SE Machinery Pty Ltd [SEM] is a private resident Australian company incorporated in 1981. The company develops and manufactures Teftoffel, a component used in the manufacture of small engines.
The following financial information relates to SEM for the year ended 30 June 2012.
[Disregard GST.]
Revenue
Gross trading income $3,035,000
Australian public company dividends received
($600 imputation credits attached) 2,000
Profit on sale of fixed assets - furniture 2,600 3,039,600
Expenses
Bad debt written off 8,000
Cost of borrowing funds to finance working capital 300
Depreciation (including Buildings) 175,000
Education fees 22,000
Entertainment expenses 15,000
Fringe benefits tax 43,000
Legal expenses 4,600
Loss on sale of fixed assets - precision machinery 1,000
Overseas travelling expenses 24,000
Provision for long service leave 26,000
Repairs & maintenance 64,500
Research & development (carried out by CSIRO) 20,000
Salaries & wages 948,650
Superannuation contributions 76,000
Other expenses (all tax deductible) 200,000 1,628,050
Net profit before tax 1,411,550
Other information
1. On 1 May 2011 SEM received a special order and payment for ten cartons of Teftoffelex - a new product. The manufacture of Teftoffelex required some modification the company's production system. The customer agreed to contribute $500,000 to the cost of modifications. Under the terms of the contract the amount was described as ‘capital contribution to establishment and construction costs'.
The contract provided for supply of Teftoffelex in August 2012 and the advance payment of the agreed price as follows:
Capital contribution to modifications $ 500,000
100 cartons @ $7,000 $ 700,000
$1,200,000
The 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 or all of the $1,200,000 amount.
Other Information (continued)
2. The bad debt of $8000 was written-off after SEM entered into a scheme of arrangement 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 finance working capital. Borrowing expenses were $300.
4. Depreciation:
Company policy is to use straight line [prime cost] depreciation and to adopt tax rates for accounting purposes except in respect of buildings. Building depreciation was $15,000. Apart from extensions [Note 6], all buildings were constructed before 1982. Included in the expense is depreciation on motor vehicles provided to staff (except new car for Managing 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 2,277
6. Additions to fixed assets during 2011/11:
• Extensions to administration building - construction commenced
1/10/11; 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 the school fees of the directors' children. The reason given for the policy was to provide a standard of educational instruction appropriate to the possible future directors of the company.
8. Entertainment expenses of $15,000 was spent on meals at restaurants. Records show 60% related to employees and their associates and 40% related to clients.
The company uses the actual basis for FBT meal entertainment valuation purposes.
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 500
10. Overseas travel:
In December 2011 one of the directors travelled to the USA to seek out new agencies to handle the company's products; costs totalled $11,000.
In February 2012 the Marketing Manager attended the International Engine Exhibition in Singapore. His wife accompanied him. After the
Exhibition 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: $20,395.
12. The following amounts were debited to Repairs & Maintenance Expense:
• Costs incurred in early November 2011 replacing the roof on a building purchased for use as a warehouse in August 2011. The work was
completed on 12 November: $7,000.
• Costs of converting an old store into a lunch and change room for employees; completed 31 October 2011; life 5 years:
- showers and toilets 30,000
- partitioning and panelling 10,000
- furniture for lunch room 5,000
Required 2:
1. Indicate with explanations, sections of the Acts and relevant case law 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.