended 30 June 2022
