INCOME TAXATION

TOPIC- DEDUCTIONS - TUTORIAL EXERCISES

Objectives

The objective of this tutorial is to practice problem solving skills; both through self assessment of conceptual knowledge of the topic of Deductions (focussing on General Deductions for this tutorial) and through tutorial discussion of the multiple choice and short answer problems set out below.

Tasks

1. Please prepare short answers to tutorial questions 10-111, 10-112 & 10-114.

We will discuss the answers in class.

2. MULTIPLE CHOICE QUESTIONS

Question 1

Kate borrowed $100,000 from the local bank on 30 June 2011 for a period of five years, at an interest rate of 10% pa. Interest is to be paid annually in arrears on 30 June (first payment being due on 30 June 2012). The purpose of the loan is to invest $50,000 in shares yielding very good dividends and to on-lend $50,000 to her brother Nicholas, at an interest rate of 4% pa. What amount can Kate claim as her interest expense in the current year, assuming that she paid $10,000 to the local bank on 30 June 2012?

A $10,000

B $7,000

C $5,000

D $8,000

E Nil

Question 2

Which of the following outgoings is not a deductible expense under s 8-1 of the Income Tax Assessment Act 1997?

A The cost to a doctor of leasing a paging unit to enable patients to contact him in emergencies.

B The cost of food and drink paid for by a professional footballer to enable him to gain weight to improve his prospects of being a better player and earn more income.

C The cost of travelling from one place of work to another where bulky goods are transported between the two places.

D Safety gloves and glasses paid for by a welder.

E Interest payments on a loan taken out originally to purchase a fast food business. The business was unsuccessful and has been closed, but the loan is yet to be repaid.

Question 3

Which one of the following would be classified as revenue expenses and be deductible under s 8-1 of the Income Tax Assessment Act 1997?

A Company formation costs.

B Costs of purchasing a security system installed by a judge at her home after her appointment to the court. The Attorney-General's Department insisted on the installation as a condition of her appointment.

C Costs of demolishing plant that is no longer useful to make way for the construction of a new building.

D Legal costs incurred by a company in resisting a ‘take-over'.

E Legal costs paid by a builder after she was sued for compensation for faulty work on a building which she built for a client.

Question 4

Which of the following expenses would not be deductible under the second positive limb of s 8-1 of the Income Tax Assessment Act 1997?

A Legal expenses incurred by a company carrying on a retail business.

B An employee claiming a work-related expense.

C Salary and wages paid by a primary producer carrying on a business.

D Public liability insurance incurred by an individual carrying on a consulting business.

E Advertising costs paid by a trust operating a retail business.

Question 5

Dixon Ltd carries on a publishing business and owns a magazine that it publishes monthly. It had the following expenditure during the year ended 30 June 2007.

- In a recent magazine article one of the stories made a defamatory remark about a well-known movie star and the company had to pay $50,000 compensation to the movie star.

- The company paid $35,000 to a managing director to encourage him to terminate his contract of employment early, because he was performing unsatisfactorily.

- $12,000 was stolen by thieves from one of the company's safes and the money was not recovered. The money had been collected from sales of the magazine.

Based on the above expenditure, what amount will be deductible under s 8-1 of the Income Tax Assessment Act 1997?

A $50,000

B $85,000

C $97,000

D $12,000

E $47,000

Question 6

Which of the following expenses is least likely to be deductible under s 8-1 of the Income Tax Assessment Act 1997?

A An amount of $250,000 paid for a feasibility study prior to the commencement of a business. The business never commenced operation.

B Costs incurred on maintenance during a temporary cessation of production at a food processing plant.

C Costs incurred by a manufacturing business to rectify faults in products that it formerly produced, but has not produced for the past two years.

D Interest paid by a taxpayer on borrowings used to finance a business that was subsequently sold, but the borrowings have not been paid off.

E Costs of trading stock purchased by a retailer.

Additional Problems

1. Study Manual: Qs 10-095; 10-102; 10-105. (Note; there are some matters raised in 10-105 that are yet to be covered in lectures.)

2(a). Consider the following list of typical debit items in a company's P&L Account and indicate which would be allowable deductions under s8-1:

[Hint: consider whether the item is i) a loss or outgoing; ii) whether it is incurred;

iii) whether it satisfies the expenditure/income [or business] nexus; iv) whether is of a capital, private or domestic nature.]

Accrued wages expense

Advertising expense

Bad debts provision

Depreciation (plant & equipment)

Discounts allowed

Donations to political parties

Hire purchase payments

Interest

Insurance of plant & equipment

Lease payments

Staff morning & afternoon tea Payroll tax

Printing & stationery

Provision for long service leave

Purchases of stock

Repairs (including stock of spare parts)

Rates (on factory)

Staff training

Fringe benefits tax

Income tax expense

2(b) Some of the items in 1(a) are allowable deductions, albeit in qualified form, under specific provisions. What prevents double deductibility? Indicate which specific provisions will apply to the items in 1(a).

3. [Note: the following two questions were on last semester's exam.] T Tree conducts an electrical repair business. With a view to future retirement he purchases 10ha and plants native wildflowers that he plans to harvest and sell. As a preliminary he arranges to clear the land and plough in compost. It is expected that the first commercial crop will not be harvested for six years. He incurs interest on a loan to finance the land purchase, land preparation costs, fertilizer costs and costs of acquiring native seedlings.

Advise T of the tax consequences of the venture.

4. Sue Sage is a university lecturer. She sets aside a spare bedroom in her flat to use as a home office/study. She estimates that it is used for 20 hours per week during which time she prepares lecture material and marks assignments. She is also conducts research for the second edition of a book she has written. The first edition generated royalties of $7000 and she expects the second edition to be more successful. She estimates 75% of her time is spent working on the book. Would Sue be entitled to a deduction for a proportion of mortgage interest on the loan to purchase her two bedroom flat, for rates and for electricity.