For the year ended 30 June, BBNT Pty Ltd, a lawn mower manufacturer, reported an operating (accounting) profit of $750,000. The company does not elect to be taxed as a SBE taxpayer.
In coming to this profit figure the financial accountant had taken into account the following items:
(a) $30,000 has been claimed as a deduction being the amortisation of goodwill arising from the acquisition of a business two years earlier.
(b) A provision has been raised for future warranties equal to 2% of sales. During the year the sales amounted to $5 million.
(c) Depreciation on the buildings was $50,000. However for tax purposes only $25,000 is tax deductible.
(d) The company spent $75,000 on legal expenses opposing an application by Heavy Mowers Pty Ltd to extend its patent on a brand of mower. If the patent was not extended, then BBNT could produce a similar mower.
(e) The company borrowed $200,000 on 1 January of the current year to cover the purchase of new plant. The loan is repayable in 10 years. The cost of borrowing was $2,500 and this amount was written as a deduction in the company financial accounts when it was paid.
(f) Because of a shortage of working capital the company was forced to sell off some land for $300,000 in February of the current year. The land had been bought in October 1995 at a cost of $180,000. The company only brought to account in its financial statements the difference between the current market value of $220,000 and the proceeds, namely $300,000, as their accounting gain on sale.
(g) The directors also advised the financial accountant to make a provision for:
(i) bad and doubtful debts of $30,000;
(ii) annual leave and long service leave of $60,000.
(h) The company also purchased for the managing director a new car at a cost of $120,000. The car was purchased by the company on 1 July of the current year. The effective life of the car is 7.5 years. For accounting purposes the financial accountant has claimed depreciation in the accounts of $12,000 being 10% of the cost.
(i) The company also needed to acquire a series of parts to hold as stock on hand. At the end of the year the company had closing stock of $146,000. Of this figure the directors believed that $85,000 represented obsolete stock and wished to write off this amount. The financial accountant had not done this in deriving the profit of $750,000 as he was unsure of how to account for it in the financial accounts. The obsolete stock had been scrapped at the end of the year and taken to a metal recycler.
The company has carry forward losses of $150,000. There has been no change in the ownership of the company between the start of the loss year and the end of the current year other than 35% of the shares were sold to a Perth based (unrelated) company. The company received the following dividends:
Cash dividend from BHP Ltd of $23,000 fully franked.
Dividend from Intergroup Ltd of $7,800 which was 75% franked. The company had elected to reinvest the dividend and receive shares instead of cash.
Cash dividend from Microsoft Inc, a US company, of A$8,200. An amount of A$1,447 had been withheld as tax by the US Internal Revenue Service.
Dividend of $3,000 unfranked from Golden Beach Pty Ltd which was declared on 5 May of the previous year by the directors but not actually paid until 5 July of the current year.
The company accountant had only brought to account as income the actual cash when received in respect of the above dividends. It did not account for any dividends due.
The company directors come to you as the taxation adviser of the company and wish to know what the taxable income is for the company and the tax payable. The company wishes to maximise its tax deductions.
Financial Accounts – BBNT Pty Ltd – year ending 30 June
Reconciliation of financial accounting to tax accounting – you need to add back non-taxation income and deductions and adjust for taxation items.
Net Profit based on the financial accounts – $750,000
Add back non-tax amounts:
1. amortisation of goodwill 30,000
2. warranty provision 100,000
3. depreciation on building 50,000
4. loan fees 2,500
5. provision for bad debts 30,000
6. provision for leave 60,000
7. depreciation on car for MD 12,000
Add franking credits and foreign withholding tax = $9,857, BHP dividend (23,000 X 30/70) plus $10,307 including dividend and franking credit for dividend from Intergroup Ltd $7,800 + 7,800 X 30/70 = 3,343 x 75% = 2,507. Note that the dividend is still assessable income even where it is reinvested in more company shares. The amount withheld in the USA on the Microsoft dividend must be added, ie $1,447. The dividend from Golden Beach was paid after the end of the financial year and dividends are only income when paid. Therefore, the total addition is $21,611, namely 9,857 + 7,800 + 2,507 + 1,447.
The capital gain for tax purposes is $120,000 (sale proceeds of $300,000 less cost base of $180,000). $80,000 has been included. As such, the net capital gain needs to be increased by $40,000.
The legal fees spent on opposing the extension of a patent application by Heavy Mowers is considered revenue in nature: FCT v Consolidated Fertilizers (1991) 22 ATR 281 at [12.840]. If the outgoing were considered capital in nature, then the amount would be added back in the reconciliation above.
Gross profit for taxation purposes: $750,000 + $284,500 + $21,611 + $40,000 = $1,096,111
Less deductions according to tax law:
1. depreciation on building 25,000 (Div 43)
2. loan fee 250 (s 25-25)
3. depreciation on motor vehicle 15,324 (Div 40 )
4. obsolete stock 85,000
5. carry forward losses 150,000
(Depreciation on motor vehicle – luxury car limit: $57,466 x 100/7.5 x 200% (DV) x 365/365 = $15,324)
Gross profit less deductions: $1,096,111 – 275,574 = $820,537 – taxable income
Taxable income x tax rate 30%: 820,537 x 30% = $246,161 – tax payable less offsets
Tax payable less offsets:
1. PAYG instalments 0
2. Imputation credits and foreign tax credit 21,611
Net tax payable = 246,161 – 21,611 = $224,550